On December 31, 2005, after a number of years and several failed attempts, the amendments to the Securities Act creating liability for secondary market disclosure came into force. The opposition to the amendments had come primarily from issuers concerned about the potential for U.S. style so called "strike" class action suits. The Ontario legislation (which over the intervening years has become virtually universal across Canada) purported to prevent this kind of litigation by providing in Section 138.8 that (i) no action may be commenced without leave of the court granted upon motion with notice to each defendant, and (ii) the court will grant leave only where it is satisfied that (a) the action is being brought in good faith, and (b) there is a reasonable possibility that the action will be resolved at trial in favour of the plaintiff. The section goes on to prescribe three procedural requirements. Subsection (2) states that, upon application for leave, the plaintiff and each defendant shall serve and file one or more affidavits setting forth the material facts upon which it intends to rely. Subsection (3) states that the maker of such an affidavit may be examined on it in accordance with the rules of the court. Subsection (4) states that a copy of the application and any affidavits filed with the court shall be sent to the Commission.
Two Ontario Superior Court of Justice decisions, reaching different results, have now considered these procedural provisions. The first decision potentially opens the door for plaintiffs to achieve indirectly what the provisions were intended to prevent. The second potentially puts defendants on the horns of a dilemma whether or not they should file an affidavit in the first place.
Silver v. IMAX Corporation
In this action, the plaintiffs alleged that IMAX Corporation's financial results between February 17, 2006 and August 9, 2006 did not comply with GAAP and were materially false and misleading. In support of their application for leave to commence the action, the plaintiffs filed affidavits of the representative plaintiffs, three proposed experts and a member of the class counsel team. In response, each defendant filed an affidavit as well as those of a proposed expert and a law student employed by counsel. A motion was brought by the plaintiffs to compel the defendants to answer 26 questions they had refused to answer in cross-examination on their affidavits and to produce documents requested by the plaintiffs.
The Court stated that the usual test for determining whether a question should be answered in a cross-examination on an affidavit is whether the information to be elicited has a "semblance of relevance" to the issues in the motion. This means the deponent may be asked questions not only about the facts contained in the affidavit but also questions within his or her knowledge which are relevant to any issue on the motion. The defendants argued for a more restrictive test, first, because (until leave was granted) there were as yet no defendants to the statutory claims and, second, because it would negate the gatekeeper function of the court. They did not propose an alternative workable test but, rather, for restraint by the court in ordering the extensive production of otherwise confidential material at such an early stage in the proceedings.
The Court held that the defendants' arguments were not persuasive and proceeded to deal with each refused question in turn, ordering that some be answered and others not. In rejecting both of the defendants' arguments, the Court stated with respect to the first that the Securities Act provides its own procedure that specifically requires proposed defendants to put forward information (presumably otherwise confidential) and that specifically authorizes examination on such information. With respect to the second, the Court did not specifically address the gatekeeper function. Rather, the argument is dealt with primarily in a litigation context. In satisfying the statutory test for obtaining leave, plaintiffs cannot rely on their allegations but must put forward evidence, which can be tested on cross-examination. Likewise, each prospective defendant must come forward with its defences, with evidence in support. "The merits of the claim are clearly relevant, and based on the evidence adduced and tested, the plaintiffs must establish their good faith and that the action has a reasonable possibility of success at trial."
According to the Court, the challenge is that the statute provides no guidance as to what type, quality and quantity of evidence will enable a court to determine whether the test is satisfied. "We are left with what the statute prescribes - a mandatory requirement for each plaintiff and each proposed defendant to set out facts by affidavit, with the right to cross-examine the deponents of such affidavits." The Court goes on to say:
"This is not a discovery process, in the sense that the parties are not compelled to produce affidavits of documents disclosing all relevant documents within their power or control, and they are not subject to examination on everything having a semblance of relevance to the action, including the common law claims. In deciding this motion the Court must take a hard look at what facts are potentially relevant and material to the statutory claim and defences, as presented in the draft pleading and in the respondents' affidavits. Any question which is clearly not tethered to this inquiry in the sense that it is pursuing other potential wrongdoing or practices of Imax, would have no semblance of relevance. However a question that is potentially relevant to the facts alleged in respect to the statutory claims set out in the proposed statement of claim and in the defences raised in the responding affidavits must be answered even if it might also reveal some other potential issues or wrongdoing not currently contemplated by the statutory claim."
Ainslie v. CV Technologies Inc.
Similar to IMAX, in this action against CV Technologies Inc., Grant Thornton LLP and three present or former officers and directors, the plaintiffs alleged that the financial statements of CV for 2006 and the first quarter of 2007 falsely represented that they were prepared and reported in accordance with GAAP. The plaintiffs delivered affidavits and the defendants filed the affidavits of two experts. Grant Thornton filed no affidavit material on the basis that they intended to rely on the facts disclosed in the plaintiffs' filing upon which they proposed to cross-examine.
The plaintiffs' position was that subsection (2) of Section 138.8 requires each defendant to file an affidavit upon which they can be cross-examined and asked the Court to compel Grant Thornton to comply. They argued that, without the benefit of this requirement and the ability to cross-examine, a plaintiff would be deprived of the tools necessary to meet the standard for obtaining leave. The defendants argued that the plaintiffs' position would afford them greater rights than in an action where leave was unnecessary.
The Court reviewed the legislative history of the provisions and acknowledged that the leave provisions were specifically inserted as a means to dissuade plaintiffs from bringing coercive and unmeritorious claims aimed at pressuring a defendant into a settlement to avoid costly litigation. The Court stated that the purpose of the subsection is not to benefit plaintiffs or to level the playing field but rather to protect defendants. No onus is placed upon proposed defendants and nor are they required to assist plaintiffs in securing evidence upon which to base an action. The essence of a leave application is to require plaintiffs to demonstrate the propriety of their claim before a defendant is required to respond. A defendant is required to file an affidavit setting forth the material facts on which it intends to rely. If there are no such material facts, there is no requirement to file an affidavit. The language in subsection (4) supports this interpretation because, had the intention been to make the affidavit mandatory, the section would have required "the", rather than "any", affidavits filed with the Court to be sent to the Commission. The IMAX decision was distinguished because in that case the defendants had filed affidavits.
In conclusion the Court states:
"In my view, the 'gatekeeper provision' was intended to set a bar. That bar would be considerably lowered if the plaintiffs' view is correct. As I have already indicated, a defendant who does not file affidavit material accepts the risk that it may be impairing its ability to successfully defeat the motion for leave and is probably foregoing the right to assert the statutory defences under Part XXIII.1 of the Act [with respect to the motion for leave]. However, parties are entitled to present their case as they see fit and this includes the right to oppose the leave motion on the basis of the record put forward by the plaintiffs as GT intends, or on the basis of the affidavits of experts as CV intends.
To accept the plaintiff's submissions would require each defendant to produce evidence that may not be necessary for the leave motion and would serve no purpose other than to expose those defendants to a time-consuming and costly discovery process. It would sanction 'fishing expeditions' prior to the plaintiff obtaining leave to proceed with their proposed action. This is an unreasonable interpretation of subsection 138.8(2). It is inconsistent with the scheme and object of the Act. Properly interpreted, the ordinary meaning of subsection 138.8(2) is that a proposed defendant must file an affidavit only where it intends to lead evidence of material facts in response to the motion for leave."
These two decisions leave defendants in a quandary. Under IMAX, if they file affidavits, they are exposed to the uncertainties of the "semblance of relevance" test which allows plaintiffs the opportunity to ask questions going beyond the contents of their affidavits and to seek production of extensive documentation. At this point it is difficult to determine how far the plaintiff bar will seek to stretch these rules to potentially circumvent the gatekeeper function of the court and achieve indirectly what the provisions of the statute were clearly intended to prevent; namely, plaintiffs seeking to induce quick settlements from defendants reluctant to incur the expense of potentially frivolous litigation. Under CT Technologies, a defendant can simply refuse to file an affidavit. However, by doing so they must be prepared to rely solely on their cross-examination of the plaintiffs to persuade the Court that the test for leave has not been satisfied.
These two decisions demonstrate that the courts are well aware of the gatekeeper function the Securities Act has imposed upon them. That being said, their function is constrained by the words of the statute that appear to have produced unintended results. From the perspective of potential defendants, neither decision provides comfort. Future courts will have to find a way to interpret the statute so as to meaningfully restrain plaintiffs' counsel. Otherwise a legislative solution may well be required lest coerced pre-motion settlements result in there being no gate to keep.