In Theratechnologies Inc. v. 121851 Canada Inc., released on April 17, 2015, the Supreme Court of Canada provides guidance for the first time with respect to the test for leave to assert a statutory claim for secondary market misrepresentation or failure to provide timely disclosure. In short, the Court held that the leave test is a robust screening mechanism that requires plaintiffs to present credible evidence in support of their claim. The Court also added to the existing jurisprudence regarding what constitutes a “material change”, reaffirming that there needs to be a change to the business, operations or capital of the defendant and not just a change in the stock price.
In 2009, Theratechnologies Inc. filed a new drug application with the FDA. The FDA appointed an advisory board to assess the application and asked the advisory board some questions about the drug’s safety. The FDA’s questions became public and led to a drop in Theratechnologies’ share price. The plaintiff sold its shares after the decline. Ultimately, the FDA approved the new drug application and the share price recovered.
The plaintiff commenced a proposed class action and asserted a claim under the Securities Act(Québec) for failure to make timely disclosure of a material change. The plaintiff argued that Theratechnologies should have disclosed that it had adequate responses to the FDA questions. The plaintiff sought “authorization” to commence its claim under the Securities Act (Québec).The plaintiff was successful before the motion judge and the Québec Court of Appeal.
The Test for Leave
The test for leave in a secondary market misrepresentation/timely disclosure claim is largely the same in every province. Plaintiffs must prove that the claim was brought in “good faith” and that it has a “reasonable possibility of success”. The second part of that test has been analysed by many judges over the last few years, including the Ontario Court of Appeal in Green v. CIBC.
In Theratechnologies Inc., the Court began its analysis by considering the history and objectives underlying the leave test. In the early to mid 2000s, provincial securities acts were amended to make it easier for shareholders who purchased (or sold) shares in the secondary market to recover damages when an issuer made a misrepresentation or failed to make timely disclosure.
The Court acknowledged that historically, secondary market purchasers “did not have access to a statutory cause of action”, leaving shareholders in common law provinces to rely on common law misrepresentation claims that required proof of reliance. In Québec, shareholders were likewise required to demonstrate reliance by establishing fault, prejudice and causation under Arts. 1457 and 1607 of the Civil Code of Québec ("C.C.Q"). This should put an end to shareholder claims that secondary market purchasers can claim under the statutory cause of action in s. 130(1) of the Securities Act (Ontario) and equivalents if they purchased their shares during the period of a prospectus distribution.
The statutory reforms created a cause of action for secondary market purchasers that did not require plaintiffs to prove reliance. Recognizing that this could open the floodgates for strike suits aimed at extracting quick settlements from issuers, the statutory reforms also added a requirement that plaintiffs obtain “leave” or “authorization” before commencing a claim.
The “reasonable possibility of success” part of the leave test was meant to equip courts with a tool to screen out claims based on an evidentiary record rather than simply the strength of the allegations in the claim. The Court explained that this screening mechanism was intended to provide a “robust deterrent” to prevent cases without merit from proceeding, which is perhaps the strongest language used to date to describe the purpose and strength of the leave test.
The Court added that plaintiffs need to offer both “a plausible analysis of the applicable legislative provisions” and “some credible evidence in support of the claim”. However, the Court cautioned that imposing onerous evidentiary requirements would undermine the purpose of the “screening mechanism” if it effectively resulted in a mini-trial.
The Court also considered whether the test on a leave motion was the same as the test for the authorization of a class action under art. 1003 of the C.C.Q. The Court held that it was not. The Court held that the leave test imposes a “different and higher” standard than the standard for authorization of a class action in Québec (i.e. whether “the facts alleged seem to justify the conclusions sought”).
While the tests for certification in Ontario and authorization in Québec are not identical, the Court’s differentiation of the tests applicable on certification and leave is important. Given the Ontario Court of Appeal’s finding last year in Green v. CIBC that the standard on certification and leave are identical, the Supreme Court’s ruling in Theratechnologies should strengthen the test for leave motions in Ontario and other common law provinces.
In applying the leave test, the Court also considered what constituted a “material change”. The Court explained that under the Securities Act (Québec), a material change has two components: (1) there must be a change in the “business, operations or capital” of the defendant; and (2) the change must be material in the sense that it would reasonably be expected to have a significant effect on the market price or value of the securities at issue.
The Court found that a material change had not taken place in this case because there was no change to the business, operations or capital of Theratechnologies. The underlying concerns expressed by the FDA and the Company’s awareness of these issues had already been publicized by the Company in previous press releases.
The Court also rejected the plaintiff’s argument that the market reaction itself was evidence that the FDA’s concerns constituted a material change. While the market reaction supported the plaintiff’s position that the information was material, the Court held that it did not amount to a material change because there was no change in Theratechnologies’ “business, operations or capital”.
Importantly, the Court warned that conflating “material fact” and “material change” would “significantly expand timely disclosure obligations” beyond what is set out in the Securities Act (Québec). Doing so would result in “excessive disclosure” that would “bury...shareholders in an avalanche of trivial information – a result that is hardly conducive to informed decision making.”
In the past year the Supreme Court has released a number of decisions relating to class actions. While recognizing that class actions are essential for providing access to justice, the Court has also now confirmed that not every case should be permitted to go forward to trial. It is important that the leave/authorization test for securities class actions have teeth as it is not only the plaintiff shareholders whose rights need to be considered, but also the current shareholders of the issuer who ultimately suffer from the costs of litigating unmeritorious claims. Striking out those claims at an early stage makes sense, and with a meaningful leave/authorization test that can be done.