The much anticipated decision of the Supreme Court of Canada in Kerr v. Danier Leather Inc. (Danier) was released October 12, 2007. The Supreme Court’s decision affirms the result of the Ontario Court of Appeal’s judgment, which was a stunning reversal of the decision at trial, and stands as one of the first major judgments interpreting Canadian securities legislation. In its reasons, however, the Supreme Court, disagreed with the Appeal Court on a number of issues.
The Supreme Court’s judgment resolves a number of important securities law issues in Canada. In particular, the court found the following:
- When a prospectus is accurate at the time of filing, Ontario securities law limits the obligation of post-filing disclosure to notice of a material change and does not require an issuer to amend a prospectus, or to publicize and file a report for the modification of material facts occurring after a receipt is obtained for the prospectus.
- When an issuer has fully complied with the securities law requirements with respect to disclosure in a prospectus, including the filing of an amendment in respect of a material change, it would be inconsistent with Ontario securities law to impose civil liability against the issuer for failing to disclose post-filing information that does not amount to a material change.
- A change in an issuer’s "results of operations" from those forecast will not necessarily constitute a material change. This will only be the case if the change in "results of operations" from those forecast stems from an underlying change in the business, operations or capital of the issuer. In the circumstances of Danier, the intra-quarterly shortfall in forecasted revenue did not constitute a material change.
- The business judgment rule (often applied by courts in cases challenging decisions taken by a board of directors) may not be used to limit a public company’s disclosure obligations under applicable securities laws.
- There was, as a matter of fact, an implied representation in the Danier prospectus that the forecast of results was prepared by management using objectively reasonable facts and assumptions. However, that implied representation was made only as of the date of the prospectus.
- The costs of this litigation should be borne by the unsuccessful representative plaintiff in the class action.
Danier filed a prospectus on May 6, 1998, for an initial public offering of its common shares. The prospectus contained a forecast of estimated results to June 27, 1998, the end of Danier’s fiscal year. The IPO closed on May 20, 1998. Prior to the closing, management became aware of certain facts that might have resulted in Danier’s failure to achieve the forecast, but management continued to believe that Danier would in fact achieve its forecast. On June 4, 1998, after further results became available, Danier issued a press release revising its fourth-quarter forecast downward. As a result, the Danier share price dropped. Subsequently, Danier’s business results improved and the original forecast was substantially achieved by June 27, 1998.
A class action was brought against Danier and its senior management, alleging that the forecast constituted a misrepresentation under the Securities Act (Ontario) and at common law. This issue gave rise to a number of subsidiary issues, including whether a forecast is in fact a representation; what the effects are of cautionary statements in a prospectus; and whether a final prospectus, once filed and receipted by the regulators, must be updated if new material facts emerge post-filing but before closing.
The Trial Judgment
The trial judge acknowledged that a forecast, being a statement about the future, does not constitute a misrepresentation if the results are not achieved, but may be so if it does not represent management’s best judgment because: (i) the forecast was not prepared using reasonable care and skill; (ii) management did not generally believe the forecast; (iii) management’s belief in the forecast was unreasonable; or (iv) management was aware of facts that would undermine the forecast.
The trial judge held that in the period between the filing of the prospectus on May 6 and the closing on May 20, certain factual assumptions underlying the forecast had become untrue. He found that although the CEO and CFO of Danier still held the belief that the forecast was achievable, that belief was not reasonable. He thus concluded that the prospectus, at the time of closing, contained a misrepresentation giving rise to liability.
The Court of Appeal The Appeal Court overturned the trial judge on three grounds: (i) Ontario law imposes no obligation to update or amend the prospectus for changes in material facts after the date of filing the final prospectus, notwithstanding the actual closing of the securities offering takes place later; (ii) there was no implied representation in the Danier prospectus that the forecast of results was reasonably achievable; and (iii) the trial judge did not give deference to the business judgment of Danier’s senior management or to the fact that the forecast was substantially achieved in arriving at his conclusions. In a subsequent decision, the Appeal Court also ordered that the representative class action plaintiff pay the costs of the litigation.
For our discussion of the Appeal Court’s main decision, please see
The Supreme Court dismissed the appeal and found the following:
Obligation to Update Prospectus
The Supreme Court agreed with the Appeal Court’s finding that the duties of disclosure in the Securities Act (Ontario) were found in the prospectus filing and delivery provisions and that Section 130 of the Act, which creates a civil cause of action for misrepresentation in a prospectus, was a remedies section and cannot be read inconsistently with these provisions. A prospectus must contain full, true and plain disclosure of material facts at the time of its filing and receipt. Thereafter, the only obligation to update is to amend the prospectus if a material change occurs. Liability will only arise if the amended prospectus contains a misrepresentation. There is no continuing obligation to update the prospectus for changes of material facts occurring during the course of the distribution of securities.
The appellants argued the trial judge had erred in not finding the intra-quarterly results of Danier’s operations constituted a material change that should have been disclosed through an amendment to the prospectus. The definition of material change includes a "change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price or value of any of the securities of the issuer." The Supreme Court reviewed the distinction between a change in an issuer’s results of operations and a change in the business, operations and capital of an issuer. The Supreme Court held that a change in an issuer’s results of operations will not necessarily constitute a material change. This will only be the case if the change in results of operations from those forecast stems from an underlying "change in the business, operations or capital of the issuer."
Implied Representation as to Reasonableness
The Appeal Court disagreed with the trial judge and found there was no implied representation of objective reasonableness in respect of the forecast, either in fact or at law. The Supreme Court disagreed with the Appeal Court and found, based on the wording contained in the Danier prospectus, there was, as a matter of fact, an implied representation as to objective reasonableness. In other words, the language of the Danier prospectus was such that a potential investor could be entitled to infer not only that the forecast represented management’s best judgment, but also that management’s judgment was "based on facts and assumptions that reasonable business people in possession of the same information as Danier’s management would reasonably regard as reliable for the purpose of a forecast." The Supreme Court, however, found these representations were made only at the date of the prospectus and not as of the IPO’s closing date.
The Supreme Court did not comment on whether there was an implied representation at law. As a result, the Supreme Court has left open the possibility that in a prospectus situation there is such an implied representation at law in respect of any forward-looking information.
In view of the new civil liability regime under Ontario’s securities laws that provides a safe harbour for forward-looking information if, among other things, the person making the statement had a reasonable basis for drawing the conclusions or making the forecasts or projections set out in the disclosure document, it is arguable there is an implied representation of objective reasonableness at law for forward-looking information contained in continuous disclosure documents.
Business Judgment Applied to Disclosure Issues
The Appeal Court had analyzed the defendants’ alleged breach of disclosure requirements of the Securities Act through the prism of the business judgment rule. The Supreme Court disagreed with this analysis. In short, the Supreme Court held that, while forecasting is a matter of business judgment, the disclosure requirements under the Securities Act are a legal matter to be determined by the legislature and the courts, and are not to be subordinated to the exercise of business judgment. Accordingly, management does not have the luxury of considering whether disclosure should or should not be made if disclosure is mandated by the Act.
The Supreme Court upheld the Appeal Court's decision to award costs against the representative class action plaintiff. In class action suits, courts have often moved away from the customary rule that costs should be awarded against an unsuccessful party. These decisions have focused on the access to justice concerns of awarding significant costs against a representative plaintiff with a claim for a small amount.
The Supreme Court focused on the fact that this was "a dispute where private commercial interests predominated." Of importance is the Supreme Court’s willingness to look beyond the form of the action as a class proceeding brought on behalf of all investors. The Supreme Court stated explicitly that it should not be assumed that class proceedings invariably engage access to justice concerns. The Supreme Court also approved Justice Nordheimer’s observation in an earlier Ontario decision that "the David and Goliath scenario [of class actions] does not necessarily represent an accurate portrayal of the real conflict." The Supreme Court was strict in interpreting what constitutes a "test case," a "novel point of law" or "a matter of public interest" -- justifications that class action plaintiffs have used to fend off cost awards in the past. This tough-minded approach to costs will have important implications in the future for persons who participate on the plaintiff’s side in commercial class actions. Practical Implications for Market Participants
The Supreme Court has reaffirmed what had been the prevailing view of the liability regime under the Securities Act in connection with public offerings. A prospectus must be true and accurate as of the date of filing it in final form. Thereafter, during the course of distribution, an issuer must amend the prospectus upon the occurrence of a material change, but does not otherwise have a continuing obligation to update the document, even for material facts, during the distribution period. Issuers and underwriters will continue to be encouraged by this result, particularly in the case of distributions that take some time to complete.
The judgment further reinforces the need to make the difficult distinctions between material changes and material facts. These differences are also relevant for the new secondary market liability regime, where failure to file a timely material change report can lead to liability. However, it should be noted that TSX and TSX Venture policies require listed companies to disclose "material information" on a timely basis. Material information includes both material changes and material facts, and Canada’s securities regulators have indicated that issuers not complying with these stock exchange policies could be subject to an administrative proceeding before a provincial securities commission.
In connection with the disclosure of forward-looking information, the judgment of the Supreme Court in Danier has left open the question of whether there is an implied representation regarding objective reasonableness at law. As a result, issuers and underwriters may wish to operate on the basis that such an implied representation exists, and review forward-looking information accordingly. This is consistent with the civil liability regime for continuous disclosure, which requires as an element of the safe harbour protection accorded forward-looking information that "the person or company had a reasonable basis for drawing their conclusions or making the forecasts and projections set out in the forward-looking information." In any event, issuers and underwriters should carefully review disclosure surrounding forward-looking information to determine what types of representations may reasonably be inferred from the language in a prospectus.
Finally, the management and board of directors of public companies can no longer rely on the extension of the business judgment rule to decisions involving difficult disclosure issues following the Supreme Court’s rejection of that notion. As a result, issuers will need to re-examine difficult disclosure issues, where disclosure may not have been made as a result of management’s strong view that an outcome was unlikely to have had a negative effect.