The Supreme Court of Canada decision in Sharbern Holdings Inc. v. Vancouver Airport Center Ltd., has addressed a key issue of importance to the corporate world:  “What must an offering memorandum contain?”  The Court reaffirmed the test, long established in provincial appellate cases, that only material facts need to be disclosed in offering memoranda or disclosure statements.  Noting that materiality will be determined on an objective basis, the court defines the test as information that a reasonable investor would likely have considered important in making her decision.  Only information which is determined, objectively, to be material needs to be disclosed.

There is a constant tension when preparing disclosure statements or offering memoranda between enticing a potential investor and scaring them away. This tension is exasperated by numerous statutes that impose disclosure obligations upon issuers. Those statutes require issuers to disclose to potential investors information affecting their investment decision, either at the time of issuance or even for secondary market disclosures. The struggle for issuers and companies is to determine when disclosure of information is required and how much is too much.

The Supreme Court of Canada, in the recent decision Sharbern Holdings Inc. v. Vancouver Airport Center Ltd., dealt with this issue.  Shabern was a class action lawsuit brought by investors in a Hilton hotel claiming misrepresentations by omission.  To determine the question of misrepresentation, the Supreme Court addressed the need to balance too much information with too little disclosure. In particular, the court considered whether a failure to disclose certain information in an offering memorandum and disclosure statement amounted to a misrepresentation. The case turned upon whether the omitted information was material, and the test for determining such materiality.

The case is a refreshing confirmation that issuers need not disclose every possible piece of information. As noted at the outset of the decision, “issuers are not subject to an indeterminate obligation, such that an unhappy investor may seize on any trivial or unimportant fact that was not disclosed to render an issuer liable for the investor’s losses.” Instead, the obligation of an issuer is simply to disclose those facts for which, objectively, there is a substantial likelihood that a reasonable investor would have considered important in making his or her decision. The court was at pains to distinguish this standard as being one that a reasonable investor would have considered important, rather than a fact that merely might have been important.

Such a materiality standard strikes a balance between too much and too little disclosure. While potential investors are vulnerable to the superior knowledge of an issuer as to what need or need not be disclosed, the materiality standard avoids investors being buried in an avalanche of trivial information. A standard requiring the disclosure of too much information would be equally detrimental to the decision making of investors, as it would be difficult to parse the important from the unimportant information.

The test for materiality is determined at the time the disclosure is made. The courts are not to apply 20/20 hindsight. The court can consider the economic environment at the time the disclosure is made, the reasonable projections of financial benefits at that time, and the extent of the disclosure of risk all as part of the “total mix” of information available to the investor. It is only upon the consideration of this “total mix” of information that the court will determine whether the omitted fact is material.

The court also emphasized the distinction between the question of materiality and the business judgment rule. Under the business judgment rule, courts recognize that judges are less expert than managers in making business decisions. Managers should be free to take reasonable risks without having to worry that their business choices would later be second guessed by the judges.  As such, the courts will show deference to these decisions.

However, no similar considerations apply regarding the legal disclosure requirements. The question of materiality involves the application of a legal standard to a given set of facts. This falls squarely within the realm and expertise of judges. Furthermore, a manager’s assessment of risk does not have anything to do with their requirement to meet disclosure obligations. Rather, such legal disclosure requirements are set by the legislature and the courts, and not business management.

The court noted that there are no hard and fast rules in determining what is material, and it must be determined on a case by case basis. However, the court helpfully points out that the omitted fact must be considered in the context of the broader factual setting. This not only means in the context of the entire disclosure document, but also in the context of concurrent or subsequent conduct or events.  Such conduct or events would shed light on potential or actual behavior of investors in the same or similar situations.

On the facts in Sharbern, the alleged misrepresentation was a failure to disclose details of an agreement whereby the developer and manager of the Hilton hotel was also acting as the developer and manager of a neighbouring Marriott hotel.  The plaintiffs alleged that the details of the compensation agreement placed management in a conflict of interest situation, with a personal incentive to favour the Marriott hotel over the Hilton hotel.  Management had guaranteed a gross return on the purchase price for the Marriott hotel investors, but had no similar guarantee for the Hilton hotel.  While the Hilton investors were told in the disclosure statement that the developer and management were also involved with the Marriott, and had entered into documents “similar in form and substance” to those with the Hilton hotel, the details were not included.  Furthermore, the disclosure statement said that the developer “was not aware of any existing or potential conflicts of interest … that could reasonably be expected to materially affect the purchaser’s investment decision”.

The court considered extensive factual and expert evidence at trial concerning the actual and industry practice with respect to the management of hotels.  The defendants led evidence showing that common management of competing hotels was normal in the industry, and further did not have any actual detrimental impact on the performance of these hotels.  The court also noted that, at the time of the disclosure statements, the hotel business in this geographic area was booming, suggesting that neither occupancy rates nor competition from the Marriott would have been a problem.  The court even went further and suggested that conduct of investors who at the time otherwise received the omitted information, or investors who were subsequently fully informed of the omitted information, was relevant to the analysis. Where a fully informed investor nonetheless invested in the Hilton, or when investors who were subsequently provided full details of the compensation agreements raised no objection for a number of years, then the court may conclude that the information was not material to a reasonable investor. In those circumstances, it would be unfair to allow the investors to subsequently latch onto this omitted information as a basis to recover their subsequent losses in the investment.

It should be noted that the court was extremely critical of the failure of the plaintiff to lead any evidence as to the materiality of the omitted facts. The plaintiffs simply relied upon the omission, and deemed reliance provisions in the relevant statutory schemes governing the disclosure statements. The court noted that the mere fact of the omission was insufficient, and the onus was on the plaintiff to prove that the fact was also material before liability may arise.

Even for a deemed reliance provision in a statute, the onus lay upon the plaintiff to prove materiality of the omission before deemed reliance would apply. The court noted that any such deemed reliance would also be a rebuttable presumption, even if the statute did not specifically provide for same. To find otherwise would lead to an absurd and unjust result, since a non-rebuttable presumption of reliance would allow an investor to claim to have relied upon the deemed misrepresentation even if the investor had complete knowledge of all the facts. This would place issuers in the position of having to guarantee the losses of fully informed investors, an unfair result.

In the final analysis, the court held that the omitted facts were not material.  This recent decision of the Supreme Court of Canada, following its earlier decision in Kerr v. Danier Leather, recognizes and supports the difficult decisions and judgments made by reasonable business persons. By recognizing an objective standard of materiality, and permitting the court to consider the entire factual matrix surrounding the investments at the time they are made, the court affirms that investors are primarily responsible for their own investment decisions. The court imposes an obligation upon the investor to prove that any omitted evidence is, objectively, truly material.

As concluded by the court, “there must be a substantial likelihood that a reasonable investor would consider the fact as having significantly altered the total mix of available information.” It is only then that an issuer may be subject to liability, either at common law or through statutory deemed misrepresentation provisions. This is a welcome confirmation of previous case law and reaffirmation that not every potentially relevant piece of information need be disclosed.