Case Name:
Weber's Hardware (Huntsville) Ltd. v. Home Hardware
Ltd.
Between
Weber's Hardware (Huntsville) Limited, Applicant, and
Home Hardware Limited, Respondent
[2006] O.J. No. 4031
22 B.L.R. (4th) 160
151 A.C.W.S. (3d) 840
2006 CarswellOnt 6139
Court File No. 336-00
Ontario Superior Court of Justice
W.A. Jenkins J.
Heard: June 26, and 27, 2006.
Judgment: October 10, 2006.
(58 paras.)
Civil procedure -- Settlements -- Enforceability -- Under a settlement reached by the parties, the defendant had agreed to pay the fair market for shares of the plaintiffs' company, and the value of certain shareholder's loans, the value of which the court set at $294,201, which included certain business expenses.
Corporations and associations law -- Sale of a business -- Share purchase agreement -- Under a settlement reached by the parties, the defendant had agreed to pay the fair market for shares of the plaintiffs' company, and the value of certain shareholder's loans, the value of which the court set at $294,201, which included certain business expenses.
In furtherance of a settlement agreement of a claim by the plaintiffs under the Business Corporations Act, the parties consented to an order requiring the defendant to pay fair market value for the shares of a hardware company, plus the amount of the outstanding shareholder's loans to the two plaintiffs -- However, in the year that elapsed between the agreement and the final sale of the shares, those loans had increased in value by $152,931, and the parties now sought a determination of the proper amount of those loans payable by the defendant -- The plaintiffs claimed the extra funds were incurred to cover business expenses for the hardware company -- HELD: The shareholder loan was reduced to $294,201 which included the original amount plus professional fees and other expenses; any monies held in trust would be paid out to the plaintiffs -- The legal and accounting fees relating to the prosecution of the application against the defendant under the Business Corporations Act were legitimate expenses of the company, as they were required to encourage the defendant to purchase the plaintiffs' hardware store -- The legal and accounting fees relating to the valuation of the plaintiffs' shares in the hardware store, however were not legitimate expenses of the company and were not recoverable as part of the shareholder loan.
Statutes, Regulations and Rules Cited:
Business Corporations Act, R.S.O. 1990, c. B-16
Income Tax Act, R.S.C. 1985, C-1
Counsel:
Raymond G. Colautti, for the Applicant
Paul Seitz, for the Respondent
1 W.A. JENKINS J.:-- In this case the issue is how much of the shareholder loan to Weber's Hardware (Huntsville) Limited should be repaid to the shareholders William Weber and Elizabeth Stokes by Home Hardware Limited as part of the purchase price of Weber's Hardware (Huntsville) Limited.
Background
2 The trial was the culmination of a protracted dispute between William Weber and Elizabeth Stokes and Home Hardware. The dispute began when Home Hardware purchased the Beaver Lumber chain including the Huntsville store, which was in competition with Weber's Hardware. Proceedings were commenced by Weber's Hardware against Home Hardware under the Business Corporations Act, R.S.O. 1990 C. B-16, and eventually, the parties agreed that Home Hardware would purchase the shares of Weber's Hardware.
3 In furtherance of their agreement, the parties consented to an order requiring Home Hardware to pay fair market value for the shares together with the amount of the outstanding shareholder's loan to William Weber and Elizabeth Stokes. The parties agreed that the fair market value of the shares should be established as of January 31, 2001, by way of a reference.
4 Madam Justice Hilda M. McKinlay was selected by the parties as the referee, and she heard evidence from both sides as to the value of the Weber Hardware shares. In her report of February 18, 2002, she said:
Under the circumstances, I think that a cap rate of 4.25 is appropriate, which applied to EBITDA of $118,018 results in capitalized EBITDA of $501,577. After deducting indebtedness of the company and adding its investment in H.H., the resultant fair market value of the company is $537,815.00. There is no dispute as to the debt owed by the company to Mr. Weber. It is $189,390.00. When that is paid to Mr. Weber, the resultant value of the shares of Weber's is $348,425.00.
Neither of the parties challenged Madam Justice McKinlay's report and it was subsequently confirmed.
5 Problems arose in early 2002 when the parties came to close the sale of the shares. At that time they found that in the year that had elapsed since January 31, 2001, the shareholder loan had increased to $342,321.43. As a result, the amount owing for the shares and shareholder loan was alleged to be $690,746.43. Home Hardware refused to pay the amount of the increased shareholder's loan and the matter came before me on the trial of the issue of how much Home Hardware is required to pay to William Weber and Elizabeth Stokes for the shareholder's loan.
6 The increase in the shareholder's loan is $152,931.43, and that is the amount in dispute. Home Hardware takes the position that the value of the shares and the shareholder's loan was determined by Madam Justice McKinlay at $537,815 as of January 31, 2001, and that is the only amount that it is required to pay. Since her decision was not appealed by Weber's Hardware, Home Hardware alleges that the matter is now res judicata.
7 At the opening of the trial, Home Hardware moved for summary judgment dismissing William Weber and Elizabeth Stokes' claim for the increased shareholder's loan. I reserved my decision on that motion.
8 In the event its motion for summary judgment fails, Home Hardware contends that the increase in the shareholder's loan was used by Weber's Hardware, in part, to pay personal expenses of William Weber and Elizabeth Stokes as opposed to debts incurred by the company in the ordinary course of its business. Home Hardware therefore alleges that it should not have to pay the increase in the shareholder's loan. It asks that I find that it is only responsible to pay $189,390 on account of the shareholder's loan.
9 William Weber and Elizabeth Stokes contend that the full amount of the shareholder's loan of $342,321.43 was advanced to cover expenses incurred by Weber Hardware in the ordinary course of its business, and that amount should be repaid by Home Hardware. They ask for judgment for the full amount of the shareholder's loan.
Form of Proceedings
10 When these proceedings began Weber's Hardware was named as the applicant. Weber's Hardware is now owned by Home Hardware, as all of its shares have been transferred to that company.
11 The only issue remaining is how much Home Hardware must pay William Weber and Elizabeth Stokes to complete the transaction. If necessary, I would entertain a motion to add William Weber and Elizabeth Stokes as parties to these proceedings.
The Applicant's Evidence
12 William Weber testified that he and Elizabeth Stokes each owned 50 percent of the shares in Weber's Hardware. He said that since Weber's Hardware was a Home Hardware dealer, Home Hardware got copies of its' monthly statements. Those statements showed the balance of the shareholder's loan at the end of each month. As a result, Home Hardware knew about the increase in the shareholder's loan before the transfer of the Weber's Hardware shares.
13 Mr. Weber said the shareholder's loan increased during 2001 because both sales and profits were down and the company needed money. He said sales were down because Home Hardware opened a second outlet at the Beaver Lumber property. He said profits were down due in part to the cost of the litigation with Home Hardware.
14 As a result, Mr. Weber testified that he and his wife cashed in RSPs, mortgaged their house and borrowed money from their parents to lend Weber's Hardware the money it needed in order to continue in business. He said the money from the increased shareholder's loan was used to pay down the bank loan, to pay money owed to Home Hardware and to pay legal and accounting expenses.
15 Mr. Weber said that all of the legal and accounting bills that Weber's Hardware paid with the proceeds from the shareholder's loan related to the dispute with Home Hardware and were incurred to protect the interests of the company. As a result, he said that the bills were legitimate company expenses.
16 The legal bills in issue are as follows:
March 6, 2001 - Raphael Partners account to Weber's Hardware Limited for $15,656.42;
October 17, 2001 - Raphael Partners account to Bill Weber and Weber's Hardware Limited for $6,510.49;
January 10, 2002 - Raphael Partners account to Weber's Hardware Limited for $24,622.90;
May 10, 2002 - Raphael Partners account to Weber's Hardware Limited for $15,814.30.
The accounting bills are as follows:
October 20, 2000 - B.D.O. Dunwoody account for $4,880.81;
August 28, 2001 - B.D.O. Dunwoody account for $8,881.00;
December 31, 2001 - B.D.O. Dunwoody account for $2,893.56;
December 31,2001 - B.D.O. Dunwoody account for $20,603.61.
The legal and accounting bills total $99,863.09.
17 On cross-examination Mr. Weber agreed that the original application brought by Weber's Hardware was returnable on February 19, 2001. At that time Mr. Justice Shaughnessy ordered, on consent, that Home Hardware buy the shares of Weber's Hardware. As a result, there was an agreement as early as February 2001 that Home Hardware would purchase the Weber's Hardware shares at a price to be determined.
18 In addition, Mr. Weber admitted that Home Hardware was ordered to pay Weber's Hardware the costs of several of the court attendances relating to this dispute. Home Hardware's counsel suggested to Mr. Weber that by claiming money used to pay Raphael Partners' accounts he is seeking to recover some of the legal costs twice.
19 Richard Wise, a chartered accountant and business valuator gave evidence on behalf of William Weber and Elizabeth Stokes. He testified that the increase in the shareholder's loan that occurred after January 31, 2001, was caused by a shortfall in funds required to pay down the bank, to pay Home Hardware and to pay the legal and accounting fees relating to this dispute. As a result, the shareholders were required to advance funds to Weber's Hardware. During the 12 months following January 31, 2001, the shareholder's loan increased by approximately $144,932.58.
20 Mr. Wise testified that the company's accountants, B.D.O. Dunwoody conducted a review of the company's legal and accounting expenses during the period February 1, 2001, to January 31, 2002, and concluded that these expenses were properly recorded as business expenses of Weber's Hardware. He said that the review was conducted in accordance with "Accounting Review Standards" which are high standards and that the Weber's Hardware statements were prepared in accordance with generally accepted accounting practices.
21 Mr. Wise testified that the legal and accounting expenses were incurred in the ordinary course of business in order to protect the company's assets and undertaking. He said those expenses were correctly recorded under general and administrative expenses and no adjustments were made by the two business valuators who looked at the value of Weber's Hardware.
22 Mr. Wise said that he looked at the Revenue Canada definition of personal expenses and in his view, these legal and accounting expenses were not personal expenses within that definition. In his opinion, they were legitimate business expenses.
The Respondent's Evidence
23 Paul Ross testified on behalf of Home Hardware. He is an accountant and business valuator with KPMG. He was retained by Home Hardware to value Weber's Hardware shares and he testified at the arbitration before Madam Justice McKinlay.
24 Mr. Ross' affidavit of May 29, 2002, was filed earlier in these proceedings, and was admitted during the trial as Exhibit 8.
25 In his affidavit, Mr. Ross says the following:
3. In the course of my engagement on this file I had occasion to review the expert reports prepared by B.D.O. Dunwoody and filed on behalf of the shareholders of the Applicant. In both of the B.D.O. reports the item known as loans due to shareholder was uniformly reported as $189,390. This number was also confirmed in the direct testimony of the B.D.O. representative at the hearing before the Special Referee. The shareholder loan account was consistently reported as $189,390.
4. In the course of my work on our share valuation I was never informed by anyone on behalf of the Applicant that this number was the subject of a material adverse change. I was present throughout the hearing before the Special Referee, and there was no mention of any change by any witness.
5. My own valuation relied upon the disclosed shareholder loan figure of $189,390.
6. The disclosure of a material adverse change to this number would have resulted in a review and reconsideration of my own opinion as to the share values, and also requests for back-up information in order to understand and appreciate the meaning and significance of the material change.
7. I have been informed that it now appears that the shareholder loan account was in fact some $340,000, and not $189,390 as disclosed. I have also been informed that the bulk of this increase appears to have been used to pay legal and accounting expenses incurred during this share valuation exercise.
8. The non-disclosure of this information prevented any use of it at the hearing. KPMG advised Home Hardware as to the share valuation without knowledge of this material adverse change.
9. I was given no disclosure of the material change in the shareholder loan account. In my practice in business valuations this is unprecedented. My professional colleagues rely on me to disclose all relevant financial information when opinions as to value are being prepared, and I place the same reliance on my colleagues. The status of the shareholder loan account is information in the exclusive domain of the Applicant and I must rely on the figures as disclosed.
10. The material adverse change in the financial condition of the company was known before the hearing but was not disclosed. The expensing of professional services in the corporation for matters designed and intended to benefit the shareholders personally is not only improper in my professional opinion, it also renders the evidence at the hearing as to value incomplete and skewed.
11. The expenses incurred by the two shareholders of Weber's Hardware (Huntsville) Limited, namely Bill Weber and Elizabeth Stokes, are proper deductions by them in their own individual tax arrangements, but the deductibility as individuals for the two shareholders does not equate to a corporate expense.
12. The proceedings before the Special Referee and the professional valuations of the individual shareholdings were not matters intended to benefit the Applicant corporation or its business activity.
26 On cross-examination, Mr. Ross agreed that when he swore his affidavit, he did not know that Home Hardware got monthly statements from Weber's Hardware that showed the increases in the shareholder's loan. He said he was subsequently advised of that by counsel for Home Hardware.
Motion for Summary Judgment
27 The respondent, Home Hardware takes the position that Madam Justice McKinlay established the value of the Weber's Hardware shares and the shareholder's loan in her decision of February 18, 2002. It contends that the amount of the shareholder's loan was not a flexible number and that this was not a normal commercial closing that was subject to adjustments.
28 Home Hardware says that Madam Justice McKinlay was in effect the trial judge and that she heard evidence, made findings, and gave judgment. Since her decision was not appealed, Home Hardware contends that the parties are bound by her decision and the value of the shareholders loan is res judicata.
29 In her decision of February 18, 2002, Madam Justice McKinlay refers to the shareholder's loan on page six. In the second last paragraph on that page, she says:
There is no dispute as to the debt owed by the company to Mr. Weber. It is $189,390. When that is paid to Mr. Weber, the resultant value of the shares of Weber's is $348,425.
30 It is clear from her decision that the shareholder's loan was not the subject of any inquiry during the hearing. The amount of the loan was simply taken from the financial statements of Weber's Hardware for the year-end, January 31, 2001.
31 The doctrine of res judicata can only be applied to prevent Weber's Hardware from raising the amount of the loan as an issue if that is something that was clearly decided by Madam Justice McKinlay.
32 In this case, it is clear from her decision that there was no inquiry into the reason for the advances by the shareholders or the amount of the loans. The question of the company's future financial needs was not canvassed by Madam Justice McKinlay. As well, there was no discussion between the parties prior to the advances being made about the need for such advances or recovery of the advances by the shareholders.
33 Clearly the company needed an infusion of cash after January 31, 2001, to pay down the bank, to pay the amounts owed to Home Hardware and to pay professional fees. The shareholders advanced funds to cover those expenses on the assumption that they would recover the monies as part of the shareholder's loans. Otherwise they would never have advanced the money.
34 I am satisfied that the decision of Madam Justice McKinlay does not deal with the amount of the shareholder's loan in a substantive way and her decision does not prevent the applicants from seeking to recover the increased amount of the shareholder's loan. The motion for summary judgment is therefore dismissed.
The Shareholder's Loan
35 The remaining issue is determination of the amount of the shareholder's loan that Home Hardware is obliged to pay to William Weber and Elizabeth Stokes. They contend that the full amount of the loan which totals $342,321.43 is owing as those funds were used by the company to pay expenses incurred by it in the ordinary course of business.
36 The amounts in dispute at the trial were the payments by the company to Raphael and Partners of their accounts totaling $62,604.11 and the payments to B.D.O. Dunwoody of their accounts totaling $37,258.98. Those legal and accounting fees total $99,863.09 and they were all paid by the company with money loaned to it by William Weber and Elizabeth Stokes. As a result, William Weber and Elizabeth Stokes are seeking to recover those fees as part of the shareholder's loan.
37 The issue then is what part of those fees was a legitimate business expense of the company, and what part should have been paid by William Weber and Elizabeth Stokes as personal expenses. Mr. Weber and Ms. Stokes are entitled to amounts properly loaned to the company to pay it's expenses. They are not entitled to recover amounts used by the company to pay their personal expenses.
38 What constitutes legitimate business expenses of the company was dealt with by both Mr. Wise, the valuator who testified on behalf of Weber's Hardware, and by Mr. Ross, the business valuator who testified on behalf of Home Hardware.
39 Mr. Wise said that the legal and accounting expenses incurred by the company met B.D.O. Dunwoody's review standards and they were included as expenses in the company's financial statements. He said that no adjustments were made to those expenses by two business valuators who looked at the value of Weber's Hardware. In arriving at his opinion he said he looked at Revenue Canada's definition of personal expenses and those expenses did not fit within that definition.
40 The approach taken by Mr. Wise to quantifying the shareholder's loan is a global approach. He doesn't appear to have examined the legal and accounting bills in any detail. Consequently, I am unable to accept his opinion that all of the fees charged to the company are business expenses that are recoverable by William Weber and Elizabeth Stokes as part of the shareholder's loan.
41 Mr. Ross complained that when he was asked to review the B.D.O. Dunwoody valuation of the Weber's Hardware shares, he was not told about the increase in the shareholder's loan. With respect to Mr. Ross, he should have either asked about any increase in the shareholder's loan, or checked the monthly statements for Weber's Hardware, which were supplied to Home Hardware.
42 Mr. Ross said that expensing of professional services in the company for matters intended to personally benefit the shareholders was improper. In his opinion, the expenses incurred by William Weber and Elizabeth Stokes with Raphael Partners and B.D.O. Dunwoody were deductible by them as individual shareholders and they should not have been recorded as corporate expenses.
43 In my view, Mr. Ross is wrong about some of the expenses incurred by William Weber and Elizabeth Stokes with Raphael Partners and B.D.O. Dunwoody. Some of those expenses had to be incurred in order to further the sale of Weber's Hardware to Home Hardware.
44 I have, however, reviewed the references in The Income Tax Act, R.S.C. 1985, C-1. to accounting and legal fees that are properly deducted by private companies as business expenses. Those references do not include accounting or legal fees incurred by shareholders seeking to have their shares in a private company valued. To be deductible by the company the expenses must be incidental to the company's business.
45 In this case, I am satisfied that the legal and accounting fees that relate to the prosecution of Weber's Hardware application against Home Hardware under the Business Corporations Act are legitimate expenses of the company. As I have previously stated, they were required in order to encourage Home Hardware to purchase Weber's Hardware.
46 The legal and accounting fees that relate to the valuation of the shares of William Weber and Elizabeth Stokes in Weber's Hardware are not, however, legitimate expenses of the company, and are not recoverable by William Weber and Elizabeth Stokes as part of the shareholder loan. The determination of the amounts properly expensed by Weber's Hardware and included in the shareholder's loan requires an analysis of the accounts.
Legal Fees
47 The Raphael Partners' account of March 6, 2001, totals $15,656.42. It covers the period from December 13, 2000, to March 6, 2001, and includes services rendered in connection with the application by Weber's Hardware under the Business Corporations Act. That application was brought by Weber's Hardware in an effort to protect its market share in the Huntsville area. It represents a legitimate company expense, and should be included as part of the shareholder's loan.
48 The Raphael Partners' account of October 17, 2001, totals $6,510.49 and covers the period from March 9, 2001, to October 1, 2001. That account deals with the ongoing dispute between Weber's Hardware and Home Hardware and the closing of the purchase of the Weber's Hardware shares pursuant to the order of Reilly J. of September 6, 2001. The account is for services rendered by Raphael and Partners in an effort to bring the proceedings to a successful conclusion. It is also a legitimate company expense of Weber's Hardware and should be included in the amount recovered as part of the shareholder's loan.
49 The Raphael Partners' account of January 10, 2002, totals $24,622.90 and covers the period from November 6, 2001, to December 18, 2001. That account deals with valuation of the shares of William Weber and Elizabeth Stokes in Weber's Hardware and with the valuation hearing. It is a personal expense of William Weber and Elizabeth Stokes, and should not be recovered by them as part of the shareholder's loan.
50 The Raphael Partners' account of May 10, 2002, totals $15,814.30 and covers the period from February 15, 2002, to May 8, 2002. That account deals with Weber's Hardware efforts to close the purchase of its shares by Home Hardware and is a legitimate company expense. It should be included in the amounts recovered by William Weber and Elizabeth Stokes as part of the shareholder's loan.
51 I therefore find that the Raphael Partners' accounts of March 6, 2001, October 17, 2001, and May 10, 2002, totaling $37,981.21 are legitimate expenses of Weber's Hardware and are recoverable by William Weber and Elizabeth Stokes as part of their shareholder loan.
Accounting fees
52 The B.D.O. Dunwoody account of October 20, 2000, totals $4,880.81 and covers the period from September 27 to October 17, 2000. That account deals with services rendered in connection with the application by Weber's Hardware under the Business Corporations Act. It represents a legitimate company expense and should be included as part of the shareholder's loan.
53 The B.D.O. Dunwoody account of August 28, 2001, totals $8,881 and covers the period from February 1, 2001, to June 25, 2001. That account deals with the ongoing dispute between Weber's Hardware and Home Hardware concerning the value of Weber's Hardware and B.D.O. Dunwoody's appraisal. It represents a legitimate company expense and should be included as part of the shareholder's loan.
54 The B.D.O. Dunwoody account of December 31, 2001, in the amount of $2,893.56 is for services rendered on November 7, 2001, for attending at the ADR Chambers in Toronto. That account deals exclusively with the valuation of the shares of William Weber and Elizabeth Stokes in Weber's Hardware. It is a personal expense of William Weber and Elizabeth Stokes and should not be recovered by them as part of the shareholder's loan.
55 The B.D.O. Dunwoody account of December 31, 2001, in the amount of $20,603.61 covers the period from June 11, 2001, to December 21, 2001. That account also deals with the valuation of the shares of William Weber and Elizabeth Stokes in Weber's Hardware, and it is a personal expense of William Weber and Elizabeth Stokes and should not be recovered by them as part of the shareholder's loan.
56 I therefore find that the B.D.O. Dunwoody accounts of October 20, 2000, and August 28, 2001, totaling $13,761.81 are legitimate expenses of Weber's Hardware and are recoverable by William Weber and Elizabeth Stokes as part of their shareholder's loan.
Conclusions
57 As a result of the foregoing, I find that legal and accounting fees totaling $51,743.02 are legitimate expenses of Weber's Hardware, and are recoverable by William Weber and Elizabeth Stokes as part of their shareholder loan. I therefore find that the shareholder loan of $342,321.43 should be reduced to $294,201.36. That amount includes the original shareholder's loan of $189,390 plus advances to cover professional fees of $51,743.02 and other expenses of $53,068.34.
Judgment
58 I therefore order that any funds being held in trust pending the outcome of the trial, together with interest thereon be paid to Home Hardware, and that Home Hardware pay to William Weber and Elizabeth Stokes the amount of the shareholder's loan calculated in accordance with my assessment together with prejudgment interest. I believe that the amount owing for the shares has already been paid. If necessary, the parties may make written submissions concerning the costs of this action within 30 days of the date of this judgment.
W.A. JENKINS J.
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