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When Legal Costs Exceed the Value of Assets, Insolvency Must Ensue

The 1998 decision of the Saskatchewan Court of Queen's Bench in Dyck v. Dyck marked the final chapter in the demise of the Dyck Historical Society, which was destroyed by the legal costs incurred in a fight amongst the members over what type of society it should be.

1. Facts

Dyck Historical Society ("DHS") was a non-profit corporation formed under Saskatchewan law. Its only asset consisted of the homestead site that the court said was rich with historical significance. The corporation had 71 members. All of the members of the society were members of the Dyck family through blood or marriage.

An acrimonious dispute broke out as to whether the society should be designated as a charitable corporation or a membership corporation. A special meeting to decide the issue was held, at which a majority of the members voted to be a membership corporation but stipulated that, on liquidation or dissolution of the corporation, the remaining property of the society was to be donated to one or more charitable organizations.

Some of the members on the losing side who were not present at the meeting attempted to vote under a pooling agreement. However, the chair presiding at the meeting ruled that the pooling agreement constituted a proxy and the articles of the society did not allow voting by proxy.

Nevertheless, the losing side never accepted the result of the membership vote and continued to agitate. More litigation ensured.

Ultimately, the corporation borrowed $18,000 from two of its members to pay its legal costs. Later, the corporation's property was mortgaged to secure the indebtedness. Still later, the corporation transferred the property to the mortgagee for $16,400, all the directors resigned en masse and the corporation was allowed to be dissolved.

2. Rulings

(a) Pooling Agreement

Nevertheless, the losing side in the membership vote challenged the validity of the chair's disallowance of the votes under the pooling agreement.

Justice Barclay agreed that the pooling agreement was properly characterized as a proxy, which is an instrument by which a member appoints a proxy-holder to attend and vote on his behalf at a meeting of members. The pooling agreement was used to permit some members to vote on behalf of members who were not present. The court found that this objection failed and there was no other basis to attack the resolutions that were passed at the meeting.

(b) Purported Transfer of Land at Undervalue

The corporation transferred the mortgaged property to the mortgagees in exchange for a credit on the mortgage indebtedness in the same amount. The court was satisfied that there was no merit in the contention that the land was undervalued on the transfer.

3. Key Observations

The Dyck case is another sad reminder of the governance difficulties that repeatedly afflict certain small not-for-profit ("NFP") organizations.

First, some memberships are too large and unwieldy for the size and scale of the organization. Large memberships often degenerate into polarization, factionalism and litigation over issues that have little intrinsic moment. DHS had 71 members. The assets of DHS had a value of about $16,400. Ironically, the membership was split over whether the residual assets should be distributed to the members or a charitable corporation. But, in the end, the assets were dissipated in the cost of litigation and went to the corporate lawyer.

Second, litigation is too expensive for many small NFP organizations and can quickly outstrip the entire net worth of the corporation - as it did in this case. A quick resolution was imperative, or there would be no point.

Third, members of an NFP organization must learn to accept the will of the majority. Once an informed majority has spoken, it generally becomes exceedingly difficult for the losing side to upset that result in court.

One wonders whether the internal fight within DHS would have been avoided if, for example (1) the number of members of the corporation had been limited to, say, three or five family members (a small, odd number; thus avoiding a potential deadlock), (2) all directors had to be members of the corporation (and vice versa so that there was no chance of any faction seizing control from the board) and (3) the by-laws provided for alternative dispute resolution (including final and binding arbitration which would oust the jurisdiction of the courts). As it was, DHS was killed by the cost of family infighting vastly disproportionate to the issues at stake and the modest resources of the corporation.

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