Page: 1 PROVINCE OF PRINCE EDWARD ISLAND PRINCE EDWARD ISLAND COURT OF APPEAL. JOHN McGOWAN and CAROLYN McGOWAN THE BANK OF NOVA SCOTIA

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1 Page: 1 PROVINCE OF PRINCE EDWARD ISLAND PRINCE EDWARD ISLAND COURT OF APPEAL Citation: McGowan v. Bank of Nova Scotia 2011 PECA 20 Date: Docket: S1-CA-1202 Registry: Charlottetown BETWEEN: AND: JOHN McGOWAN and CAROLYN McGOWAN THE BANK OF NOVA SCOTIA APPELLANT RESPONDENT Before: Justice John A. McQuaid Justice Gordon L. Campbell Justice Wayne D. Cheverie Appearances: Ian W.H. Bailey, counsel for the Appellant Gary G. Demeulenaere, counsel for the Respondent Place and Date of Hearing Place and Date of Judgment Charlottetown, Prince Edward Island November 14, 2011 Charlottetown, Prince Edward Island December 14, 2011 Written Reasons by: Justice John A. McQuaid Concurred in by: Justice Gordon L. Campbell Justice Wayne D. Cheverie

2 Page: 2 PRACTICE Pleadings - striking out pleadings The Court of Appeal dismissed an appeal from the order of the motions judge that the appellants statement of claim did not disclose a reasonable cause of action. COMPANY LAW - NATURE OF CORPORATIONS - Lifting the corporate veil - shareholders, derivative and personal actions against a third party The Court of Appeal confirmed the order of the motions judge that the appellants statement of claim did not disclose a reasonable cause of action against the respondent either by way of a derivative action or a personal action. TORTS - Negligence - Duty of Care, Particular Relationships The Court of Appeal also confirmed the order of the motions judge that the appellants statement of claim did not allege facts which disclosed that the respondent owed a duty of care to the appellants as shareholders of the corporation. Authorities Cited: CASES CONSIDERED: Hercules Management Ltd. v. Ernst & Young, [1997] 2 S.C.R. 165; Houle v. Canadian National Bank, [1990] 3 S.C.R. 122 (SCC); Anns v. Merton London Borough Council, [1978] A.C. 728 (H.L.); Kamloops (City of) v. Nielsen, [1984] 2 S.C.R. 2; Cooper v. Hobart, [2001] 3 S.C.R. 537 (SCC); Foss v. Harbottle (1843), 67 E.R. 189 RULES CONSIDERED: Prince Edward Island Rules of Civil Procedure, Rules 21.01(1)(b), 21.01(3)(d) Reasons for judgment: McQUAID J.A.: BACKGROUND AND FACTS [1] John McGowan and Carolyn McGowan, the appellants, were shareholders in McGowan Tractor & Equipment (1977) Ltd. ("McGowan Tractor"). The Bank of Nova Scotia, the respondent, is a chartered bank with a branch office in Montague, Prince Edward Island. At all material times McGowan Tractor and the appellants did their banking business with the respondent at this branch. [2] McGowan Tractor was in the business of selling farm equipment. To operate this business, the company arranged a $150,000. line of credit with the respondent in

3 Page: In 2001 the respondent requested the company to pay out the balance on the line of credit. After a period of discussion and negotiation between the company and the respondent, the line of credit was paid out in McGowan Tractor struggled financially and its assets were sold in [3] On December 11, 2007, the appellants commenced an action in the Supreme Court against the respondent by way of statement of claim. The appellants alleged that as a result of the sale, the value of the 250 shares they each held in McGowan Tractor was reduced to $1. each, and they lost all their personal equity in the company. They claimed general damages, special damages for loss of earnings, loss of benefits and other losses. They also claimed punitive or exemplary damages. [4] The statement of claim alleges that the appellant, John McGowan, had initially signed a personal guarantee of the company's line of credit up to $30,000. As part of the negotiations referred to above, Mr. McGowan, at the request of the respondent's branch manager, increased his personal guarantee to $60,000. [5] The appellants' allege that they had a long business relationship with the respondent, both personally and as shareholders of McGowan Tractor. The respondent's insistence that the company pay out the line of credit within the time periods requested by the respondent placed great stress on both appellants. The appellants also allege that the respondent's conduct consisted of the "erratic behavior" of the respondent's branch manager including his threats that he would return cheques written by the company if it did not accede to his requests to have the line of credit paid out. This conduct allegedly caused their health to deteriorate to the point where John McGowan was hospitalized. [6] The appellants take the position that the respondent dealt with them and McGowan Tractor as one and that the court should lift the corporate veil of the company and find that damages suffered by the company as the result of the respondent's actions were damages suffered by the appellants. The causes of action which the appellants assert are disclosed in the statement of claim are summarized in paragraphs 20, 21 and 22 thereof. They read as follows: 20. The Plaintiffs further state that the actions of the Bank and its employee Robert McNutt in making the demand for payment of the operating credit and their subsequent actions relating thereto, as herein set out, amounted to an abuse of the Bank s contractual rights and a breach of its contract with the business and the Plaintiffs, which resulted in their suffering the damages claimed by the Plaintiffs from the Defendants as set out in paragraph 1 hereof. (my emphasis)

4 Page: The Plaintiffs further state that the Defendant breached its contract with the business and the Plaintiffs, in failing to provide them with reasonable notice of its demand for payment of the operating credit and failing to provide a reasonable time period to the Plaintiffs and the business within which to pay it. The plaintiffs state that by reason of the Defendant s failures that they suffered the damages claimed by the Plaintiffs from the Defendant s as set out in paragraph 1 hereof. (my emphasis) 22. The Plaintiffs further state in the alternative that the Defendant owed a duty of care to the business and Plaintiffs, as a result of their banking relationship, and that by reason of the actions of the Defendant, as hereinbefore set out, that the Defendant was in breach of the appropriate standard of care. The Defendant was thereby negligent in doing what it did to the business and the Plaintiffs with the result being that the business and the Plaintiffs suffered the damages claimed by the Plaintiffs from the Defendant as set out in paragraph 1 hereof. (my emphasis) THE MOTION AND THE APPEAL [7] On June 5, 2009, the respondent, prior to filing a statement of defence, made a motion in the Supreme Court pursuant to Rules 21.01(1)(b) and 21.01(3)(d) of the Rules of Court. The respondent sought to have the statement of claim struck out on the ground that it did not disclose a reasonable cause of action and on the further ground that it was frivolous, vexatious or otherwise an abuse of the process of the court. [8] Taylor J. heard the motion and while he dismissed the motion on the ground that the statement of claim was frivolous, vexatious or otherwise an abuse of the process of the court, he allowed the motion and struck out the statement of claim on the ground that it did not disclose a reasonable cause of action. See: McGowan v. Bank of Nova Scotia 2010 PESC 17; [2010] P.E.I.J. No. 13; (2010), 296 Nfld. & P.E.I.R. 321; (2010), 96 C.P.C. (6th) 320. [9] The appellants appeal from the order of the motions judge. They ask this court to find that he erred and that his order striking the statement of claim be set aside. DISPOSITION [10] I would dismiss the appeal. THE REASONS OF THE MOTIONS JUDGE [11] The motions judge found that the statement of claim constituted a derivative

5 Page: 5 action by the plaintiffs as shareholders of McGowan Tractor. He also found that pursuant to the laws of Prince Edward Island derivative actions are not permitted. See: paragraphs 9 to 13 of the reasons of the motions judge. [12] With respect to the appellants' claim that they also had a reasonable cause of action against the respondent in contract or tort against the respondent, the motions judge found that the material facts pleaded in the statement of claim did not disclose such causes of action. See: the reasons of the motions judge at paragraph 14. THE ISSUE AND THE STANDARD OF REVIEW [13] The issues in this appeal are, whether the motions judge erred in law when he found that the appellants did not have a derivative action against the respondent and whether he erred when he found they did not have a cause of action in tort or breach of contract. As these issues raise questions of law alone, the order of the motions judge is reviewable by this court on a standard of correctness. Accordingly, this court is at liberty to substitute its assessment of the law on these issues for that of the motions judge. [14] In my opinion and for the reasons which follow, the motions judge was correct on both issues. ANALYSIS (i) Derivative Action - Rule in Foss v. Harbottle (1843), 67 E.R. 189 [15] The respondent takes the position that the statement of claim does not disclose a reasonable cause of action because it attempts to establish what is known as a derivative action. The motions judge explained the nature of such an action at paragraph 9 of his reasons. In short, it is an action brought by shareholders of a corporation who derive their right to do so as a result of their connection to a separate legal entity, the corporation in which they hold shares. [16] Subject to laws of some jurisdictions within Canada, derivative actions are permitted on certain conditions. It is accepted that the laws of Prince Edward Island do not permit derivative actions by shareholders. Furthermore, even if the laws of the Province permitted such actions, the nature of a derivative action is that it must be for the benefit of the corporation and not the individual shareholders. [17] At paragraph 11 of his reasons, the motions judge quoted paragraph 59 of the decision of the Supreme Court of Canada in Hercules Management Ltd. v. Ernst &

6 Page: 6 Young, [1997] 2 S.C.R Writing for the Court, La Forest J. states that an individual shareholder of a corporation does not have a cause of action for any wrongs done to the corporation. If there are wrongs done to the corporation, the action must be brought by the corporation or by the shareholder as a derivative action. The corporation alone and not the shareholders are liable for its actions and any contractual arrangements it makes. The shareholders have no liability. Similarly, the corporation has a cause of action to enforce its contractual arrangements and to recover damages for any wrongs it suffers as the result of a breach. An individual shareholder has no such cause of action unless the shareholder brings the action for the benefit of the company as a derivative action. [18] At paragraph 59 of his reasons in Hercules Management La Forest J. specifically stated as follows: [59 ] The rule in Foss v. Harbottle provides that individual shareholders have no cause of action in law for any wrongs done to the corporation and that if an action is to be brought in respect of such losses, it must be brought either by the corporation itself (through management) or by way of a derivative action. The legal rationale behind the rule was eloquently set out by the English Court of Appeal in Prudential Assurance Co. v. Newman Industries Ltd. (No. 2), [1982] 1 All E.R. 354, at p. 367, as follows: The rule [in Foss v. Harbottle] is the consequence of the fact that a corporation is a separate legal entity. Other consequences are limited liability and limited rights. The company is liable for its contracts and torts; the shareholder has no such liability. The company acquires causes of action for breaches of contract and for torts which damage the company. No cause of action vests in the shareholder. When the shareholder acquires a share he accepts the fact that the value of his investment follows the fortunes of the company and that he can only exercise his influence over the fortunes of the company by the exercise of his voting rights in general meeting. The law confers on him the right to ensure that the company observes the limitations of its memorandum of association and the right to ensure that other shareholders observe the rule, imposed on them by the articles of association. If it is right that the law has conferred or should in certain restricted circumstances confer further rights on a shareholder the scope and consequences of such further rights require careful consideration. [19] The appellants rely upon Houle v. Canadian National Bank, [1990] 3 S.C.R. 122 (SCC), in support of their position that the statement of claim discloses, alternatively, a cause of action against the respondent in the tort of negligence. I will

7 Page: 7 address this issue later in these reasons. However, it is of note this decision is instructive on whether it is possible to pierce the corporate veil of a corporation and provide shareholders with a remedy when a third party breaches a contractual obligation or in some other manner wrongs a corporation. [20] In Houle the bank took steps to realize upon its security which it held by way of a contractual relationship with the corporation. The Court found the bank acted impulsively when it realized upon the security. The shareholders commenced an action against the bank in the Province of Quebec on the basis that the bank had abused its contractual rights and on the basis that the action of the bank amounted to a delictual wrong under the provisions of the Quebec Civil Code. [21] The Court found that the shareholders did not have a cause of action. The shareholders were not parties to the contract between the bank and the corporation. Furthermore, the shareholders did not have any right of action based on contract between themselves and the bank. A personal guarantee had been provided by the shareholders to the bank; however, the shareholders were never called upon to pay under the provisions of the guarantee. Therefore, the Court found that the bank would have no liability to them as the result of action taken pursuant to the guarantee. [22] Notwithstanding the business relationship with the bank was a "family one" where it might be considered that the corporation and the shareholders were "one," the Court was not prepared to lift the corporate veil. The Court noted that the shareholders chose certain benefits of incorporation, and they must live with the consequence. [23] Similarly, in the case at bar the appellants chose to incorporate McGowan Tractor and thereby create a separate legal entity. They had no liability to the respondent for the indebtedness owed by the company to the respondent, except to the extent that Mr. McGowan contractually assumed personal responsibility by way of his personal guarantee to pay $60,000. of the company's indebtedness. The statement of claim does not disclose that Mr. McGowan was ever called upon to pay under the provisions of the personal guarantee. Therefore, it is not possible at law for the appellants to pierce the corporate veil and maintain causes of action against the respondent for wrongs alleged to have been inflicted on the corporation, McGowan Tractor. [24] In their statement of claim, the appellants framed their primary cause of action as if it were a derivative action. In the alternative, they also attempted to frame personal causes of action against the respondent in tort and breach of contract. [25] With respect to the derivative actions, the motions judge was correct when he

8 Page: 8 concluded such actions are not permitted under the laws of Prince Edward Island. Therefore, the statement of claim does not disclose a reasonable cause of action. [26] The motions judge was also correct when he concluded that even if a derivative action was permitted in this province, the facts set forth in the statement of claim do not disclose an action in the nature of a derivative action. The motions judge correctly determined that, in the context of the facts set forth in the statement of claim, the action of the appellants was for their personal benefit as shareholders and not for the benefit of the corporation, McGowan Tractor. (ii) Actions in negligence and breach of contract [27] Because the appellants assert the statement of claim discloses facts which are capable of establishing alternative causes of action, it is necessary to consider whether the statement of claim discloses a personal cause of action against the respondent in tort or contract. At paragraph 14 of his reasons the motions judge found it did not. Again, I conclude he was correct. [28] Where a shareholder has been harmed, he or she may have a personal cause of action if the requisite elements of the cause of action are established by the pleadings. In Hercules Management La Forest J. stated at paragraph 62: [62 ] One final point should be made here. Referring to the case of Goldex Mines Ltd. v. Revill (1974), 7 O.R. (2d) 216 (C.A.), the appellants submit that where a shareholder has been directly and individually harmed, that shareholder may have a personal cause of action even though the corporation may also have a separate and distinct cause of action. Nothing in the foregoing paragraphs should be understood to detract from this principle. In finding that claims in respect of losses stemming from an alleged inability to oversee or supervise management are really derivative and not personal in nature, I have found only that shareholders cannot raise individual claims in respect of a wrong done to the corporation. Indeed, this is the limit of the rule in Foss v. Harbottle. Where, however, a separate and distinct claim (say, in tort) can be raised with respect to a wrong done to a shareholder qua individual, a personal action may well lie, assuming that all the requisite elements of a cause of action can be made out. (my emphasis). [29] As I stated, the appellants assert that their statement of claim discloses a personal cause of action in negligence and breach of contract or breach of a duty of good faith. The respondent, on the other hand, takes the position that the appellants' statement of claim does not disclose the "requisite elements" of a personal cause of action in any of these.

9 Page: 9 [30] The appellants rely on the decision in Houle to support their position that as shareholders they have a cause of action in negligence against the respondent. In Houle the court found that, although there was a contractual obligation on the bank solely to the corporation, the bank did, nevertheless, have a duty to the shareholders to act in a prudent and diligent manner with respect to the disposition of the company's assets. The shareholders had established that as a result of the manner in which the bank dealt with the assets of the company, the value of the company's shares had been reduced. The obligation on the bank arose, according to the court, from Article 1053 of the Quebec Civil Code which reads as follows: Every person capable of discerning right from wrong is responsible for the damage caused by his fault to another, whether by positive act, imprudence, neglect or want of skill. [31] The court found the bank liable for the decrease in the value of the shareholder's shares because pursuant to Article 1053, the bank had a delictual liability to the shareholders. [32] With respect, the decision in Houle does not assist the appellants because it is based on the provisions of Article 1053 of the Quebec Civil Code. Prince Edward Island is a common law jurisdiction and the Civil Code is not applicable. The test for establishing negligence at common law is to make a determination whether the wrongdoer owed the injured party a duty of care. This is much different than imposing liability of the basis that one has the duty to distinguish " right from wrong" as provided for in Article [33] At paragraph 21 of the statement of claim, the appellants allege that the respondent owed a duty of care to them and McGowan Tractor " as a result of their banking relationship ". They also allege in the same paragraph that the respondent was " negligent in doing what it did to the business and the Plaintiffs with the result being that the business and the Plaintiffs suffered damages claimed by the Plaintiffs ". [34] To maintain a cause of action in negligence, the appellants would have to establish that the respondent owed them a duty of care. Therefore, to avoid being struck as failing to disclose a reasonable cause of action, the appellants' statement of claim must plead sufficient facts which, if proven at trial, would establish that the respondent owed the appellants a duty of care. [35] It is well established that the test for determining if a duty of care is owed by one party to another is that set forth in Anns v. Merton London Borough Council, [1978] A.C. 728 (H.L.). This was subsequently endorsed and adopted in Canada by

10 Page: 10 the decision of the Supreme Court of Canada in Kamloops (City of) v. Nielsen, [1984] 2 S.C.R. 2. This test is commonly referred to as the Anns/Kamloops test. [36] Subsequently in Cooper v. Hobart, [2001] 3 S.C.R. 537 (SCC) at paragraph 30, McLachlin C.J.C. and Major J. explained the Anns/Kamloops test by pointing out that at the first stage of the test there are two questions to be addressed. Was the relationship between the plaintiff (the appellants) and the defendant (the respondent) sufficiently proximate such that harm was reasonably foreseeable as the result of the defendant's actions, and secondly, are there reasons, despite the fact there was proximity of relationship between the parties, that liability in negligence should not be found? If foreseeability and proximity are established at the first stage of the test, the issue at the second stage of the test is whether there are any residual policy considerations, beyond the relationship of the parties, why a duty of care should not be imposed. [37] At paragraph 30 of Cooper v. Hobart, McLachlin C.J.C. and Major J. stated as follows: [30] In brief compass, we suggest that at this stage in the evolution of the law, both in Canada and abroad, the Anns analysis is best understood as follows. At the first stage of the Anns test, two questions arise: (1) was the harm that occurred the reasonably foreseeable consequence of the defendant's act? and (2) are there reasons, notwithstanding the proximity between the parties established in the first part of this test, that tort liability should not be recognized here? The proximity analysis involved at the first stage of the Anns test focuses on factors arising from the relationship between the plaintiff and the defendant. These factors include questions of policy, in the broad sense of that word. If foreseeability and proximity are established at the first stage, a prima facie duty of care arises. At the second stage of the Anns test, the question still remains whether there are residual policy considerations outside the relationship of the parties that may negative the imposition of a duty of care. It may be, as the Privy Council suggests in Yuen Kun Yeu, that such considerations will not often prevail. However, we think it useful expressly to ask, before imposing a new duty of care, whether despite foreseeability and proximity of relationship, there are other policy reasons why the duty should not be imposed. [38] At paragraph 31, the court went on to explain that proximity at the first stage of the test characterizes the type of relationship in which a duty of care could arise. Also, sufficiently proximate relationships are identified by the use of categories which are not closed because new categories of negligence may be introduced. McLachlin C.J.C. and Major J. stated:

11 Page: 11 [31] On the first branch of the Anns test, reasonable foreseeability of the harm must be supplemented by proximity. The question is what is meant by proximity. Two things may be said. The first is that proximity is generally used in the authorities to characterize the type of relationship in which a duty of care may arise. The second is that sufficiently proximate relationships are identified through the use of categories. The categories are not closed and new categories of negligence may be introduced. But generally, proximity is established by reference to these categories. This provides certainty to the law of negligence, while still permitting it to evolve to meet the needs of new circumstances. [39] The ultimate purpose of the proximity analysis is to determine if the relationship between the plaintiff and the defendant is sufficiently close or proximate to make it just and fair that a duty of care should be imposed upon a defendant. The factors to be considered in conducting the proximity analysis are not restricted; however, it usually will involve a consideration of the expectations, representations, reliance and property or other interests of the parties involved in the proceeding. See: Cooper v. Hobart at paras. 33 & 34. [40] The relationship brought to issue in the appellants' statement of claim is between the respondent and the shareholders of a corporation which had a contractual arrangement with the respondent to repay money it had borrowed. As the parties have not identified this as a category of relationship where a duty of care has been recognized in the past, this court must consider if it is the type of relationship in which a prima facie duty of care does arise. [41] The relationship disclosed by the facts in the statement of claim was the relationship which existed between the respondent and McGowan Tractor. There was a contractual relationship between the appellant, John McGowan, and the respondent because of the latter's personal guarantee of the indebtedness. However, the statement of claim does not disclose any facts which, if proven at trial would establish that Mr. McGowan suffered any harm as the result of action of the respondent in relation to the personal guarantee. All the facts in the statement of claim relate to action which the respondent took against McGowan Tractor and not the appellants collectively, or any one of them individually. [42] The respondent dealt with the assets of the company and the indebtedness of McGowan Tractor which was a legal entity separate from the appellants as shareholders. There was no proximity of relationship between the appellants and the respondent such that it should have been foreseeable on the part of the respondent that actions which it took against McGowan Tractor would cause harm to the appellants as shareholders. This is particularly so in light of the fact that the appellants

12 Page: 12 incorporated McGowan Tractor as a means of limiting liability to that of the company and as a means of protecting themselves, personally, against liability. There was no proximity of relationship between the respondent and the appellants which would give rise to a prima facie duty of care on the part of the respondent. It would be unjust and unfair to impose upon the respondent a duty of care to the shareholders of the company with respect to actions which the respondent took against the company and not the appellants personally. [43] Finally and furthermore, even if there was proximity of relationship such as to make it foreseeable on the part of the respondent that if it caused harm to McGowan Tractor it would be foreseeable that harm would result to the appellants as shareholders, policy reasons would dictate that a prima facie duty of care should be negated. The policy reason being that to do so would necessarily pierce the corporate veil. To do so in the circumstances of the facts as pleaded in the appellants statement of claim would violate this long standing rule at common law. [44] Therefore, at common law, in the absence of facts in the statement of claim which disclose a duty of care is owed to the appellants by the respondent, the statement of claim does not disclose a reasonable personal cause of action in negligence against the respondent. The order of the motions judge striking the statement of claim should be confirmed. [45] With respect to whether the statement of claim discloses a reasonable cause of action for breach of contract or breach of good faith, I agree with the motions judge that the statement of claim does not disclose facts which would sustain an action for either. The contractual arrangements placed in issue by the facts in the statement of claim are between the respondent and McGowan Tractor, not between the respondent and the appellants as shareholders of that corporation. [46] The appeal is dismissed. The respondent shall have its costs of the appeal on a partial indemnity basis. I would fix those costs at $3,000., inclusive of all applicable taxes and disbursements. I AGREE: Justice Gordon L. Campbell Justice John A. McQuaid I AGREE:

13 Justice Wayne D. Cheverie Page: 13