



COURT OF APPEAL FOR ONTARIO

CITATION: Phoenix Interactive Design Inc. v. Alterinvest II
    Fund L.P.,

2018 ONCA 98

DATE: 20180202

DOCKET: C62718

Pepall, Lauwers and Huscroft, JJ.A.

BETWEEN

Phoenix
    Interactive Design Inc. and

1932780 Ontario Inc.

Applicants (Respondents/

Appellants by way of
    cross-appeal)

and

Alterinvest
    II Fund L.P. by its General Partner,

Business Development Bank of Canada

Respondent (Appellant/

Respondent by way of
    cross-appeal)

George Benchetrit and Michael Kril-Mascarin, for the
    appellant/respondent by way of cross-appeal

Raymond F. Leach and Michael A. Polvere, for the
    respondents/appellants by way of cross-appeal

Heard: May 24, 2017

On appeal from the judgment of Justice Johanne N.
    Morissette of the Superior Court of Justice, dated August 31, 2016, with
    reasons reported at 2016 ONSC 5442, 61 B.L.R. (5th) 237.

Pepall J.A.:

A.

INTRODUCTION

[1]

This appeal involves the principles applicable to the calculation of a
    bonus that the respondents promised to pay to the appellant on the sale of the respondents
    company.  The applications judge determined that the bonus payable amounted to
    $242,552.79 and not $888,462.78 as claimed by the appellant.  She dismissed the
    respondents claim that no bonus was payable because it contravened the
    criminal rate of interest found in s. 347 of the
Criminal Code
, R.S.C.
    1985, c. C-46; was unconscionable; and was
ultra vires
the objects of
    the appellant, the Business Development Bank of Canada (BDC).

[2]

The appellant appealed from her decision and the respondents
    cross-appealed.  For the reasons that follow, I would allow the appeal in part and
    dismiss the cross-appeal.

B.

Background Facts

[3]

BDC and other financial institutions established
    the appellant, Alterinvest II Fund L.P. (ALP), to provide subordinate debt
    and equity financing to small and medium sized businesses in Canada.  The
    respondent, Phoenix Interactive Design Inc. (Phoenix), was seeking such
    financing.  It was in the business of developing, distributing, and supporting
    automated teller machine and bank branch automation software.  Kyle MacDonald
    was the founder of Phoenix, and its President and Chief Executive Officer.  She
    was also the principal of the respondent, 1932780 Ontario Inc. (193),
    (together with Phoenix, the Phoenix parties), which was formed in March 2015 as
    the amalgam of a number of predecessor companies.

[4]

In November 2010, ALP offered Phoenix and 193s
    predecessors a loan for $2.25 million with a November 23, 2015 maturity date. 
    The purpose of the loan was to refinance an existing loan of $1.25 million and
    to meet Phoenixs working capital needs with additional financing of $1 million.
     ALP, Phoenix and 193s predecessors entered into a loan agreement on February
    16, 2011.  The loan had a fixed rate of interest of 12.8% per annum and monthly
    royalties payable commencing in February 2011.

[5]

In the loan agreement, Phoenix and 193s
    predecessors were described as the Borrowers. The parties agreed that ALP
    would be paid a bonus if any of the Borrowers were sold.  Specifically, the
    bonus provision, contained in s. 4.6(a) of the loan agreement, stated:

If any of the following events occur:
if
    50% or more of any Borrower (consolidated assets or shares) is sold
or
    merged with an unrelated company; if there is a change of control of any
    Borrower; or if any Borrower goes public prior to the Maturity Date or extended
    maturity date of the Credit Facilities,
then a bonus of 1% of the net
    proceeds received by the shareholder, after transaction costs,

determined
    as at the closing date of such transaction
becomes due and payable.
    Notwithstanding any repayment of the Credit Facilities, the bonus referred to
    herein will remain in full force and effect until the Maturity Date

(or
    any amended maturity date agreed by the Bank)
so that in the event of sale,
    IPO, or similar transaction the Borrowers obligation to pay the bonus will
    survive prepayment.

[Emphasis added.]

[6]

Accordingly, the bonus was 1% of the net
    proceeds of sale after transaction costs and was payable notwithstanding any
    prepayment of the loan.  The bonus would remain in force until the maturity
    date, that is, November 23, 2015.

[7]

Paragraph 8.1 of the loan agreement precluded a
    sale or reorganization of any of the Borrowers without ALPs consent.

[8]

In the fall of 2014, Diebold Inc. (Diebold)
    approached Phoenix regarding a possible purchase of the company.  In February
    2015, MacDonald met with ALP to advise that negotiations were underway for the
    sale of Phoenix.  She also advised that the Phoenix parties were not willing to
    pay ALP the bonus in accordance with the loan agreement because she believed
    that the fee would be disproportionate to the amount outstanding on the loan.  ALP
    disagreed and responded by confirming that it would seek payment of the bonus. 
    On March 5, 2015, Phoenix paid the full amount of $408,944.66 that was
    outstanding under the loan agreement for principal, fees, and royalties. 
    However, that amount did not include any sum on account of the bonus.

[9]

Prior to the closing of the stock purchase transaction,
    193s predecessor companies amalgamated to form a new company, 1926723 Ontario
    Inc. (Targetco).  Phoenix Interactive International Inc. (Holdco), which
    was owned by MacDonald, held all the shares in Targetco.  Targetco issued
    dividends totaling $50 million on March 10 and 11, 2015.  In satisfaction of
    the dividends, Targetco issued promissory notes totaling $50 million to Holdco.

[10]

On March 13, 2015, Diebold bought Phoenix for
    $92.5 million.  The $50 million debt under the promissory notes from the
    pre-closing reorganization, plus an additional $5.125 million of debt (largely representing
    income tax liabilities arising from the reorganization), formed part of the
    purchase price and were repaid by the purchaser on the date of closing.

[11]

The parties were unable to agree on the amount
    of the bonus payable to ALP.  The Phoenix parties argued that the bonus
    calculation should not include the $55.125 million, whereas ALP argued that
    those funds formed part of the proceeds of sale and therefore should be
    included in the bonus calculation.

[12]

BDC commenced an application against the Phoenix
    parties and MacDonald seeking information on the sale price, in order to
    calculate the bonus owed to BDC, and a declaration that the bonus was payable. 
    The Phoenix parties then commenced an application for a declaration that: the
    bonus contravened the criminal rate of interest found in s. 347 of the
Criminal
    Code
; was unconscionable; and was
ultra vires
the objects of BDC.  Ultimately, $975,000 was ordered to be paid
    into court as security for the Phoenix parties obligations with respect to the
    bonus, interest, and costs.

C.

Applications Judges Decision

[13]

The applications judge dismissed the Phoenix
    parties application.  She also dismissed BDCs request that the bonus be based
    on the $92.5 million proceeds of sale less the transaction costs.

[14]

Dealing first with the interest rate, the
    applications judge rejected the Phoenix parties argument that once they paid
    off the loan, there was a zero balance and therefore an infinite annual
    interest rate that was usurious.  She held that payment of the bonus was
    required regardless of any prepayment, and, because the bonus was still owing, there
    was not a zero balance in the loan account.  In addition, relying on
Garland
    v. Consumers Gas
, [1998] 3 S.C.R. 112
and
Pegelder Construction Co. v. Dancorp
, [1998] 3 S.C.R. 90, she
    concluded that the prepayment, a voluntary act of the debtor, could not give
    rise to an illegality.  She accepted the evidence of ALPs expert that the applicable
    maximum rate of interest was 26.9%.  As such, the payment of the bonus was
    never contrary to s. 347 of the
Criminal Code
, which prohibits
    interest rates in excess of 60%.

[15]

The applications judge also rejected the Phoenix
    parties argument that the bonus was unconscionable.  She concluded that the
    conditions required to establish unconscionability as outlined in
Titus
    v. William F. Cooke Enterprises Inc.
,

2007 ONCA 573, 284 D.L.R. (4th) 734, at
    para. 38, were not present. These conditions are as follows:

(a)
a grossly unfair and improvident transaction;

(b)   a victims lack of independent legal
    advice or other suitable advice;

(c)   an overwhelming imbalance in bargaining
    power caused by the victims ignorance of business, illiteracy, ignorance of
    the language of the bargain, blindness, deafness, illness, senility, or similar
    disability; and

(d)  the other partys knowingly taking
    advantage of this vulnerability.

[16]

She also found the bonus was not
ultra
    vires

BDCs objects, because BDC had the statutory power
    to make loans and investments, determine and charge interest, and determine
    employee remuneration.

[17]

Lastly, the applications judge addressed the
    calculation of the bonus and whether the $55.125 million characterized as certified
    indebtedness represented proceeds of sale.  She determined that that sum was
    not to be included in the calculation of the bonus.  She observed that the
    bonus was to be activated on transfer to an unrelated company.  It was not
    payable if the Borrowers undertook a reorganization with a related company.  If
    the reorganization had arisen a year prior to the sale, there would have been
    no complaint from BDC.  She reasoned that Phoenix made a transfer to a related
    company to pay dividends to MacDonald for her efforts as a key employee and to
    achieve tax efficiency, not to deny ALP the bonus.  Additionally, in her view,
    the issue of consent did not apply to the pre-sale transaction, which was for
    dividend purposes.

[18]

The applications judge also deducted from the
    bonus calculation $9 million in income taxes payable by Phoenix and $604,063
    for professional fees paid to Deloitte, who had advised Phoenix during the sale
    to Diebold.  She held that the fees related to the structuring of the sale of
    the business and as such should be deducted from the bonus calculation.

[19]

The applications judge therefore ordered the
    Phoenix parties to pay $242,552.79 to BDC, representing a 1% bonus based on net
    proceeds of sale of $24,255,279.

[20]

ALP appeals from the applications judges
    decision and the Phoenix parties cross-appeal.

D.

Issues

[21]

There are four issues to consider:

(i)    should
    the bonus calculation include the sum of $55.125 million?

(ii)   is the bonus contrary to s.
    347 of the
Criminal Code
?

(iii)   is the bonus unconscionable?

(iv)  is the bonus
ultra vires
BDCs legislated mandate?

[22]


For the reasons that follow, I would answer
    issue 1 in the affirmative, and issues 2 to 4 in the negative.

E.

Analysis

(1)

Should the bonus calculation include the sum of $55.125
    million?

[23]

ALP submits that the sum of $55.125 million should
    not have been subtracted from the $92.5 million purchase price for the purposes
    of calculating the bonus.

[24]

I agree.  In my view, the applications judge
    erred in deducting this amount from the sale proceeds.  She erred for two
    reasons.

[25]

First, the purchase price between the Phoenix
    parties and Diebold was $92.5 million.  Phoenix conceded that the $55.125
    million debt was repaid by the purchaser and was received by Phoenix on the closing
    of the sale to the purchaser.   The applications judge failed to consider the
    terms of the purchase agreement.  Omitting this figure from the calculation of
    the bonus ignores the purchase agreement terms.

[26]

Second, the establishment of the debt of $55.125
    million was created by the Phoenix parties as part of the pre-sale
    reorganization.  No such reorganization was permitted under paragraph 8.1 of
    the loan agreement absent ALPs consent.  No such consent was requested or
    received.  Indeed, MacDonald stated that she had forgotten that the provisions
    requiring ALPs consent were in the loan agreement.  A party is precluded from
    taking advantage of and benefitting from a state of affairs caused by its own
    wrongdoing:
Barclays Bank PLC v. Metcalfe & Mansfield
    Alternative Investments VII Corp.
, 2013 ONCA 494, at
    para. 149.

[27]

The fact that the transaction was stated to be for
    dividend purposes with a related company is immaterial.  The reference to an
    unrelated company in the loan agreement went to the nature of the sale
    transaction that would trigger the payment of the bonus.  It was speculative to
    suggest that if the indebtedness had arisen a year earlier, there would have
    been no complaint from ALP.  Moreover, as evident from the underlying
    documentation, the reorganization was clearly part of the purchase
    transaction.  The Phoenix parties acknowledged that the $55.125 million was
    paid to them on the closing of the sale transaction from the sale consideration
    received from the purchaser.  At its heart, that sum formed part of the
    proceeds of disposition on account of the sale to the purchaser.  I agree with
    ALP that it would be a strange result if Phoenixs obligation to pay the bonus
    was reduced or eliminated due to their tax minimization manoeuvres, which
    contravened the terms of the loan agreement, did not actually reduce the amount
    they received, and formed part of the consideration for the sale to the
    purchaser.

[28]

The applications judges treatment of the
    remaining deductions is also inconsistent with her analysis.  The bonus
    provision in the loan agreement provided for a payment equal to 1% of net
    proceeds after transaction costs.  ALP accepted that adjustments for working
    capital and legal fees were appropriate deductions for the purposes of
    calculating the quantum of the bonus.  However, it disputed the deductions for professional
    fees and income taxes arising from the sale to Diebold in that the former
    included fees unrelated to the sale transaction and the latter did not
    constitute transaction costs as described in the loan agreement.  The
    applications judge, having concluded that the $55.125 million was part of the
    pre-sale transaction and therefore did not form part of the proceeds of sale,
    nonetheless permitted the professional fees and income taxes relating to the
    pre-sale transaction to be deducted from the bonus calculation.

[29]

The applications judges conclusion was
    inconsistent with the result.  Having reversed her conclusion, I would uphold
    her decision on the professional fees and income taxes; these all formed part
    of the costs of the transaction with Diebold.

[30]

As such, the net proceeds amounted to $79,380,048,
[1]
1% of which is $793,800.48.

(2)

Is the bonus contrary to s. 347 of the
Criminal
    Code
?

[31]

The Phoenix parties submit that the bonus was
    contrary to s. 347 of the
Criminal Code
.
    Specifically, they take issue with the applications judges conclusion that the
    outstanding loan amount did not have a zero balance when Diebold bought Phoenix
    because the bonus payment was still owing.  The Phoenix parties concede that the
    account cannot be zero if an obligation exists to pay an amount in the future.  However,
    they argue that the bonus payment was not an existing obligation because it was
    based on a future event  the sale of Phoenix  that was uncertain at the time
    the loan was prepaid.

[32]

The Phoenix parties go on to challenge the
    applications judges treatment of their voluntary prepayment of the outstanding
    indebtedness based on the voluntariness principle identified in
Garland

and
Degelder
. This
    principle suggests that a legal credit agreement does not become illegal as a
    result of a voluntary prepayment.  The Phoenix parties argue that the
    voluntariness principle is inapplicable to the present case.  This is because the
    bonus payment was not outstanding, accrued, due, or owing at the time of the
    prepayment and only became payable on the sale of Phoenix.  At that time, no
    debt was outstanding.

[33]

I disagree with these submissions.  At para. 25
    of her reasons, the applications judge correctly decided that the loan
    agreement required payment of the bonus regardless of any prepayment in advance
    of the loans maturity date.  Therefore, the bonus was owing and there was no
    zero balance.  This conclusion is based on the applications judges reliance on
    s. 4.6(a) of the loan agreement, which states that the obligation to pay the
    bonus will survive prepayment.

[34]

Furthermore, the prepayment was made on March 5,
    mere days before the Phoenix sale closed on March 13.  The Phoenix parties
    cannot fairly argue that the obligation to pay the bonus was some uncertain
    future obligation.

[35]

At para. 24 of
Degelder
, the Supreme Court held that a transaction which was legal when
    entered into cannot become illegal under s. 347 through a voluntary act of the
    debtor.  As the applications judge correctly identified at para. 28 of her
    reasons, where the prepayment is within the control of the borrower and not
    required by the lender, that prepayment will be considered voluntary and cannot
    render a legal loan agreement illegal.

[36]

In the case at bar, Phoenix made a voluntary
    prepayment during the term of the loan.  This payment was not required by ALP;
    it was entirely within the control of Phoenix.  The Phoenix parties cannot rely
    on the prepayment to argue that when Phoenix was subsequently sold, the bonus was
    illegal because ALP purported to charge an effective annual interest rate that
    was infinite on a loan balance of zero.  The loan balance was only zero at that
    time
because
of the prepayment.  It would be a bizarre result if the Phoenix
    parties obligation to pay the bonus was rendered illegal by their own decision
    to prepay the loan.  The applications judge did not err in her treatment of
    this issue.

(3)

Is the bonus unconscionable?

[37]

Next, the Phoenix parties submit that the
    applications judge erred by relying on the four-part test for unconscionability
    identified in
Titus
.  They submit that the
    applicable test is that identified by the British Columbia Court of Appeal in
Morrison
    v. Coast Finance Ltd.
(1965), 55 D.L.R. (2d) 710 (B.C.
    C.A.).  The
Morrison
test consists of two elements: (a)
an
    inequality in the position of the parties, arising out of the ignorance, need
    or distress of the weaker party; and (b) the substantial unfairness of the
    bargain that is obtained by the stronger party.
The Phoenix
    parties argue that this error was significant because
Morrison
does not
    require an overwhelming imbalance in power, nor does it link inequality in
    bargaining power to independent legal advice.

[38]

I disagree that the applications judge erred in
    applying the test identified in
Titus

rather
    than the Phoenix parties preferred test of
Morrison
.  I say this for two reasons.

[39]

First,
Titus
is
    the law in Ontario. It was decided in 2007 by this court, and most recently
    re-affirmed as the leading case on the test for unconscionability in Ontario in
Kielb v. National Money Mart Co
., 2017 ONCA
    356, 66 B.L.R. (5th) 39.  This court has not endorsed the 1965
Morrison

test and lower courts in Ontario have primarily employed
    the
Titus

test since that case was decided:
    see
e.g. Girxti v. Kingston (City)
,
2010 ONSC
    5161;
John Deere Financial Inc. v. 1232291 Ontario Inc.
,
2015 ONSC 7467;
Arisoft
    Inc. v. Ali
, 2015 ONSC 7540 (Div. Ct.);
Kilislian
    v. Copper Creek GP Inc.
, 2015
ONSC 7072; and
Grenier v. Algonquin College of Applied
    Arts and Technology
, 2014 ONSC 1984.

[40]

Second, even if I were to accept that the test
    for unconscionability as articulated in
Morrison

applied, which I do not, the Phoenix parties have failed to show
    that it has been met.  An inequality in the bargaining positions of the parties
    to an agreement is an element of both the four-step test from
Titus
and the two-step test from
Morrison
.

[41]

At para. 40, the applications judge considered
    this element and concluded that MacDonald was a sophisticated business woman,
    who had the benefit of independent legal advice and fully understood the
    nature of the terms and effect of the bonus provision.  These findings are
    well-supported by the record.  For example, when negotiating the loan
    agreement, MacDonald made changes to s. 4.6(a), such that the bonus was amended
    from 1% of the value of the borrowing companies  at the closing date to 1%
    of the net proceeds received by the shareholder, after transaction costs.  ALP
    accepted these changes.  They are an example of MacDonalds sophistication and
    bargaining power.

[42]

I would not give effect to this ground of
    appeal.

(4)

Is the bonus
ultra vires
BDCs legislated mandate?

[43]

Finally, the Phoenix parties submit that the
    applications judge erred in finding that the bonus was not
ultra
    vires
.  They argue that she failed to consider whether BDCs
    exercise of its statutory powers was in accordance with its objects.  They submit
    that BDC may only structure loans on terms that are in accordance with the objects
    set out in ss. 4(1) and 4(2) of its enabling legislation, the
Business
    Development Bank of Canada Act
, S.C. 1995, c. 28 (the 
BDC
    Act
).  These objects are to support Canadian
    entrepreneurship by  raising funds or capital and to give particular
    consideration to the needs of small and medium-sized businesses.  The Phoenix
    parties further submit that the bonus provision did not advance BDCs objects
    because the bonus constituted a cash grab that was detrimental to Canadian
    entrepreneurship.

[44]

In my view, the applications judge was correct
    in concluding that the bonus provision in the loan agreement was not
ultra
    vires
BDCs mandate.  BDC must exercise its powers in
    accordance with the objects set out in the
BDC Act
.  However, in this case these objects were not violated.

[45]

Subsections 14(1)(a) and 22(b) of the
BDC
    Act

provide

BDC with the power to make loans and investments and determine
    and charge interest and any other form of compensation for services [it]
    provides in the exercise of its powers under this Act.  A plain reading of
    these provisions indicates that Parliament conferred broad discretion upon BDC in
    the exercise of its powers under the
BDC Act
.  It
    was open for BDC to negotiate the rate of return and loan structure that it did. 
    As the applications judge observed at para. 45:

By extending the loan to the applicants, BDC
    supported a Canadian entrepreneur by providing her with financial services to
    assist her to raise working capital which allowed her to ultimately sell her
    business for over $92 million.

I would decline to give effect to the
    respondents cross-appeal on this issue.

F.

Disposition

[46]

In conclusion, I would allow the appeal of ALP, with the exception
    of its appeal of the issue of deduction of professional fees and taxes, and would
    dismiss the cross-appeal of the Phoenix parties.  I would vary the applications
    judges order to order that ALP is entitled to a bonus of $793,800.48 rather
    than $242,552.79.

[47]

The parties did not reach an agreement on the costs of the appeal. 
    In the event of success, ALP requested its full costs of $23,000, on the basis
    that the loan agreement so provides.  The Phoenix parties submitted that this
    court should exercise its discretion to grant costs on a partial indemnity
    scale in the amount of $16,000.  Given that ALP was not entirely successful, I
    would grant ALP costs of $20,000, inclusive of disbursements and applicable
    tax.

[48]

The parties did reach an agreement on the costs below.  Both
parties
    agreed that the successful party would be entitled to an order of $160,000, inclusive
    of disbursements and applicable tax for their costs below.  I would therefore
    order that the
Phoenix parties
pay ALP $160,000
    inclusive of disbursements and applicable tax.

Released:

GH                                                  S.E.
    Pepall J.A.

FEB -2 2018                                     I agree
    P. Lauwers J.A.

I
    agree Grant Huscroft J.A.





[1]
This amount reflects the gross purchase price paid by Diebold for Phoenix of
    $92.5 million, less the sum of the following amounts found by the trial judge,
    at para. 57 of her reasons, to represent each respective deduction: $2.8
    million for working capital, $625,000 for working capital post-closing,
    $228,722 for transaction costs, $604,063 for professional fees, and $8,862,167
    for income taxes.


