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Corporate Corner: Institutional investors affect markets

|Written By Sam Billard

It has become commonplace to remark on the effect that the emergence of large public or quasi-public funds has had on Canada''s financial markets

Corporate Corner with Sam Billard

They are significant aggregators of capital and, as a result, financial engineers cater to their requirements. They tend to want to be "market neutral," which is to say that they do not want control positions in their investments.

This has put a strain on Canadian markets as they attempt to absorb the money flowing into these vehicles. Some of these entities, such as the Ontario Teachers' Pension Plan Board and the Ontario Municipal Employees Retirement Board (OMERS) have been active in supporting corporate governance reforms that strengthen shareholder rights.

A more subtle effect is illustrated by the recent Ontario Court of Appeal decision in Ford Motor Co. of Canada Ltd. v. Ontario Municipal Employees Retirement Board. In it the court has laid down some interesting criteria that may significantly affect the obligations of majority shareholders and directors to minority shareholders, at least in part as a result of the persistence of OMERS.

The principal business matter addressed in the opinion was a transfer pricing mechanism established between Ford Motor Co., the U.S. parent, and Ford Motor Co. of Canada Ltd., its Canadian subsidiary. This transfer pricing mechanism, dictated by the U.S. parent, resulted in the Canadian subsidiary showing losses over a 10-year period.

OMERS, as a minority shareholder of Ford Canada, brought an action against Ford U.S. and Ford Canada to the effect that its shares were undervalued as a result of this transfer pricing mechanism, which amounted to oppressive conduct on the part of both companies.

It should be stressed that transfer pricing mechanisms of the sort employed by Ford in this case are the norm in multinational corporations and completely legal. The corporate groups work within the rules of the tax legislation in the countries in which they operate in order to minimize income in high-tax jurisdictions and maximize income in lower-tax jurisdictions. In Ford's case, the high-tax jurisdiction was Canada and the low-tax jurisdiction was the U.S.

It is likely that OMERS would have known of the mechanism when making its investment. Certainly, all of the historic profitability numbers were available and Ford Canada had a long history of losses as a consequence of the transfer pricing strategy.

However, when Ford U.S. sought to take Ford Canada private, it bought out the minority shareholders at a price per share that reflected in some measure the financial performance of Ford Canada. OMERS argued that the imposition of the transfer pricing scheme was oppressive and that the value of their shares was substantially higher than the value placed on them by Ford U.S.

The Court of Appeal agreed with OMERS, finding that the fact that the transfer pricing mechanism was acceptable under the tax regimes for both Canada and the United States was not evidence that it was acceptable to shareholders. Further, it determined that the minority shareholders were entitled to rely on Ford Canada, its directors, and its majority shareholder to behave in a manner consistent with their public pronouncements to the effect that they served the interests of the Canadian public shareholders.

Accordingly, the majority shareholder could not treat the subsidiary as a wholly owned subsidiary and the directors could not simply rubber-stamp the decisions of the majority shareholder.

The Court of Appeal found that it was not open to the directors of Ford Canada to use the business judgment rule unless the decisions result from the exercise of business judgment: that is, the decisions were made honestly, prudently, in good faith, and on reasonable grounds.

In this case, the directors did not fully understand the implications of the transfer pricing mechanism and did not look into it. Accordingly, they exercised no business judgment and were open to liability to the shareholders.

Finally, the Court of Appeal determined that it could find that Ford U.S. acted in an oppressive manner even though there was no evidence that it had sought to influence the decisions of the board of directors of Ford Canada.

This decision reminds us of the reach of the oppression remedy. It also serves as a warning to majority shareholders and directors, should they need further reminding, that more is expected of them. Thanks to large, professionally managed minority shareholders like OMERS and Teachers, it can be anticipated that this trend will continue.


With this column Sam Billard, a partner at Aird & Berlis LLP practising primarily in the debt finance area, joins Law Times as our Corporate Corner columnist. Matt Kindrey, student-at-law, assisted with this article.

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