A venture capital corporation (MMV) acquired 49% of the voting common shares of the respondent while in interim bankruptcy proceedings and subscribed $1,000 for a large number of non-voting common shares giving it over 99.8% of all the common share equity. It then financed taking the respondent out of bankruptcy proceedings at a modest cost, and transferred a loan portfolio of U.S.$86 million to the respondent, effectively in consideration for secured debt and preferred shares, thereby reducing the equity interest of the five arm’s length holders of 51% of the MMV voting common shares to less than 0.01% and also permitting the use of the respondent’s non-capital losses.
In applying Deans Knight to reverse the Tax Court finding that there was no abuse of s. 111(5), Monaghan JA stated (at paras. 34-35):
The object, spirit and purpose of subsection 111(5) – its rationale – is
“to prevent corporations from being acquired by unrelated parties in order to deduct their unused losses against income from another business for the benefit of new shareholders”.As in Deans Knight, what happened here is exactly what subsection 111(5) seeks to prevent.
Regarding the respondent’s submission that the original five voting common shareholders still could have elected a new board that would pay them dividends, Monaghan JA stated (at paras. 45-46):
The power imbalance is self-evident. MMV had the right to demand immediate repayment of the credit facility and to demand redemption of the preferred shares within 30 days. Had it done so, the respondent would have been unable to pay dividends and, once those demands had been met, would have had little, if any, assets of value. Given this, and their collective infinitesimal interest in the respondent, the prospect of the five original shareholders electing directors and paying themselves dividends was illusory.
Put another way, while their common shares provided the five original shareholders with de jure control, they had no effective way to use that control to benefit from the respondent’s losses.