On January 11, 2013, the Ontario Superior Court of Justice (Divisional Court) delivered its decision in Re Rankin, upholding the decision of the Ontario Securities Commission (the “Commission”) dismissing an Application to set aside an order in which it approved a settlement agreement between Commission Staff and the appellant, Andrew Rankin (“Rankin”).

Rankin was managing director of the mergers and acquisitions branch of RBC Dominion Securities. Charged with ten counts of insider trading and ten counts of tipping under ss. 76(1) and (2) of the Securities Act, R.S.O. 1990, c. S.5 (the “Act”), he was ultimately convicted of all ten counts of tipping but was not convicted of insider trading.

Rankin committed these offences by providing confidential information to Daniel Duic, (“Duic”), an acquaintance who himself was in negotiations with the Commission and subsequently settled with it. Duic provided evidence on which the trial judge relied to convict Rankin, sentencing him to 6 months’ imprisonment.

On November 9, 2006, Rankin’s conviction was overturned and a new trial was ordered by Justice Nordheimer of the Superior Court of Justice. Before the commencement of the new trial, on February 19, 2008, Commission Staff reached a settlement agreement with Rankin, which included an admission of guilt. The Commission approved the settlement agreement on February 21, 2008, and released reasons on March 17, 2008.

In August, 2008, Rankin learned that in late 2007, Duic had been under investigation for committing a “technical breach” of his settlement agreement by engaging in trading contrary to the Cease Trade Order included in his settlement agreement.

Rankin brought an Application challenging the Commission’s decision to approve the settlement agreement pursuant to s. 144 of the Act on the basis that the failure of Commission Staff to disclose the investigation against Duic resulted in manifest unfairness to Rankin in deciding to enter into the settlement agreement. The Commission rejected Rankin’s Application.

On appeal, the Divisional Court held that the Commission’s decision not to revoke the settlement agreement was reasonable. The Divisional Court concluded that the information in question would not likely have materially impacted Rankin’s defence strategy, apart from calling Duic’s credibility into question. It further found that the Commission was correct to conclude that the omission of such information did not cause manifest unfairness to Rankin.

Justice Matlow dissented. According to Justice Matlow, it was essential that Rankin be fully apprised of the evidence against him, including the full scope and nature of the investigations against Duic. Furthermore, held Justice Matlow, the Commission erred in considering whether information relating to the investigation against Duic was “crucial information in connection with the negotiation of the Rankin Settlement Agreement” instead of information relevant to Rankin’s decision to enter into the settlement agreement. As Matlow J. put it,

[t]he Commission’s formulation of the test required the Commission to determine whether or not the undisclosed information, as at the time when Rankin agreed to the settlement, “would likely have affected the outcome of the Rankin Administrative Proceeding“. Not only was this requirement irrelevant to the merits of Rankin’s motion before the Commission but, because it called for the Commission to make a determination, as at that time, of the likely outcome of a future hearing, first assuming that Rankin did not have the undisclosed information and then comparing it on the assumption that he did, it was unworkable.

According to Justice Matlow, Rankin should have been provided with all information relevant to his decision to enter into the settlement agreement, not merely that information which was crucial to its negotiation.

Commentary:

The result of the Court’s split decision in this case raises many questions. What rights do persons accused of offences under the Act have to disclosure of the case against them? If an accused person faces possible incarceration resulting from breaches of the Act, should criminal law disclosure obligations not apply to Commission Staff?

The decision of the Divisional Court in this case would suggest the answer is “no”.

If an accused person enters a guilty plea in the criminal context because the crown does not disclose material information relevant to the case against the accused, the accused may succeed in having the guilty plea withdrawn. To do so, the accused must prove (a) that the Crown did not meet its disclosure obligations; and (b), that on a balance of probabilities the lack of disclosure impaired the accused’s right to make full answer and defence (see R. c. Taillefer (2003), 179 C.C.C. (3d) 353 (SCC)).

The Divisional Court distinguished the present case from pure criminal cases, indicating instead that proceedings before the Commission are administrative and quasi-criminal. In such context, the Divisional Court suggested, the public interest does not require the setting aside of the settlement agreement, and concluded that from the perspective of a reasonable person, if disclosed, the information would not have affected the outcome of the proceedings.

This case highlights the distinction between the prosecution’s criminal and quasi-criminal disclosure obligations. Given that an accused person prosecuted under criminal or quasi-criminal charges may suffer the same punishment, namely, a loss of liberty, one might reasonably ask why a distinction exists between the crown’s disclosure obligations in each circumstance.

This question is not resolved by the court in this case, and it appears that at least for the time being, the prosecution will be subject to a lower standard of disclosure in quasi-criminal proceedings than in criminal proceedings, notwithstanding that proceedings under each regime may impose similar if not identical punishments on those convicted.

On March 19, 2013, the Ontario Superior Court of Justice (Divisional Court) released its judgment in Cornish v. Ontario Securities Commission, on appeal from a decision of the Ontario Securities Commission (the “Commission”) issued September 28, 2011. The appeal concerned the Commission’s interpretation and application of the term “material change” in the Securities Act, R.S.O. 1990, c. S.5 (the “Act”) and the obligations of reporting issuers to disclose such material changes.

This case provides greater insight and certainty into the meaning of “material change” and the obligations of reporting issuers when such changes occur.

Facts

Cornish was President and CEO of Coventree Inc. (“Coventree”), a niche investment bank specializing in structured finance. Coventree managed and administered ten separate trusts commonly called “conduits” which issued asset-backed commercial paper debt instruments (“ABCP”).

On January 19, 2007, the Dominion Bond Rating Service (“DBRS”) issued a press release in which it changed its credit rating criteria for certain credit arbitrage transactions. The effect of this change was to require Coventree to secure an unattainable type of liquidity to back credit arbitrage transactions going forward. Before this change, the now DBRS-restricted type of credit arbitrage transactions represented 40% of the conduits’ assets, and their use was the largest contributor to Coventree’s growth.

Coventree referred to the DBRS press release in a letter to its shareholders on February 14, 2007, and again in its second quarter Management’s Discussion & Analysis (“MD&A“), publicly filed on May 14, 2007. It stated that the DBRS January Release would “have the effect of reducing the profitability of the Company by substantially curtailing its ability to grow, if not halt in the short term, its credit arbitrage business.”

In July 2007, Coventree took various steps to attempt to address the lack of demand for new ABCP. However, on August 13, 2007, the market for Coventree-sponsored ABCP collapsed, and Coventree’s ABCP investors could not sell or redeem their ABCP instruments. Cornish prepared and issued a press release disclosing the market disruption as a material change.

The Commission found that Coventree breached the Act by failing to issue a news release and failing to file a material change report about the DBRS January Release. The Commission reached this conclusion despite the fact that Coventree’s mentions of the DBRS January Release in its February 14, 2007 letter to shareholders and in its May 14, 2007 MD&A did not result in any significant change in the price of Coventree shares.

Material Change Analysis

Section 75 of the Act requires “forthwith” disclosure of material changes to a reporting issuer’s business, operations or capital. Section 1.1 of the Act defines “material change as”

[A] change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price or value of any of the securities of the issuer.

Regarding the application of s. 75 of the Act, the court in this case states:

The first part of the analysis under s. 75 of the Act requires a determination as to whether a change in the “business, operations or capital” of the issuer has occurred and, if so, when. The second part of the analysis requires an assessment of whether the change was material in the sense that it “would reasonably be expected to have a significant effect on market price or value of the securities.”

The court clarified that the appropriate test to be applied in determining materiality is the “market impact test” which considers what effect certain facts, events or developments would reasonably be expected to have had on the market price or value of Coventree shares.

The court also identified governing principles in applying s. 75 of the Act, and determining if a material change has occurred. The following are the most salient principles identified by the court:

1. Materiality should be assessed objectively from the perspective of an investor and prospectively through the lens of expected market impact. A super critical interpretation of the meaning of “material change” does not support the goal of promoting disclosure or protecting the investing public. If the decision is borderline, the information should be considered material.

2. “Assessments of materiality are not to be made against a standard of perfection or with the benefit of hindsight.”

3. “When a reporting issuer is considering material change disclosure it must apply an objective test as to the expected market impact as it will not have the benefit of actual market impact information.”

4. “Materiality is a highly contextual issue that requires the commission to apply statutory obligations to a particular company in the context of its industry and the market. No single factor will be determinative of whether a material change occurred. In making determinations about materiality common sense must prevail in assessing the broader factual context or the ‘total mix’.”

5. “Since materiality is highly contextual there is no bright line test to determine whether a material change has occurred. That assessment depends on particular circumstances and events.”

6. “A disclosure obligation arises when the material change actually occurs and if the financial impact is experienced at a later date the disclosure obligation is not delayed to that later date.”

7. “The determination of whether a material change has occurred does not require deference to the business judgment of management.”

8. “The commission does not always need evidence of effect on market price to find a material change” has occurred.

Additionally, the court explained why evidence as to an actual impact on the market price of shares is not necessary to prove that a material change has occurred. In the absence of an actual impact on market price, a careful analysis of detailed evidence of the reporting issuer’s business and operations, market conditions and various other market-related factors would be sufficient. As an expert tribunal, the Commission merely applies its expertise to the evidence before it to explain why a lack of change in share price was not determinative of a material change issue.

This case provides greater certainty to reporting issuers in determining their obligations to disclose material change. Notwithstanding that Coventree did in fact inform its shareholders of the likely impact of the DBRS January Release, Coventree did not go far enough in reporting the material change. Based on the principles identified by the court with respect to the application of s. 75 of the Act, reporting issuers faced with similar material changes will not satisfy their obligations under the Act if they fail to file a material change report and news release. Their obligations are not lessened even if an actual change in share value does not result from the material change.

In a recent decision,the Supreme Court of British Columbia set aside and declared invalid an annual general meeting of shareholders and the resolutions passed at the meeting following a proxy fight between management and dissident shareholders. The court found that management’s proxy solicitation firm had improperly executed proxies on behalf of shareholders, based on instructions given by telephone to representatives of the proxy-solicitation firm (the “TeleVote System”). The court concluded that the TeleVote System failed to provide a contemporaneous, reliable, and verifiable record of proxies and voting instructions with the result that the use of such a system was oppressive to shareholders.

Background

The court’s decision arose in the context of a proxy fight between the incumbent slate of directors of Mosquito Consolidated Gold Mines Limited (“Mosquito”) and a dissident slate led by two former directors of Mosquito. Each side delivered information circulars to shareholders and engaged proxy-solicitation firms to solicit proxies from shareholders.

Management’s proxy-solicitation firms offered telephone and internet voting, using a unique control number found on a shareholder’s proxy or voting information form. In addition, one of management’s firms used the TeleVote System. Under this system, a call centre was established in which representatives of the solicitation firm telephoned registered shareholders and non-objecting beneficial owners of shares to solicit their votes for the management slate. The call centre operators were permitted to accept verbal instructions from individuals and execute proxies on their behalf.

At Mosquito’s shareholder meeting, the validity of the proxies obtained through the use of the TeleVote System was challenged by the dissident slate but the Chair of meeting ruled that the proxies were valid. The shareholder vote was in favour of the management slate, albeit by a narrow margin. Had the proxies obtained through the TeleVote System been excluded, the dissident slate would have been elected.

Oral Instructions by Telephone Not Standard Practice

A company controlled by one of the members of the dissident slate filed an application seeking a declaration that Mosquito’s annual general meeting was conducted in a manner that was oppressive to it as a shareholder of Mosquito, as well as orders nullifying the resolutions passed at the meeting and requiring a new shareholder meeting to be held.

In granting the application, the court held that, while Mosquito shareholders had a reasonable expectation that their proxies would be solicited by telephone, they did not reasonably expect that their proxies would be sought and votes would be cast at the same time. This process departed from the standard commercial practice of voting methods for shareholder meetings under securities instruments and the Securities Transfer Association of Canada Protocol. Moreover, the use of the TeleVote System was not disclosed in management’s information circular together with the other specified voting methods, including delivering a proxy by mail, hand, or fax or appointing a different proxy holder by mail or through the internet.

Lack of Verification and Safeguards

While the court noted that the use of telephone solicitation systems is a legitimate attempt to streamline shareholder proxy solicitations and the absence of guidelines does not automatically disqualify the use of such systems, it identified several problems with the use of the TeleVote System in the context of the battle for control of the board of directors of Mosquito. In particular, amongst other deficiencies, the court criticized

• The acceptance of oral instructions without an immediate link to a verifiable, written confirmation;
• The absence of a unique identifier to ensure the identity of the individual giving instructions;
• The failure by management to make prior disclosure of the use of the TeleVote System;
• The lack of sufficient safeguards to ensure that votes were taken in a manner that allows the shareholder to make his or her choices privately, on a fully informed basis, and without undue pressure from a proxy solicitor; and
• The imbalance between the use of the TeleVote System by the management slate and the traditional proxy solicitation process used by the dissident slate.

Ultimately, the court concluded that the use of the TeleVote System constituted oppressive and unfairly prejudicial conduct and impaired the right of shareholders to a fair and transparent voting process.

Conclusion

In the event that an incumbent slate of directors finds itself in a proxy contest, the management slate must ensure that the proxy solicitation tactics used by its proxy solicitors are fully disclosed in management’s information circular and that such tactics will produce verifiable and reliable results. The failure to ensure the existence of sufficient safeguards risks invalidating the election of directors and other shareholder business at an otherwise valid shareholder meeting.

This article was originally published in Corporate Governance Report, Vol. 8, No. 1 and is republished with permission.

We are delighted to announce our new global law firm, Dentons!

On March 28, FMC combined with international firms Salans and SNR Denton. Each founding firm has built its solid reputation and valued clientele by responding to the local, regional and national needs of a broad spectrum of clients of all sizes—individuals; entrepreneurs; small businesses and start-ups; local, regional and national governments and government agencies; and mid-sized and larger private and public corporations, including international and global entities.

We are now working together with 2,500 talented lawyers and professionals in 79 locations in 52 countries across Africa, Asia Pacific, Canada, Central Asia, Europe, the Middle East, Russia and the CIS, the UK and the US. Our Securities Litigation team now has a global network that will benefit Dentons’ clients. Check out Introducing Dentons for an overview of our new firm and please do not hesitate to contact us with any questions or comments.

These are very exciting times — for our clients, for our work and for the insights we bring to this blog. To find out more about our new firm, about what makes Dentons different, please visit www.dentons.com.

In certain circumstances, directors and officers may find that their claims for indemnification under a directors’ and officers’ insurance policy have been denied by the insurance company as a result of various exclusions contained in the policy.

However, the Ontario Court of Appeal’s recent decision in Lloyds Syndicate 1221 (Millennium Syndicate) v. Coventree Inc. suggests that, depending on the circumstances in which the insurance agreement was entered into, the words of the policy, including any exclusion clauses, may not be determinative as to whether the directors and officers are entitled to coverage.

Notice of potential claims

Coventree Inc. was a major participant in Canada’s asset-backed commercial paper (“ABCP”) market. When the ABCP market collapsed in August 2007, Coventree found itself exposed to potential regulatory and civil liability.

Coventree Inc. and its directors and senior officers were insured under a policy issued by the Great American Insurance Company (“Great American”) that had a coverage limit of $1 million. The policy was set to expire on October 17, 2007 and Great American advised Coventree Inc. that the policy would not be renewed.

However, the policy included coverage for claims commenced after the policy’s expiration provided that Coventree Inc. delivered notice of the potential for such claims before the policy expired.

On October 16, 2007, Coventree Inc. gave notice to Great American of all potential claims that it envisioned could arise from the ABCP market collapse (the “Great American Notice”). The Great American Notice was worded as broadly as possible to maximize post-expiry coverage.

Prior act coverage

Coventree Inc. also sought supplementary coverage by obtaining insurance from Lloyds Syndicate 1221 (“Lloyds”). After a series of negotiations, Lloyds issued an insurance policy for Coventree Inc. in the amount of $10 million for the period from October 17, 2008 to October 17, 2010 (the “Lloyds Policy”).

The Lloyds Policy provided coverage for any alleged act that occurred before October 17, 2007. However, this prior act coverage was capped at the first $5 million of the $10 million limit.

OSC proceedings

In July 2009, the Ontario Securities Commission commenced regulatory proceedings against Coventree Inc. and two of its senior officers. Coventree Inc. incurred more than $12 million in legal fees in responding to the proceedings and sought to recoup some of this amount from its insurers.

Since the regulatory proceedings fell within the scope of the potential claims identified in the Great American Notice, Great American agreed to pay out its coverage limit of $1 million. Lloyds, however, denied coverage to Coventree Inc. on the basis that while the Lloyds Policy included prior acts, it excluded the potential claims referred to in the Great American Notice.

Alleged carve-out

Lloyds relied on a carve-out provision in Coventree Inc.’s insurance application form to deny coverage to Coventree Inc. for claims identified in the Great American Notice. When Coventree Inc. had applied for insurance coverage from Lloyds, it had been asked the following question:

6(c) Has anyone for whom this insurance is intended given notice under the provisions of any other previous or current insurance policy of any facts or circumstances which may give rise to a claim being made against the Company [Coventree] and/or any Director and/or Officer? If Yes, please provide details.

This question was followed by a carve-out provision stating:

It is understood and agreed that if any such claims exist, or any such facts or circumstances exist which could give rise to a claim, then those claims arising from such facts or circumstances are excluded from the proposed insurance.

Coventree Inc. answered question 6(c) in the affirmative and attached the Great American Notice to the application. Lloyds argued that pursuant to question 6(c) and the carveout provision, any claim for which Coventree Inc. had provided notice to a previous insurer would be excluded from coverage.

Policy context and purpose

Both the application judge and the Court of Appeal rejected Lloyds’ position and held that the Lloyds Policy provided coverage against claims referred to in the Great American Notice. The Court of Appeal emphasized the negotiations surrounding the Lloyds Policy rather than the wording of the policy documents themselves.

The court stated that while the examination of any written contract must begin with the text of the agreement, the words alone may not be determinative of the objective intention of the parties.

The court determined that it could examine the factual circumstances at the time of the negotiation and signing of the contract to determine what a reasonable person would have understood the agreement to mean.

The court found that when Coventree Inc. applied to Lloyds, it was specifically seeking additional insurance coverage for matters in the Great American Notice since Great American’s coverage was limited to $1 million. After the ABCP market crash, Coventree Inc. was financially devastated and in the process of winding down its operations.

Coventree Inc. did not require insurance for any subsequent acts since it was not conducting any new business. Coventree Inc.’s sole objective in obtaining insurance from Lloyds was to ensure that prior acts would be covered by the policy.

Parties’ communications

The court determined that in answering question 6(c) in the affirmative and providing Lloyds with a copy of the Great American Notice, Coventree Inc. ensured that Lloyds was aware of the potential claims that could be made during the Lloyds Policy period.

The court further noted that the main topic of the negotiations between Coventree Inc. and Lloyds was the potential litigation risks that were the subject of the Great American Notice.

In subsequent communications, Lloyds sent a proposal to Coventree Inc. with the phrase, “waive questions number 6 and 7.” The Court found that this was clear evidence that Lloyds knew about the Great American Notice as well as Coventree Inc.’s interest in obtaining coverage for acts covered by the notice.

In addition, that by delivering such a proposal, Lloyds indicated that it would not exclude coverage of potential claims described in the Great American Notice.

Although Lloyds’ proposal did not form part of the final insurance documents, the court found that it was a relevant part of the factual matrix which, when viewed objectively, showed that the parties intended the Lloyds Policy to include claims covered by the Great American Notice.

The court also noted that the Lloyds Policy stated that coverage for acts prior to October 17, 2007 would be capped at $5 million. The court reasoned that since the Lloyds Policy provided a cap on coverage for prior acts, it implicitly covered claims referred to in the Great American Notice up to $5 million.

Exclusion clause rejected

The court rejected Lloyds’ submission that two general provisions in the Lloyds Policy operated to exclude coverage for claims referred to in the Great American Notice. Notably, one of the provisions was an exclusion clause for claims for which notice was previously given to another insurer.

The court held, however, that an exclusion clause in an insurance contract should be construed narrowly, with the result that the general exclusion clause could not be interpreted as altering the parties’ specific agreement that the Lloyds Policy covered potential claims identified in the Great American Notice.

Significance

The Court of Appeal’s decision in this case is noteworthy for the court’s reliance on the context under which the insurance policy was issued, and the purpose for which the insured obtained coverage — rather than the wording of the policy itself — in interpreting the policy. This shift in interpretive focus is exemplified by the court’s refusal to consider the exclusion clause for prior claims once it concluded that the parties intended for the Lloyds Policy to cover such claims.

Ultimately, the court’s decision suggests that directors and officers(as well as the companies that may be obligated to indemnify them) may be able to overcome exclusions of coverage where they can demonstrate that the context and purpose underlying the policy favours an interpretation which extends coverage to them.

However, the Court of Appeal’s decision may not be the final word on the matter, as Lloyds has sought leave to appeal this decision to the Supreme Court of Canada.

This article was co-authored with Dentons’ Soloman Lam. It was originally published in Legal Alert, Vol. 31, No. 8 and is republished with permission of Carswell, a division of Thomson Reuters Canada Limited.

Directors of Canadian companies with operations outside of Canada can take comfort in the Ontario Court of Appeal’s recent decision in Piedra v. Copper Mesa Mining Corporation. In that decision, the court dismissed an appeal by three residents of Ecuador from a decision striking their claims against Copper Mesa Mining Corporation (“Copper Mesa” or the “Company”) and two of its directors (the “Directors”). The claims had been stricken for failing to disclose a reasonable cause of action.

Broadly speaking, the plaintiffs had alleged that the Company and the Directors were negligent in not preventing alleged assaults by the Company’s security forces against the plaintiffs. In its decision, the court canvassed a director’s duty of care to foreign residents for acts of the corporation outside of Canada and determined that any claims by such plaintiffs must be specifically pleaded against the defendants.

Background

The plaintiffs were citizens of Ecuador who had opposed the exploration and development of an open-pit copper mine adjacent to several small villages in the Junín area of Ecuador (the “Junín Project”). The project was being developed by subsidiaries of Copper Mesa, a junior mining company incorporated under the laws of British Columbia. Copper Mesa’s shares were listed on the TSX.

The plaintiffs alleged that Copper Mesa’s subsidiaries subjected the plaintiffs and other local villagers to a campaign of intimidation, harassment and violence carried out by locally hired security forces. The plaintiffs claimed that the Directors knew of local opposition to the project (including the potential for violence) but failed to take any steps to prevent the violence from occurring.

The defendants brought a motion to strike the plaintiffs’ claims under Rule 21.01 of the Rules of Civil Procedure on the basis that the claims disclosed no reasonable cause of action. The motion judge agreed and dismissed the action. The plaintiffs appealed to the Court of Appeal.

Claim against the Directors

The plaintiffs argued that the Directors were personally liable for the torts committed by Copper Mesa’s subsidiaries. As a result of a meeting with community members, the Directors had knowledge of local opposition to the Junín Project and, according to the plaintiffs, failed to use that knowledge to prevent the harassment and violence experienced by the local villagers.

The plaintiffs relied on Copper Mesa’s prospectus disclosures and other publicly available documents as further evidence of the Directors’ knowledge about the potential for conflict surrounding the Junín Project. The court concluded that the claim against the Directors disclosed no reasonable cause of action as the foreseeability and proximity requirements to establish a duty of care were not satisfied by the plaintiffs’ pleadings. The court reaffirmed the principle that a director’s personal liability for the acts of the corporation is limited except when the director’s personal actions are themselves tortious.

In this case, there was no direct connection between the violence in Ecuador and the Directors. Moreover, there was no factual basis to suggest that the Directors had committed any personal wrongdoing.

Choice of defendants

The court commented that the plaintiffs’ choice of defendants highlighted the weakness of the connection between the incidents of violence in Ecuador and the Directors named in the action. The court questioned the decision not to include as defendants in the action the perpetrators of the alleged torts in Ecuador, Copper Mesa’s subsidiaries and their management teams, as well as other Copper Mesa officers or directors.

Further, the plaintiffs decided not to advance a direct claim against Copper Mesa as the parent company. Instead, the plaintiffs indirectly claimed against Copper Mesa on the basis of vicarious liability for the claims made against the Directors.

Significance

It remains to be seen whether this action would have survived the motion to strike the claims if the plaintiffs had chosen to name other defendants in the action, for example, Copper Mesa’s subsidiaries and their management teams. The plaintiffs’ choice not to include these potential defendants may have resulted from a concern that, had these defendants been included, the plaintiffs may have faced a jurisdictional challenge, given that these defendants have no apparent connection with Ontario.

Several Canadian companies, particularly those in the resource and mining industries, carry on business in foreign jurisdictions and may face opposition to development projects from local residents for various reasons.

Ultimately, the Court of Appeal’s decision establishes that bald, generalized claims against directors for the alleged wrongful acts of agents or employees in foreign jurisdictions are insufficient to sustain a cause of action against them. It is not enough to assert liability against a director simply because of the director’s position. Instead, if plaintiffs wish to pursue a claim, they must set out particularized allegations regarding the director’s knowledge, specific wrongful acts or failures to act, to maintain a claim.

This article was co-authored with FMC’s John Zerucelli. It was originally published in Legal Alert, Vol. 31, No. 5 and is republished with permission of Carswell, a division of Thomson Reuters Canada Limited.

In the recent decision of Tucci v. Smart Technologies Inc. (2013 ONSC 802), Justice Perell confirmed that the statutory cause of action for misrepresentation in a prospectus (set out in s. 130(1) of the Ontario Securities Act, R.S.O. 1990, c. S.5 (the “OSA”)) does not apply to purchasers in the secondary market even when those purchasers buy securities during an ongoing IPO.

Background

In Tucci, the defendant Smart Technologies (“Smart”) filed a prospectus for the purposes of an IPO in respect of which the period of distribution began on July 15, 2010. In addition to Smart, both the defendants Intel Corporation and School S.a.r.L. sold Smart shares pursuant to the IPO. The IPO closed on July 20, 2010. However, prior to closing, the Smart shares began trading on the secondary market (on both the TSX and NASDAQ). The plaintiff alleges that on November 9, 2010, Smart made corrective disclosure in respect of a misrepresentation contained in its prospectus. The plaintiff subsequently commenced a proposed class action asserting a claim for damages under s. 130 of the OSA (as well as similar claims under the relevant sections of other Canadian securities legislation).

At the certification motion before Justice Perell, the defendants consented to certification of the action subject to one contested issue regarding the scope of the plaintiff’s proposed class definition. Section 130(1) of the OSA provides that where a prospectus contains a misrepresentation, “a purchaser who purchases a security offered by the prospectus during the period of distribution or during distribution to the public” has a cause of action against, amongst others, the issuer and underwriters of the securities in question. This statutory cause of action has conventionally been understood to be available only to purchasers buying securities in the primary market, and not purchasers in the secondary market (who have their own statutory cause of action set out in s. 138.1 of the OSA for which leave is required). The plaintiff challenged this conventional understanding by seeking to certify a class which included persons who acquired Smart shares on the secondary market between July 15 and 20, 2010, arguing that during the period of distribution, purchasers in both the primary and secondary markets are similarly situated and, as a matter of public policy, it is desirable to treat similarly-situated persons equally. The plaintiff also sought to distinguish existing Ontario case law restricting the s. 130 cause of action to primary market purchasers on the basis that those cases only addressed secondary market purchasers who bought securities after the primary market distribution had been completed.

In rejecting the plaintiff’s submissions, Justice Perell held that a secondary market purchaser does not purchase securities offered by a prospectus but, rather, purchases securities offered by a secondary market vendor, likely at a different price and on different terms of sale than primary market purchasers. Justice Perell also noted that the plaintiff’s “strained interpretation” would have the anomalous result that some s. 130 claimants (the secondary market purchasers) would not have the alternative statutory right of rescission which is only available against the issuer, selling security holders and underwriters (and not secondary market vendors). In the result, the plaintiff’s proposed class definition was revised by excluding secondary market purchasers.

Commentary

This result is consistent with previous decisions, including Menegon v. Philip Services Corp. (2001 CanLII 28396 (ON SC)), in which FMC’s J.L. McDougall and Michael Schafler successfully argued that extending s. 130 to secondary market purchasers could expose issuers and their advisors to indeterminate liability, as primary market purchasers might sell their purchased securities during the period of distribution to secondary market purchasers, who may themselves resell the securities several times.

On February 6, 2013, the Court of Appeal for Ontario agreed to review its much discussed decision in Sharma v. Timminco Limited (2012 ONCA 107).

Background

Timminco concerned a proposed class action in which the plaintiff sought to assert a claim for secondary market misrepresentation pursuant to section 138.3 of the Ontario Securities Act, R.S.O. 1990, c. S.5 (the “OSA”), for which leave of the court is required under s. 138.8(1). Section 138.14 of the OSA provides that an action under s. 138.3 must be commenced within three years of the date of the alleged misrepresentation (or within six months following the issuance of a news release disclosed that leave has been obtained, whichever occurs first). The plaintiff had asserted in his Statement of Claim that he intended to seek leave as required by the OSA but, for various reasons, had not obtained leave by February 2011 (when the three-year limitation period was about to expire). The plaintiff thus sought and obtained an order declaring that the limitation period had been suspended by s. 28(1) of the Class Proceedings Act, 1992, S.O. 1992, c. 6 (the “CPA”), which provides that “any limitation period applicable to a cause of action asserted in a class proceeding is suspended in favour of a class member on the commencement of the class proceeding”. The defendants appealed to the Court of Appeal on the issue of whether pleading the intention to seek leave was sufficient to suspend the limitation period. The Court of Appeal overturned the initial decision, concluding that without leave having been obtained, no cause of action under s. 138.3 was being “asserted” so as to engage s. 28(1) of the CPA. As such, the cause of action for secondary market misrepresentation was not a legal right and could not be enforced. The Supreme Court of Canada declined to review the decision.

Since its release in February 2012, Timminco has attracted criticism from the plaintiffs’ bar which argues that the court’s approach has proven to be unworkable given the inherent delays in the court system, and the ability of corporate defendants to exacerbate those delays. In contrast, the defence bar has praised Timminco as providing certainty.

In the meantime, two further secondary market liability cases had come before the Court of Appeal on appeal: Green v. Canadian Imperial Bank of Commerce (2012 ONSC 3637), in which Justice Strathy reluctantly declined to certify a class action because it was time-barred by the three-year limitation period; and Silver v. IMAX (2012 ONSC 4881), in which Justice van Rensburg granted an order issuing retroactive leave under s. 138.8 of the OSA to allow the claim to proceed. IMAX is particularly interesting in that oral argument on the leave application had concluded before – and Justice van Rensburg’s decision was released after – the three-year limitation had expired. At the request of the plaintiffs in both cases, the Court stated that it would appoint a special five-judge panel to hear the two appeals and reconsider the issues raised by Timminco. The panel is set to convene in May 2013.

Commentary

Limitation periods are meant to provide certainty by representing an ultimate cut-off for potential legal proceedings. Recent legislative reforms were aimed at making Ontario’s limitation period laws even stricter by eliminating the “special circumstances” doctrine. IMAX represents a departure from this trend and a step back towards the “special circumstances” doctrine. On the other hand, Timminco seemed harsh. What, specifically, has motivated the Court of Appeal to reconsider the issue is not known. Typically, however, full panels of the Court of Appeal are convened to reconsider decisions that have sparked public debate, which has been the case here. It may be that the Court of Appeal wishes to clarify its prior ruling – for example, by promulgating a new test for these types of cases. It may also be that the Court overrules itself. Our own view is that the Court may well provide clarification as to the meaning of the word “asserted” found in s. 28(1) of the CPA; the Court may, for example, hold that the launching of a leave motion under s. 138.3 of the OSA should suffice to suspend the applicable limitation period, since that step is akin to “asserting” a claim within the meaning of s. 28(1) of the CPA. It may also hold that as long as the motion is heard before the limitation period expires, the limitation period will have been complied with.

Deloitte & Touche Inc. (“Deloitte”), the long-acting trustee for the Estate of Bre-X Minerals Ltd., has brought motions in the Alberta and Ontario courts seeking leave to discontinue the class action litigation that it has been prosecuting against, amongst others, former Bre-X principal John Felderhof and his ex-wife Ingrid Felderhof, as well as the Estate of founder and CEO David Walsh.

As a brief background, in October 1997, an action was commenced in Alberta by investors who lost money on the collapse of Bre-X. In November 1997, the Alberta Bankruptcy Court authorized Deloitte to prosecute the class action on behalf of these investors; shortly thereafter, Deloitte was granted carriage in Ontario in January 1998 (collectively, the “Deloitte Action”). The Deloitte Action asserted that John Felderhof failed to promptly disclose material changes relating to Bre-X’s gold mining properties, and that he conspired with others to deceive investors by issuing false statements, announcements and press releases.

Deloitte’s motions for discontinuance are being brought for two reasons: Deloitte no longer has the financial resources to prosecute the Deloitte Action, and it believes that there is no reasonable prospect of significant recovery from the Felderhofs or the Walsh Estate. Deloitte’s motions are opposed by David Carom, one of the plaintiffs in a second class action against the Felderhofs and the Walsh Estate which, until recently, was in a litigation partnership with the Deloitte Action.

In anticipation of Deloitte’s Ontario discontinuance motion hearing (currently scheduled for March 4, 2013), Mr. Carom recently brought a cross-motion seeking an order that Ingrid Felderhof and Jeannette Walsh (David Walsh’s widow) attend to be examined as witnesses under Rule 39.03 of the Rules of Civil Procedure, and that Ingrid Felderhof allow class counsel to obtain an appraisal of a property in the Cayman Islands. Deloitte opposed the cross-motion based on its concern that its discontinuance motion could be affected in the event that either of the proposed witnesses failed to comply with any order made by the court.

At the cross-motion hearing (2012 ONSC 7278), Perell J. held that since neither of the proposed witnesses had actually been served with a summons, the appropriate decision was to adjourn the cross-motion to allow Mr. Carom to serve summonses. Perell J. noted, however, that had summonses been served, he saw no basis for striking them out. With respect to the request for an appraisal, Perell J. dismissed the motion without prejudice due to the lack of advice concerning his jurisdiction to make such an order, noting that Ingrid Felderhof was not a party to the Ontario litigation.

In the recent decision of Dugai, Murphy v. Manulife Financial Corporation (2013 ONSC 327), the Divisional Court confirmed the principle that defendants have no obligation to lead evidence on a motion for leave to assert a cause of action for secondary market misrepresentation under s. 138.8(1) of the Ontario Securities Act, R.S.O. 1990, c. S.5 (the “Act”).

In Dugai, the plaintiff investors proposed a class action alleging inadequacies in the defendant corporation’s Risk Management Policies and Practices, including a cause of action for secondary market misrepresentation under Part XXIII.1 of the Act (for which they require leave under s. 138.8(1)). After being advised that the defendants did not intend to file any affidavits on the leave motion (currently scheduled for March 2013), the plaintiffs summoned two Manulife employees under Rule 39.03 of the Rules of Civil Procedure to provide relevant evidence for use during the leave motion. The defendants brought a motion to quash the summonses, and the plaintiffs brought a cross-motion to compel the defendants to file affidavits. Belobaba J. granted the defendants’ motion and dismissed the cross-motion; the plaintiffs sought leave to appeal in the Divisional Court.

In upholding Belobaba J.’s decision and dismissing the plaintiffs’ application, Harvison Young J. agreed with his analysis that the two issues on motion – whether defendants are required to serve and file affidavits on a s. 138.1 motion, and the availability of Rule 39.03 summmonses in such circumstances – have already been fully adjudicated. Both judges drew particular attention to the decision of Lax J. in Ainslie v. CV Technologies (2008), 93 O.R. (3d) 200 (S.C.J.), one of the first actions brought under Part XXIII.1 of the Act. In Ainslie, FMC’s Robb Heintzman and Matthew Fleming successfully argued that the Act only requires a defendant to file an affidavit where it intends to lead evidence in response to a leave motion, and that allowing the plaintiffs to examine the defendants in the absence of such affidavit evidence would amount to an abuse of process, as it would afford the plaintiffs greater rights of discovery than in an action where it is unnecessary to obtain leave.

Harvison Young J. concluded that the number of recent cases which accepted and applied the reasoning in Ainslie “overwhelming supports the motion judge’s interpretation of s. 138.8 that it does not require the defendants to deliver affidavits or to be subjected to cross examination when they do not intend to lead evidence in response to the leave motion”.