Canadian companies will recall that at the end of 2005, Ontario, reacting to complaints that shareholders were facing difficulties convincing courts to certify class actions for alleged corporate misrepresentations in the secondary market, amended the Securities Act (Ontario) to address that concern.
The amendments in Part XXIII of the Act created a statutory cause of action for such misrepresentations, and stipulated that any investor who bought (or disposed of) securities during the period between the date of the misrepresentation and the date it was publicly corrected could recover damages even if they did not receive or rely upon the misrepresentation in deciding to buy (or sell). The elimination of the common law reliance requirement was expected to pave the way for individual shareholders to represent a class of all investors during the relevant time period, although the amendments also included a protective element for issuers, as investors were required to obtain leave from the court before proceeding with their proposed action. That is, a shareholder must serve the draft Statement of Claim and his supporting affidavit(s) on the target company and its officers and directors sought to be named as defendants, and those individuals must serve responding affidavits defending themselves. The draft Claim, the affidavits, and the transcripts of the cross-examinations of the investor and the officers and directors are all then placed before the court. The judge will either allow the Claim to be issued as a proposed Securities Act class action, or deny the investor the right to proceed, by deciding whether the investor is acting “in good faith,” and whether their proposed lawsuit has a “reasonable possibility of success at trial.”
In 2006, it was widely expected that numerous such proposed Securities Act class actions would be served in Ontario (and in the other provinces, which rapidly passed similar amendments to their securities legislation.) Somewhat surprisingly, however, the onslaught of cases has not yet materialized. As of July 2008, it is believed that only ten draft Claims have been served on companies in Ontario (and we are not aware of any cases in the other provinces). Only one Ontario case has even progressed to the scheduling of a leave motion.
It is possible that the uncertainty as to the stringency of the leave test — the concern that the courts may require a shareholder to have in hand a significant factual foundation for his case just to obtain leave to proceed with it — has been a deterrent to counsel for potential class action plaintiffs. If so, the first interlocutory decision in the ground-breaking Ontario case will be of concern to corporate Canada, as it may be interpreted to have tipped the balance of power meant to have been created by the statutory amendments in favour of prospective plaintiff shareholders.
In Silver v. IMAX Corp., the Ontario Superior Court was asked to define, for the first time, the range of information that the proposed plaintiff shareholder could require from the proposed defendant officers and directors.
Could otherwise confidential corporate documents (including minutes of meetings of the board of directors and audit committee, and communications with the company’s auditors) be obtained? In a judgment released in May 2008, the Court concluded that the legislation granted investors “special powers” — even before leave is granted and their action issued — and ruled that the directors and officers were required to answer every question relevant to any allegation made in the draft claim, or any defence raised in the responding affidavits. Leave to appeal from this decision was refused in July 2008.
McCarthy Tétrault Notes:
The leave motion included in the Securities Act amendments in 2005 was expressly intended to prevent investors without sufficient material facts in hand from pursuing unsupported actions (to the detriment of the shareholders of the target company). Yet the Ontario court has now granted shareholders — even before they become plaintiffs — an opportunity to obtain otherwise confidential corporate information and documents to support (or even expand) their proposed lawsuit. That decision, which appears to grant investors the power to essentially conduct an oral and documentary examination for discovery before a lawsuit has even been commenced, therefore seems to contradict the very “gatekeeper” function that was the impetus for inserting the screening provision into the revised legislation in the first place.
The effect of this ruling, if it is used by investors as a grant of pre-emptive discovery-like rights, may have significant repercussions for reporting issuers and other public companies across Canada. It remains to be seen who will benefit more if extensive discovery on the merits of allegations and defences occurs before the lawsuit is even commenced. Will shareholders otherwise lacking strong evidence of corporate wrongdoing now put forward cursory draft claims in an attempt to gain that knowledge from their intended corporate and individual defendants? Will corporations decide to test the will (and pocketbooks) of prospective plaintiffs right from the outset by choosing to advance a very extensive record, including expert reports, in an aggressive defence to the leave motion, in effect trying the case before a Claim is even issued?
The risks are particularly pronounced for dual-listed issuers, as this pre-suit production decision appears to be directly at odds with the rules governing secondary market securities actions in the United States, where an immediate stay of discovery occurs to allow the defendant corporation to bring a motion to dismiss the action (so that a court thereby tests the factual and legal foundation of the action before the plaintiffs can conduct discoveries to obtain information and documents directly from the defendants). It is unclear at this date whether the evidence obtained on a Canadian leave motion cross-examination may be made available to US plaintiffs otherwise subject to a stay of discovery order.
Further, if shareholders can exercise discovery-like powers prior to the leave hearing in Canada, the leave test itself, which has not yet been interpreted by any judge, should also be impacted. Given the chance to examine on every allegation in their draft statement of claim, investors should be required to demonstrate an evidentiary foundation for every such allegation to gain leave from the court to issue their pleading and proceed.
These and other strategic considerations seem likely to make the “preliminary” stage of proposed secondary market civil liablity litigation a challenging and uncertain battleground for investors and corporations alike in the immediate future.