Buyer Beware! Failure to Perform Due Diligence Can be Costly.

In 126217 Canada Inc. v. Cytrynbaum, 2018 QCCS 2616, the Plaintiff sued Cytrynbaum and Java-U Group Inc. for shareholder oppression and requested that its $2.5 million investment in Java-U Group Inc. be returned. Cytrynbaum’s liability was sought in his capacity as a director of Java-U Group, for having failed to take the necessary measures to avoid errors in the company’s records and financial statements. Since Java-U Group had sought protection from its creditors, the action proceeded against Cytrynbaum.

In 2006, Cytrynbaum met Helwani, the sole shareholder of the Plaintiff, and they became friends. Cytrynbaum mentioned to Helwani that he was looking to increase the number of Java-U franchises and Helwani took an interest. Through the Plaintiff, he then invested $2.5 million in Java-U Group without doing any due diligence or reviewing any financial statements. From 2006 to 2009, Helwani took little interest in his investment. During the same period, no shareholders meetings were called and no audited financial statements were provided to the Plaintiff.

In 2009, in the context of his estate planning, Helwani mandated Nexia Friedman to obtain and review financial information from Java-U Group. Certain anomalies in the corporate and accounting documents were revealed. In 2011, Nexia Friedman again reported certain anomalies, and in particular highlighted the fact that it was highly irregular for no shareholders meetings to have taken place since September 2006. In August 2012, following receipt of additional information from Java-U Group, Nexia Friedman noted that the capital asset listing and unaudited financial statements for the years 2007 to 2012 were materially inaccurate, false and misleading. Yet none of these findings appeared to disturb Helwani’s confidence in Cytrynbaum.

In 2014, the Plaintiff commenced proceedings against the Defendants in order to, among other things, rectify accounting records and appoint an accounting firm to prepare audited financial statements. Richter LLP was appointed as auditor and produced consolidated audited financial statements for the years 2011 to 2015 which Nexia Friedman characterized in a report as false, misleading and an intentional and reckless attempt by the director to deceive the company and other shareholders of the company’s true financial state.

So was the Plaintiff tricked into investing? Justice Gouin did not think so. Not only does he find that there was no evidence to support Nexia’s conclusion of intentional fault, he states that the accounting anomalies would have been revealed in 2006 had the Plaintiff done any due diligence at that time.

Oppression remedies are based on reasonable expectations and in this case, given what the judge characterizes as Helwani’s “insouciance”, Helwani could not claim that his expectations were to receive proper financial information and to attend shareholder meetings:

[127]   Et que dire, et que faire alors de ce que 126217 :

a.   n’ait fait aucune vérification diligente, ni consulté quelque état corporatif ou financier interne que ce soit de Java-U Group ou des Filiales, ni posé quelque question que ce soit au moment de l’Investissement;

b.   ne se soit nullement manifestée, de quelque façon que ce soit, entre 2006 et 2009;

c.   se soit abstenue, de 2009 à 2013, d’exiger quoi que ce soit de concret, sauf poser des questions par l’intermédiaire de M. Harrar de Nexia, et ce, même si elle était ainsi informée de l’état véritable de la tenue des registres corporatifs et comptables, et des états financiers de Java-U Group;

d.   ait attendu au 29 mars 2013 pour demander qu’une première assemblée des actionnaires de Java-U Group soit convoquée; et

e.   ait attendu la réception des états financiers préparés par Richter en février et mars 2017, et du Rapport Nexia en avril 2017, pour finalement déposer, le 7 juin 2017, le Recours en oppression.

[128]   On s’attend à plus d’un investisseur le moindrement diligent.

[129]   Avant de blâmer un autre, peu importe son rôle ou sa fonction, encore faut-il que l’investisseur ait fait preuve d’un strict minimum de diligence.

So it bears repeating, buyer beware!