Superior Court of Justice renders good news decision for the worker co‑op sector

November 16th, 2012 by Paula Boutis

In early October, the Superior Court released a decision which looked at how the law governing fundamental changes to an employment contract applied in the context of worker co‑operatives. It also considered whether “sweat equity credits” amounted to “member shares” under the Co‑operative Corporations Act (CCA).

In worker co‑operatives, the employees are also sometimes owners, and are also members of the worker co‑operative.  Each member is entitled to one vote only.  The amount of equity a person may hold in the form of shares in the co‑operative does not dictate voting rights, and thus power in the corporation.  Worker co‑ops are incorporated under the CCA.  The concept of the legal wage owing to those workers is generally understood to be a fluid one. That is, the workers accept some risk, as owners; as the business does better, the wages may go up. As the business does worse, the wages may go down.

Worker‑owners, like employees in traditional businesses incorporated under the Ontario Business Corporations Act (BCA), may also choose to take some of their wages in cash, and some in the form of a “sweat equity credit” (SEC). The SEC may entitle the worker‑owner to shares in the corporation, or options for shares in the corporation, in accordance with whatever agreement is reached on when, how or if shares are issued and redeemed, and in accordance with the Articles of Incorporation of the co‑operative.

In this particular case, “wages” were in fact unknown for significant periods of time and retroactively set through various resolutions.  A certain amount of cash was always paid, depending on what the business could afford, but “sweat equity credits” accrued and would depend on what “wage” was set.  There was an understanding amongst the worker owners that their SEC would be “recognized” when the business was sufficiently financially stable, and after Class A and B external investors had their shares redeemed and dividends paid.

In this case, the plaintiff was a founding member and former worker‑owner of the defendant corporations, the worker co‑operative, and its business unit, incorporated under the BCA.  The plaintiff disputed two decisions of the co‑operative corporation’s board, which affected the “wage” he, and other worker‑owners, was entitled to.  Each worker owner was entitled to the “wage” in part by cash and the remainder as SEC; SEC was considered to be speculative by the worker owners, dependant on the success of the business and obligations to the external investors.

One co‑operative board decision set a temporary “wage” to be paid pending a determination of the “final wage”, through an internal compensation committee process. This temporary “wage” would be paid partly in cash, as a percentage of the temporary wage; and otherwise “accounted for” as SEC. The exact potential value of the SEC was to be determined on the basis of the future “wage”, to be determined, not the temporary “wage”, however.

Some 18 months after the decision which set the temporary wage, the  co‑operative board approved new “permanent” wage scales for all its worker‑owners, including for the plaintiff.  The plaintiff’s annual “wage” was decreased by approximately $12,000.  The ultimate potential value of the SEC was thus reduced, though the plaintiff had been paid a greater portion of his “wage” in actual cash than any other worker‑owner to that point.

The plaintiff, as a member of the co‑operative board, had in both cases voted in favour of the decisions, but later disputed that the decrease in wage should apply to him retroactively for the purposes of SEC; he also argued he should be given notice of the decrease in wage, on the basis that these were fundamental changes to his contract he did not agree with.  The former worker‑owner grieved these decisions through an internal process, and asked the co‑operative to apply the temporary, higher wage to his SEC calculations, and to give him six months’ notice of the new lower wage taking effect, on a go‑forward basis.  The co‑operative board agreed to give six months’ notice of the wage decrease for cash purposes, but refused to apply the higher wage to the sweat equity credit that had accrued in the prior 18 months.

The court concluded that the former worker‑owner’s affirmative vote in both cases bound him, applying settled case law that fundamental changes are permitted to contracts only where the employee agrees to them.  Indeed, the former worker‑owner not only voted in favour of these resolutions, but had moved the adoption of the new pay‑scales.  The court concluded that the former worker‑owner’s consent had been obtained through his affirmative votes.  This ended the debate over “how much” had accrued in SEC, with the plaintiff having argued it should be calculated on the higher temporary “wage”, rather than the lower permanent “wage”.

Only a small portion of the plaintiff’s SEC had accrued in the worker co‑op; a much larger portion of it had accrued in a business unit of the worker co‑op incorporated under the Ontario Business Corporations Act (BCA).  The intent was always for a worker co‑op to be established, but initially, only the for profit corporation under the BCA existed.  “Worker‑owners” were employed by the BCA corporation for several years.  After the formal incorporation of the worker co‑op, the employees’ employment was transferred to the worker co‑op, and those worker‑owners were “seconded” to the BCA corporation.  At that point, SECs accrued in the worker co‑operative.

At the time of the plaintiff’s termination by the worker co‑op, he had outstanding SECs in both the worker co‑op and the BCA corporation.

After his termination, he sought for the SECs be recognized in the form of an immediate issuance and redemption of shares, arguing that his “member shares” were required to be paid out upon his expulsion as a member of the co‑operative, in accordance with the CCA’s provisions.  The CCA required member shares be redeemed within a year of expulsion, subject only to an insolvency test or financial stability test, at the discretion of the co‑operative board.

Because a large number of SECs were in the BCA corporation, the former worker‑owner also sought relief through the oppression remedy, available under the BCA.  The plaintiff claimed that he had been oppressed by the fact of his termination and loss of management rights, and was entitled to an oppression remedy.  Specifically, he sought to force an issuance and redemption of his “shares” in the BCA corporation; or, in the alternative, he argued he was entitled to damages for breach of contract.

The court concluded that there had not been any oppressive conduct warranting relief.  In addition, the court concluded that, at most, the former worker‑owner had earned, through the SECs, a right to exercise an option for Class B shares in the corporations, but he did not have actual shares. The plaintiff chose not to opt for shares, to avoid an income tax liability in the absence of any cash payments to him.  As he did not have any “member shares”, he was not entitled to rely on the pay‑out provisions under the CCA, either.

The court also considered that had the conduct been oppressive, that an issuance and redemption of shares would result in insolvency.  Further, granting an issuance and redemption of shares for the plaintiff would be oppressive to Class A shareholders, as it would put the order of issuance and redemption out of order.  The court declined to order damages for breach of contract in the alternative, concluding that the court would be doing indirectly what it could not do directly.

This decision is good news for worker co‑operatives, in that it gives them comfort that worker‑owners will be bound to live with the decisions they make and the legal implications that follow.  It also confirms that SEC is not equivalent to actual shares.

Filed in: Co-operative Law, Litigation

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