In a decision released on October 2, 2012 in Frank v Farlie, Turner & Co., LLC, Justice Perell of the Ontario Superior Court of Justice granted three defence motions in a proposed securities class action against certain of the directors, officers and investment bankers of a Florida-based tactical body armour manufacturer, the shares of which formerly traded on the Toronto Stock Exchange. Of note, Justice Perell struck out a claim for punitive damages against certain defendants, finding that statutory claims for secondary market misrepresentations under Part XXIII.1 of the Ontario Securities Act (OSA) cannot ground a claim for punitive damages given the scheme and policy objectives of the OSA; the secondary market provisions only authorize the award of compensatory damages.

In respect of the other two motions, Justice Perell struck out a claim, without leave to amend, against one of the individual defendants for failure to properly plead a cause of action for “knowing influence” under s. 138.3 of the OSA and declined to recognize a new presumptive factor that would ground a “real and substantial connection” for the purposes of assuming jurisdiction over foreign defendants, and permanently stayed the proposed action against the Florida-based investment bankers.

BACKGROUND

The representative plaintiffs brought a proposed class action on behalf of all persons who voluntarily or involuntarily disposed of shares in Protective Products of America, Inc. (Protective Products) between October 8, 2009 and January 13, 2010. The core of the proposed action consists of claims against certain of the directors and officers of Protective Products, alleging breach of the secondary market disclosure provisions contained in Part XXIII.1 of the OSA. The plaintiffs also brought a claim against Stephen Giordanella (Giordanella), the former director and CEO of Protective Products, for “knowingly influencing” the alleged misrepresentation contrary to s. 138.3 of the OSA as well as a separate claim against investment bank Farlie, Turner & Co. LLC (Farlie Turner) and its affiliate Bayshore Partners, LLC (Bayshore) under common law for breach of duty not to inform a potential purchaser of an undisclosed material change outside of the necessary course of business – a novel cause of action.

Protective Products manufactured tactical body armour used to protect police officers and military personnel. Incorporated in Delaware, its shares traded on the Toronto Stock Exchange, classifying it as a “reporting issuer” under the OSA. In 2007, Protective Products submitted a bid on a contract with the US Army to supply body armour known as an improved outer tactical vest (IOTV). Soon thereafter, Protective Products engaged Bayshore to assist in evaluating its strategic options with respect to recapitalization or sale of the business. Bayshore prepared a confidential information memorandum (CIM) to assist in marketing Protective Products, and began canvassing the market. In August of 2009, Protective Products was informed that it would not be awarded an IOTV contract; it immediately disclosed this news to its shareholders. However, on October 8, 2009, the US Army revised its position, informing Protective Products that all technically accepted bids would be awarded an IOTV contract – a commission that could be worth up to $2.7 billion; Protective Products decided not to disclose this news. The plaintiffs allege that the US Army’s revised position constituted a material change in Protective Products’ business, operations and affairs, that it was required to disclose this information to its shareholders, and that Protective Products’ failure to do so resulted in artificial deflation of their common shares giving rise to the main cause of action in this matter.

Meanwhile, Bayshore’s efforts to market Protective Products bore fruit; approximately 50 parties entered into confidentiality agreements with Protective Products and were provided with the CIM. Of this group, a limited five were informed about the incoming IOTV contract. On December 1, 2009, Protective Products accepted an offer to purchase Protective’s assets in a bankruptcy setting by Sun Capital Partners Group V (Sun Capital). The parties signed a letter of intent, and shortly thereafter Protective Products entered Chapter 11 bankruptcy proceedings. Bayshore received approval from the bankruptcy court to continue to act as Protective Products’ investment banker, in effect acting as the receiver to sell its assets. On February 22, 2010, the US Bankruptcy Court approved the sale of Protective Products’ assets to Protective Products Enterprises (PPE), an affiliate of Sun Capital. Prior to the sale, however, Michael Frank (Mr. Frank), a merchant banker and investor in Protective Products, learned of the IOTV contract and issued the statement of claim in this proposed action.

In spite of the commencement of the proposed class action in Ontario, the bankruptcy proceedings continued in the US. In February 2011 Protective Products sued Mr. Frank in Florida seeking to permanently enjoin the proposed class action in Ontario and, after a series of other hearings, obtained the injunction. The Plan of Liquidation of Protective Products was approved by the US Bankruptcy Court in October, 2011. Mr. Frank, however, having never attorned to the jurisdiction of the Florida court, ignored the injunctive orders made in the Florida bankruptcy proceedings and pursued the proposed class action in Ontario.

In September of 2012, the Ontario Superior Court of Justice heard arguments with respect to three motions by the defendants. The directors and officers brought a motion to strike the plaintiffs’ claim for punitive damages, Giordanella moved to have the plaintiffs’ pleading struck for failing to disclose a reasonable cause of action, and Farlie Turner and Bayshore brought a motion to either stay the action as against them on jurisdictional grounds, or strike the claims against them on the basis that they disclosed no reasonable cause of action.

DECISION ON THE MOTIONS

The Motion to Strike the Claim for Punitive Damages

Justice Perell proceeded by first addressing the directors’ and officers’ motion concerning punitive damages. The defendants submitted that being exclusively statutory, the plaintiffs’ claims did not allow for a right of action for punitive damages. They argued that in order to achieve a balance between enforcement of the OSA and compensating investors on the one hand, and not discouraging persons from becoming officers and directors on the other, the legislature had utilized liability caps that should not be exceeded by punitive awards. On the other hand, the plaintiffs argued that explicit authorization under the statute to seek punitive damages is not required, and that there is no inherent bar in the OSA to prevent a plaintiff from seeking punitive damages. Rather, they argued that the enforcement of the objectives of the OSA was met through punitive awards, to which they claimed a right at common law to pursue. Reviewing the parties’ arguments, Justice Perell found the defendants’ submissions with regard to liability caps and their connection to the policy balance achieved by the legislative scheme most convincing and on this basis, he granted the directors’ and officers’ motion, striking the $20 million claim for punitive damages. His Honour stated, “I agree that allowing a claim for punitive damages would circumvent the policies of Part XXIII.1 of the Act of having caps on the quantum of purely compensatory damages and lifting those caps in exceptional circumstances.”

The Motion to Strike the Claim of “Knowing Influence”

Moving to the matter of the claims against Giordanella, Justice Perell reviewed the factual record and found it insufficient to support a cause of action. While the plaintiffs had led material evidence to show that Giordanella was an influential person, they failed to plead material facts that demonstrated what he did to exercise his influence or power – an essential element to any claim of “knowing influence” under s. 138.3 of the OSA. Finding that the plaintiffs had been provided ample opportunity to discover and present such facts, Justice Perell declined to provide the plaintiffs the option to amend their pleadings to offer further evidence, and granted Giordanella’s motion to strike thereby dismissing the proposed action against him.

The Jurisdiction Motion

Finally, on the matter of the claims made against Farlie Turner and Bayshore, Justice Perell considered whether the court had jurisdiction simpliciter over the two foreign defendants. The plaintiffs had conceded that none of the presumptive factors set out in the Supreme Court of Canada’s decision in Club Resorts Ltd. v. Van Breda applied, but argued in favour of a new presumptive factor: that Farlie Turner’s and Bayshore’s participation in Ontario’s capital markets and its engagement of the province’s regulatory regime presumptively connected them to Ontario. Proposing that this was similar to the established presumptive factor of “carrying on business”, the plaintiffs submitted that their common law negligence claim arose out Farlie Turner’s alleged failure to meet its statutory obligations under the OSA and that through its performance of professional services to Protective Products it was in a “special relationship” with Protective Products as defined by s. 76(5) of the OSA; they relied on case law about the constitutionality of provincial securities legislation and about the jurisdiction simpliciter of provincial courts over market intermediaries or investors outside of the province.

While noting his appreciation for the “ingenuity” of the plaintiffs’ arguments, Justice Perell found that they had not met the onus of demonstrating a new presumptive factor and that such factors cannot be demonstrated by “sleight of hand.” His Honour observed that the plaintiffs’ claim against Farlie Turner and Bayshore was in actuality based on the common law; however, the plaintiffs had attempted to cloak the cause of action in the OSA by referring to a duty related to a “special relationship”, giving the impression that their claim against these defendants was based in their participation in Ontario’s capital markets. Finding that Farlie Turner and Bayshore were, in fact, simply playing the role as receiver or quasi-receiver for a US public corporation in bankruptcy, they should not have to reasonably expect that the “long arm” of the OSA would reach them. In addition, Justice Perell made note of the injunction in the Florida courts and opined that, “as a matter of comity and so as not to overreach its assumed jurisdiction, an Ontario court should not interfere in a matter that is closely connected to a Florida proceeding in bankruptcy. The class action for violations of Part XXIII.1 can proceed in Ontario against the other defendants.” His Honour concluded that there was no jurisdiction simpliciter over Farlie Turner and Bayshore and stayed the action against them. In the absence of a finding of jurisdiction, Justice Perell found that he should not decide whether the plaintiffs’ novel negligence claim was tenable at law.