Can shareholders sue personally for losses in the value of company shares?
Since 1843, a company has been considered a separate legal entity from its shareholders. The practical effect of what is called the rule Foss vs. Harbottle (1843), 67 ER 189 (UKHL) is that only the company, and not its shareholders, can sue for the wrongs caused to it.
There are exceptions, such as “derivative actions”. But even in these cases, the shareholders are simply bringing the derivative action “on behalf of” the company. The lawsuit still belongs to the company.
What then happens when a shareholder suffers a personal loss resulting from a loss in value of the company’s stock? Does the shareholder have a personal cause of action? Under a strict Foss vs. Harbottle analysis, the answer is no.
But a recent decision by the Ontario Court of Appeal, Tran v. Bloorston Farms Ltd., 2020 ONCA 440, now adopts an important exception to Foss vs. Harbottle.
Bloorston Farms establishes that a shareholder can bring an action to reduce the value of the share with the company when only the shareholder, and not the company, has the right to sue the defendant.
A restaurant collapses. Who is suing?
Bloorston Farm involved the breaking of a restaurant lease. The company, of which Sang was the sole shareholder, operated a restaurant on site. Sang was the only tenant listed on the lease.
In 2014, the defendant became the owner of Sang when he purchased the building in which the restaurant was operated. The defendant landlord then demanded from the tenant an increase in rent payments. Sang challenged the changes to the restaurant’s rent and continued to pay the rent she was already paying. The owner eventually terminated Sang’s rental and the company’s food and beverage operations ceased to operate.
Sang brought an action against the landlord for breach of the lease for having locked her and the company away from the premises. The company was also a plaintiff in the action, although it was not a party to the lease.
Part of Sang’s claim concerned an action for loss of the value of its stock as the sole shareholder of the company.
The landlord brought a motion for summary judgment, arguing that Sang, as a shareholder, could not personally claim the loss in value of his shares when the company became worthless as a result of the restaurant closing. The owner relied on the rule of Foss vs. Harbottle, arguing that only a company could sue for the harm caused to it.
The motions judge rejected the landlord’s position. The Court held that there was an exception to the rule in Foss vs. Harbottle when a business suffers a loss but has no cause of action to recover the loss. In this case, the shareholder can sue for loss of value of the share.
In this case, the company was not a tenant under the lease and, therefore, only Sang could bring an action to reduce the value of the share. In the end, the motions judge awarded Sang damages of $ 140,614 for the loss in value of his action.
The Ontario Court of Appeal upheld the motions judge’s decision.
The exceptions to Foss vs. Harbottle
The Court of Appeal began its analysis by examining the Foss vs. Harbottle. As stated, this rule provides that a shareholder of a company does not have the personal right to bring an action for harm caused to the company: see Hercules Management Ltd. vs. Young,  2 RCS 165.
The policy underlying the rule in Foss vs. Harbottle is as follows: (i) the company, as a separate legal personality, is responsible for the actions of the company, not its shareholders. Therefore, the company, and not its shareholders, has the right to sue for the wrongs caused to it; and (ii) in the absence of the rule, a shareholder could still sue for harm done to the company which indirectly causes harm to the shareholder.
However, the Court of Appeal recognized that the rule has its limits and that there are two recognized exceptions to it:
I. when the shareholder and the company have separate and distinct causes of action against the defendant. In this scenario, the âidentical or overlapping factsâ constitute legal wrongs to the company and the shareholder. This can happen, in the Court’s opinion, when a shareholder and a company have causes of action against the director for distorting the value of the company’s stock;
ii. where only the shareholder has a cause of action for which the company cannot sue.
This exception is known as the “second proposition” of Johnson v. Gore Wood & Co.,  BCC 820 (UKHL).
This is the exception adopted by the Court of Appeal in Bloorston Farms:
Here, the company has no cause of action. Only the shareholder, Sang, has a cause of action. Since the rule in Foss vs. Harbottle applies only to prevent a shareholder from suing for harm caused to the company, the question is whether the rule applies where the company has no cause of action and the shareholder, who has a cause of action, makes a request for a decrease in the value of the action.
Where only the shareholder can sue
The “second proposition” of Johnson was worded by the House of Lords as follows:
When a corporation suffers a loss but does not have a cause of action to bring an action to recover that loss, the shareholder of the corporation can bring an action against them (if they have a cause of action for do so), even if the loss is a decrease in the value of the shareholding …
After reviewing previous cases in Ontario and British Columbia, including Meditrust Healthcare Inc. v. Shoppers Drug Mart (2002), 220 DLR (4e) 611 (Ont. CA) and Robak Industries Ltd. vs. Gardner, 2007 BCCA 61, the Court of Appeal in Bloorston Farms ruled that the second proposal of Johnson “Is consistent with a legal framework that is otherwise consistent with Ontario law.”
In the opinion of the Court, the second proposition “should be regarded as good law in Ontario”.
The Court proposed three justifications for the adoption of the second proposal:
I. allow shareholder action for loss of share value when the company has no cause of action “respects the separate legal identity of the company.” The shareholder pursues his own cause of action and not a cause of action which belongs to a separate legal person (the company) â;
ii. there is no risk of multiple procedures. The company has no cause of action, so only the shareholder can make the claim; and
iii. the loss of share value claim is “not simply a loss claim that reflects the loss suffered by the company (for which the company, and only the company, can sue)”. The allegation of “decrease in the value of the share results from a [shareholderâs] relationship with the perpetrator of the offense which is independent of any relationship that society has with the perpetrator â.
The Court warned, however, that its decision was not intended to open the floodgates and that the plaintiff still had to prove the elements necessary for a loss of value of the share:
This does not mean, of course, that in all such cases damages for decrease in the value of the share should be allowed. A claim for this head of damages is subject to the same requirements of proof, causation, predictability and quantification as a claim for any head of damages arising from the wrong on which the shareholder’s cause of action is based. …
Applying the above principles, the Court in Bloorston Farms concluded that the company had no contractual relationship under the lease with the landlord. Only Sang did it. Accordingly, the second proposition applied. Sang was entitled to damages for the loss in value of his stock.
A necessary step in Ontario corporate law
Bloorston Farms represents a necessary step in the evolution of the common law of Ontario. Recognizing the second proposition as an exception to Foss vs. Harbottle harmonizes Ontario corporate law with other common law jurisdictions.
The Court was careful to present the second proposal as a narrow and limited means of awarding compensation to shareholders for losses in stock value that are otherwise unrecoverable by the company.
Sure, Bloorston Farms is a classic example of the Second Proposition coming to life. The case concerned a breach of contract to which the company was not a party and under which the company did not have the right to sue.
What remains to be seen are the conceptual limits of the second proposition. Where it is doubtful whether a company has the right to sue for impairment of shares, the second proposition may well not apply.
Marco is a partner in the Litigation department of Torkin Manes. He pleads in writing for a wide range of civil litigation, including commercial litigation and administrative law. He specializes in judicial review applications and civil appeals.