Court rules in favour of labour-sponsored venture fund against fund manager

A recent Ontario Superior Court ruling casts light on how courts will view share purchase agreements between investment firms — and especially how drafting gaps and failures to make full disclosure can leave both buyers and sellers exposed to future liability.

The decision in Stuart Investment Management Ltd. v. Kiernan, delivered in late May, found that legal bills for defending an existing regulatory investigation were the responsibility of the selling investment firm as it had failed to fully disclose those issues during the negotiations, even though the selling firm did disclose other legal bills.

However, in what may be a somewhat pyrrhic victory for the buyer, the individual behind the corporate entity that negotiated the sale on behalf of the seller and incurred the legal debts, James Kiernan, was held not personally liable for the invoices, which the buyer settled with the law firm for $45,000.

On the other hand, the costs of terminating a long-term administrative employee who had agreed to work for the buyer for at least six months following the sale were held to be the responsibility of the purchaser.

The deal that provoked the litigation took place in 2013, when Montreal-based Stuart Investments agreed to sell its shares to Sunnyside Investments Inc., which was looking for a firm registered with the Investment Industry Regulatory Organization of Canada (IIROC) to provide financial services to immigrants in Quebec.

Sunnyside recruited considerable professional expertise to help with the sale, including a large law firm and a consulting company that specializes in assisting in the review of IIROC-registered companies for compliance purposes. The sale price was $150,000, with an additional $140,000 paid to Kiernan to cover six months of employment under the new owner. A long-term, administrative employee was also to be employed for a further six months, for $30,000, one-half of her annual salary.

When that employee was let go at the end of the six months, she sued for, and obtained, damages for wrongful dismissal. Those damages, more than $67,000, were paid by Sunnyside, which then brought the application to recover those costs from either the corporate seller, a firm called Cornerstone Capital (controlled by Kiernan), or Kiernan personally. However, the court ruled that the buyers were responsible for the employment termination damages.

“The terms of [the employee’s] employment agreement were anything but clear in relation to what would occur at the end of the six-month employment term,” noted Justice James Diamond in the decision. “[The agreement] did not explicitly specify whether [the employee] gave up her right to claim common-law reasonable notice, something which ought to have been addressed, especially in light of the fact that the employment agreement was a fixed-term contract.”

Failure to address issues prior to the sale also influenced the finding on the legal invoices. Kiernan argued that he alerted Sunnyside to the regulatory issue prior to the closing, but Sunnyside said it was unaware of IIROC-related legal bills that had grown to more than $50,000.

The court agreed that Kiernan’s vague comments on the point during negotiations were insufficient notice. Specifically, the decision refers to Sunnyside’s version of Kiernan’s comments as: “‘a compliance issue’ under review by IIROC, but [with the assurance] that there was ‘nothing to worry about’.”

Disclosing some items in the same category but leaving others out appeared to be particularly negative for the seller.

“The financial statements delivered prior to and on closing disclose that in the relevant ledgers, itemized invoices were posted for debts owing to third parties, including (ironically) other law firms,” the decision notes.

Justice Diamond also stated that: “A party can only make reasonable inquiries into matters of which they were aware, and I find that [Cornerstone and Kiernan] did not make adequate disclosure in the circumstances.”

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