Northern Exposure

Beware the Perils of Firing Employee-Shareholders

By Stephen Acker and Julia Kennedy

As we have repeatedly reported, courts are finding new ways to put money in former employees’ pockets in Canada. Another example is the Ontario Court of Appeal’s recent decision in Link v. Venture Steel Inc. and Ruben Rivas, where it agreed with the trial judge’s decision awarding a former employee more than $4 million in damages. Only $550,000 of the damages was pay in lieu of notice. The bulk of the damages related to shares that had been improperly purchased by the employer at the time it terminated the employee’s employment for cause.

Shareholder agreement
In 1996, William Link started setting up Venture Steel. Link was employed in a sales capacity. By 2005, when his employment was terminated for cause, Link was the vice president of sales.

In 2004, the other defendant, Ruben Rivas, entered into a shareholders’ agreement with Link and five other executives of Venture. Under the agreement, Link received 90,000 common shares of Venture – about nine percent.

The shareholders’ agreement dealt with termination of employment. In the event of termination, the shareholder’s shares could be purchased by Rivas. If the termination was without cause, the purchase price would be 100 percent of the net book value of the shares. With cause, however, the purchase price would be $1.

Termination of employment
When Venture fired Link, it alleged cause. It claimed that Link drank excessively, was dishonest, took secret profits, and stole from the company. Venture eventually withdrew all but two of its allegations of cause. But not until the trial. As such, at the time of termination, Rivas purchased Link’s shares for $1.

After the termination
Matters didn’t end at the termination. A year later, another company, Royal Laser, purchased Venture for $43.5 million. As a result, Link’s former shares were sold by Rivas to the new company.

At trial, the judge said there was no cause for Link’s termination. Instead, he was entitled to 12 months pay in lieu of notice. This amounted to approximately $550,000. Interestingly, the court didn’t penalize Link for failing to mitigate his damages during those 12 months because of the effect of noncompetition and nonsolicitation clauses in the shareholders’ agreement that remained in effect for a year after he ceased to be a shareholder.

But the real damage was to come. Because there was not cause, Rivas couldn’t properly have purchased Link’s shares for $1. As a result, the court said Link still owned his shares when Rivas sold the shares to Royal Laser for $43.5 million. As such, he was entitled to participate in the profits of that sale. That amounted to more than $3.2 million – or nine percent of the purchase price, less deductions. Link was also entitled to nine percent of a dividend that was paid – another $230,000 – and interest on the value of the shares covered by an option agreement – another $530,000.

Venture appealed the decision. The Court of Appeal agreed with the bulk of the trial decision and said:

  • Link was entitled to participate in the profits of the sale to Royal Laser. Rivas and the other selling shareholders couldn’t have excluded Link from the sale proceeds but for the wrongful actions of Venture and Rivas. The only caveat was that Link had to surrender his shares before collecting the $3.2 million.
  • Link was not entitled to nine percent of the dividend that was paid. In order to be entitled he would have had to exercise his option to purchase shares, which couldn’t be exercised given the termination of his employment.
  • The trial judge was correct in not making a deduction for failure to mitigate. Venture led no evidence about the availability of suitable employment — so could not show that Link acted unreasonably.

Lessons learned
Once the court determined that there was no just cause to fire Link, every decision Venture made in relation to Link’s shares became invalid. Before pursuing share transactions based on a just-cause termination, Canadian companies should have an airtight case to support their allegations. The consequences of being wrong about the termination can mean owing millions if these transactions are invalidated by the court.

While this is an Ontario decision, it could have persuasive value across Canada. Just cause is a tough card to play. Building a house from a deck of such cards can lead to crumbling results.

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