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Supreme Court of Canada Walks a Fine Line on IPO Disclosure and Forecast Obligations

Published: 03/14/2008

By Robert B. Cohen

On October 12, 2007, the Supreme Court of Canada released its decision in Kerr v. Danier Leather, an important decision on the disclosure obligations of reporting issuers and their directors in the context of an initial public offering (IPO). 

In the facts of this case, Danier decided to go public and undertook the necessary steps and filings in 1998. In preparation for its IPO, Danier filed three preliminary prospectuses with the OSC, each of which contained a forecast. The forecast in the preliminary prospectus was included, unchanged, in the final prospectus. The forecast was accompanied by standard cautionary language advising investors that there was no guarantee the forecast would be met. However, in the week before closing, the directors received intra-quarterly financial results that threw doubt on the reliability of the forecasts—unseasonably warm weather had been adversely effecting sales.  The new financial results were not disclosed prior to the closing of the IPO. 

At trial, the judge found that section 130 of the Ontario Securities Act mandated that Danier and its directors update the forecasts prior to closing the IPO. Failure to do so amounted to an actionable misrepresentation for which Danier and its directors were liable for millions of dollars to the plaintiff investors. The Ontario Court of Appeal later overturned the trial judge’s decision, disagreeing with the interpretation of the disclosure obligations under the Ontario Securities Act and on other grounds. While a unanimous Supreme Court of Canada dismissed the investors’ appeal, the court’s reasoning solidified the fine distinction between “material facts,” which could adversely effect a forecast (such as the impact of weather on sales of leather clothing and for which the directors need not update a forecast contained in a prospectus prior to closing) and a “material change” (such as the destruction of a company’s stores and for which the directors need update a forecast to avoid liability for misrepresentation). 

In its reasons, the Supreme Court of Canada also set out additional legal principles of interest to directors of public companies. In particular, it was held that forecasts in a prospectus carry an implied representation of objective reasonableness; however, such a representation extended only until the time at which a prospectus was filed. Furthermore, directors cannot simply rely on the “business judgment rule” to defend an action based upon allegations of misrepresentation contained in forecasts. In short, the inclusion of a forecast in a prospectus by the directors must be based upon objectively reasonable criteria and must be updated in the case of a “material change” in the business, operations, or capital of the issuer, rather than simply the results of an external event that materially effects the business, operations, or capital of the issuer) 

The Danier Leather decision will certainly bring a sigh of relief to many reporting issuers who file forecasts. However, the real task for securities counsel going forward is determining whether a significant intervening event is a “material fact” or a “material change”; only the latter requires additional disclosure. 

As a side note to this case, the Supreme Court of Canada upheld a significant cost award against the representative plaintiff in this class action, contrary to standard practice in many class action lawsuits. The award was given primarily on the basis that this was “Bay Street litigation” with a representative plaintiff with millions of dollars at stake. Such a decision will certainly send a chill to potential representative plaintiffs in similar situations.