By Wendy Berman, Kate Byers, Carly Cohen, Peter Henein, Stefanie Holland, Jason M. Holowachuk, Christopher Horkins, Marlon Hylton, Lara Jackson, Stephanie Kerzner, Robert Kligman, Jessica L. Lewis, Laurie Livingstone, Jeremy Martin, Eric Mayzel, Alexandra Murphy, W. Michael G. Osborne, John M. Picone, Tim Pinos, Brigeeta C. Richdale, Derek Ronde, Geoffrey B. Shaw, Kristin Taylor, Stephanie Voudouris
In This Issue
Hole in One: Ontario Superior Court of Justice Dismisses Oppression Class Action Against North Halton Golf and Country Club
The Ontario Superior Court of Justice recently granted summary judgment dismissing an oppression class action in which the share capital structure and two recent equity financings by North Halton Golf and Country Club Ltd. (North Halton or the Company) were alleged to be oppressive to the minority non-golfing member shareholder class. The Court held that the stated expectations of the class regarding share price and liquidity were not objectively reasonable and that the board of directors exercised its business judgment in a manner that fairly considered the interests of all stakeholders, including the expectation of the class to be treated fairly in any share issuances. The full decision is available here.
Summary and Background
North Halton is a private company which operates and manages a golf and country club (the Club). The class consists of the non-golfing member shareholders of the Company (approximately 26% of the Company’s approximately 460 shareholders).
Following a shareholder-approved capital restructuring in 2008, all new golf members were required to become shareholders of North Halton, certain share ownership and sale restrictions were adopted, and a share sale list system was implemented to facilitate share sales to new members from both treasury and individual shareholders.
The common issue in the class action related to the implementation in 2015 of two equity issuance programs at prices below historic treasury issuances and the value of the Company’s assets (primarily its land). The equity issuance programs were implemented by the Company to address prevailing business, financial, and market conditions. They followed a review and consideration by the board of directors of various strategic alternatives and the implications of such alternatives on the Company and its various stakeholders. These programs were approved by a majority of shareholders, most of whom were members of the Club, following delivery of detailed disclosure from the board of directors regarding the proposed equity issuance program and its rationale, the various alternatives considered, and an overview of prevailing business, financial, and market conditions. As a result of the equity issuance programs, the Company attracted new member shareholders, increased revenue, operated profitably again, and effectively maintained operations.
The class claimed that the equity issuance programs were oppressive because they unfairly disregarded the interests of non-golfing shareholders (many of whom wished to sell their shares) by effectively “giving away” shareholder equity for the benefit of golfing members and setting a price which was below historic prices for treasury issuances, and well below the value of the assets. The class also claimed that the Company’s directors had breached their fiduciary duties in proposing and implementing the equity issuance programs.
The action was certified as a class proceeding in 2016. The class moved for summary judgment in May 2018, seeking a windup of North Halton, a buy-out of the shares of the class, or damages in an amount equal to the “equity given away” by the Company in selling shares at “reduced” prices. Extensive affidavit evidence was filed by both parties.
Although the evidence filed by the class contained numerous affidavits from class members setting out varied expectations, at the hearing the only expectations advanced by the class were that: (i) there would be no sale of shares from treasury at prices less than historic issuances; and (ii) the minority non-golfing shareholders would be treated fairly in share pricing decisions – which should include pricing determinations based on the fair value of assets similar to the process followed as part of the 2008 equity restructuring. At the hearing, the class also limited its requested relief to damages only.
The Company argued that there was no basis to support a finding that any of the expectations articulated by the class (other than the expectation generally to be treated fairly) were objectively reasonable given the full factual context. The Company argued that the directors (i) engaged in a fair and proper review of various strategic alternatives and their effects on the Company and its stakeholders; (ii) provided shareholders with detailed information as to those alternatives; and (iii) recommended the equity issuance programs as the preferred alternative to maintain the business as a going concern while preserving and increasing value.
The Court dismissed the motion for summary judgment by the class and granted judgment in favour of the Company, dismissing the class action in its entirety. The Court accepted the Company’s position and found that the expectations of the class were not objectively reasonable as assessed in the full factual context.
The Court held that reasonable expectations are not static and must be assessed in light of the prevailing business circumstances in which the company operates and not solely with reference to unique and historic events or past practices. The Court also found that while the expectation generally to be treated fairly was reasonable, there was no basis for a finding of unfair or oppressive conduct. By recommending the share sale programs, the board provided a mechanism to avoid consistent losses, decreased membership, and dwindling revenue, so that North Halton could effectively maintain operations (and likely benefit from increased land value over time). Rather than being unfair, this process was found by the Court to be reasoned and informed, and consistent with the best interests of North Halton. On that basis, there was no reason to interfere with the board’s business judgment.
This decision reaffirms the Court’s reluctance to interfere with the business judgment of an informed board of directors acting in good faith. In deferring to the board’s business judgment, the Court cited extensively the evidence of its comprehensive deliberations, assessment of alternatives, engagement with shareholders and focus on the best interests of the Company as opposed to any particular stakeholder group.
Oppression class actions are rare, and this decision suggests that may be due to the inherent difficulty in proving the reasonable expectations of a group of shareholders when each individual member has had different experiences and has made decisions vis-à-vis their investment for different reasons. This is especially so where the class is large (as was the case here, with over 100 shareholders).
Although the reasonableness of shareholder expectations was in issue, the credibility of the many affiants was not. Accordingly, despite the voluminous evidence, the parties and the Court agreed that the matter could be resolved in its entirety on the motion for summary judgment brought by the class. This approach avoided the expense that would have been incurred in connection with a class action trial without compromising the Court’s ability to consider and address each of the issues raised. Where questions of credibility are not in issue, motions for summary judgment may be sufficient to resolve complicated questions in a more efficient manner.
If you have any questions about this decision, its implications, or class actions more generally, please contact them or any other member of our Class Actions Group.
The authors of this article gratefully acknowledge the contributions of summer student Robert Sniderman.
Ontario Court Finds Franchisee Personally Liable for $1.7 Million Dollar Costs Award in Failed Class Action
Cassels Brock litigators successfully enforce Pet Valu’s contractual and guarantee rights to claim the costs of a failed class action against the individual principal of the representative plaintiff franchisee.
On May 29, 2018, the Honourable Madam Justice Nishikawa of the Ontario Superior Court of Justice released a decision in Pet Valu Canada Inc. v. Rodger, 2018 ONSC 3353, which held that the individual officer, director, shareholder, and guarantor of the representative plaintiff in a $100 million class action commenced against Pet Valu Canada Inc. (Pet Valu) in 2009 was personally liable for the significant costs awards which Pet Valu had been awarded after defeating the class action. These costs awards totalled in excess of $1.7 million.
Justice Nishikawa’s decision helpfully recognizes the enforceability of guarantees and indemnification provisions in franchise agreements. It also provides some key lessons to representative plaintiffs in class actions, clarifies principles regarding limitation periods under a guarantee and in respect of collecting costs awards, and offers consolation to successful defendants in class proceedings who are faced with collecting significant costs awards against representative plaintiffs who have dissipated their assets.
Background to the Case
This decision arose as a result of a class action commenced on behalf of all Pet Valu franchisees alleging breach of contract, breach of the Arthur Wishart Act (Franchise Disclosure), 2000,1 and other causes of action against Pet Valu (the Class Action). The Class Action was litigated over the course of seven years, during which Pet Valu first successfully narrowed the scope of the proposed common issues on certification, and then was ultimately successful in defending the entire proceeding, which concluded in October 2016 with the Supreme Court of Canada’s refusal to grant the representative plaintiff’s application for leave to appeal. The class proceeding litigation is discussed here.
After the dismissal of the Class Action, Pet Valu was awarded its costs in the amount of $1,703,896.94, inclusive of taxes and disbursements. In addition, a number of other costs awards awarded to Pet Valu over the course of the Class Action remained outstanding, such that the representative plaintiff owed Pet Valu a total of $1,736,675.54, plus applicable interest (collectively, the Cost Awards). The decision regarding the Class Action costs award can be found here.
However, by this time, the representative plaintiff, 1250264 Ontario Inc. (125) was a former franchisee and functionally a shell corporation with no assets. With no practical hope of recovering the Costs Awards against 125, Pet Valu instead turned to its sole officer, director, and shareholder, Robert Rodger (Rodger), who had personally signed the franchise agreement as a franchisee and provided a personal continuing guarantee of 125’s performance of its obligations to Pet Valu, including under the franchise agreement.
Pet Valu commenced an action against Rodger personally, and brought a motion for summary judgment in respect of his liability for the Costs Awards. In response, Rodger brought a cross-motion to dismiss Pet Valu’s claim.
Justice Nishikawa’s Decision
Justice Nishikawa granted Pet Valu’s motion for summary judgment and dismissed Rodger’s cross-motion to dismiss the claim, holding that Rodger was personally liable for the Costs Awards on the basis of both the franchise agreement and guarantee. In doing so, she dismissed a number of defences raised by Rodger, including (i) a limitations period defence, (ii) arguments that the provisions relied on by Pet Valu did not apply, and (iii) the assertion that Pet Valu had released its claims against Rodger in the course of previous litigation between the parties.
(a) The Indemnification Provision Under The Franchise Agreement Was Enforceable
First, Justice Nishikawa reviewed the indemnification provision in the franchise agreement, pursuant to which the “Franchisee” (as defined in the agreement) agreed to indemnify Pet Valu for its costs incurred in defending “any action or claim” brought by the 125 against Pet Valu. Given the broad wording of the provision, Justice Nishikawa rejected Rodger’s argument that it did not apply to class actions. She also accepted Pet Valu’s submission that indemnification for legal costs in the franchise context is not unusual, noting that where there is a contractual right to costs, the court will generally exercise its discretion to reflect that right.
Justice Nishikawa similarly rejected Rodger’s argument that as a representative plaintiff, 125 should only be responsible for a proportionate share of the Costs Awards. She cited the Ontario class proceedings regime’s adoption of ordinary costs rules and also took note of Rodger’s admission on cross-examination that he had not shared costs awards owing to 125 with other class members.
Having found that the indemnification provision applied to the Costs Awards, Justice Nishikawa turned to Rodger’s assertion that he was not personally bound by that provision. She found that Rodger had signed the franchise agreement on his own behalf, as well as on behalf of 125, and accordingly, that he intended to be personally bound to the agreement as a “Franchisee.” In reaching that conclusion, Justice Nishikawa relied on Rodger’s admissions on cross-examination that he had received independent legal advice and was aware that he was exposed to the risk of a potential adverse costs award in the Class Action.
Justice Nishikawa also rejected Rodger’s argument that the franchise agreement was a contract of adhesion, as there was no ambiguity in the provision that ought to have been construed in favour of Rodger. Finally, she rejected Rodger’s argument that Pet Valu was precluded from relying on the indemnification provision as a result of its alleged breach of other provisions of the franchise agreement, noting that over the entire Class Action, no court had found any breach of the agreement by Pet Valu (nor was there evidence before her to support one).
As a result of these conclusions, Justice Nishikawa found that there was no genuine issue requiring a trial regarding Rodger’s liability for the Costs Awards. However, she also went on to consider his liability under his personal guarantee of 125’s obligations.
(b) The Guarantee Was Enforceable
Justice Nishikawa considered both parties’ interpretations of the language of the guarantee, and favoured Pet Valu’s interpretation over Rodger’s, concluding that Rodger had guaranteed 125’s: (a) performance of the terms of the franchise agreement; (b) payment of all debts and liabilities to Pet Valu; and (c) unpaid balances on the preceding two types of obligations.
Justice Nishikawa rejected Rodger’s characterization of the agreement and found that the unpaid Costs Awards qualified under all three categories of obligations, creating multiple bases for Rodger’s personal liability under the guarantee. Justice Nishikawa also noted that having received the benefit of signing the guarantee (without which the franchise agreement would not have been executed), Rodger could not avoid his obligations thereunder.
In reaching these conclusions, Justice Nishikawa noted that Rodger had admitted to dissipating 125’s assets after selling its Pet Valu franchise and had not availed himself of funding sources for the Class Action (such as an indemnity from class counsel, the Class Proceedings Fund, or any third party litigation funders). She commented that “[t]he consequences of these choices should not be borne by Pet Valu, which was ultimately entirely successful in defending the Class Action, but rather by Mr. Rodger, who made the choices, in full awareness of his obligations under the agreements that he signed.”
(c) The Franchisee’s Other Defences Were Rejected
Justice Nishikawa also considered various other defences raised by Rodger. For instance, Rodger had argued that the claims for the Costs Awards were statute-barred, and pointed to Pet Valu’s counterclaim for costs in the Class Action and the dates of some of the interlocutory awards (totalling $4,500), which had been awarded more than two years prior to the commencement of Pet Valu’s claim.
Justice Nishikawa accepted Pet Valu’s argument that its counterclaim, which predated any of the Costs Awards, was for future costs and could not have crystallized until it had successfully defended the Class Action. She rejected Rodger’s argument that the claim had been discovered at that time, with the quantum of costs being the only issue to be determined. She noted that even at the hearing to fix the final of the Costs Awards, 125 had asserted that no costs should be ordered. She held that Pet Valu’s claim was not discoverable until that final cost award was granted in 2016, if not later, at the expiry of the appeal period for that award.2
With respect to the older Costs Awards, Justice Nishikawa agreed with Pet Valu that so long as the Class Action remained ongoing, so too did the possibility that those awards would be set-off against others. Accordingly, to require Pet Valu to commence their action within two years of those awards would have resulted in unnecessary litigation.
In addition, Justice Nishikawa noted that a limitation period does not begin to run in respect of a continuing guarantee until the debtor defaults or a demand is made.
Finally, Rodger had argued that Pet Valu was precluded from bringing its claim by a release it had signed in connection with an injunction it had brought to shut down Rodger’s operation of a pet store in breach of his non-competition covenant under the franchise agreement some years prior. Justice Nishikawa found that the release specifically applied to “all matters unrelated to the Class Action”, and that the Costs Awards, which arose out of the Class Action, fell outside the scope of the release. Further, she noted that each of the Costs Awards had been ordered after the execution of the release.
Rodger Is Found Liable
Given Rodger’s liability for the Costs Awards under both the franchise agreement and guarantee, there was no genuine issue requiring a trial. Justice Nishikawa granted Pet Valu’s motion for summary judgment in the amount of $1,736,675.54 (representing all of the Costs Awards), plus pre- and post-judgment interest, and dismissed Rodger’s cross-motion to dismiss.
This case provides a number of lessons for parties to both franchise litigation and to class proceedings. First, it illustrates the enforceability of indemnification provisions and guarantees in the franchise law context, and shows that principals of franchisee corporations who signed agreements indemnifying those corporations with their eyes wide open will be held to them. It further shows that where a principal receives the benefits of a franchise agreement on the security of their personal guarantee, they will not be permitted to easily escape the obligations of that guarantee.
In the class action context, the decision underscores to would-be representative plaintiffs that there may be serious personal costs consequences for bringing unsuccessful class proceedings, and highlights the importance of securing indemnification from class counsel, the Class Proceedings Fund, or a third party litigation funder. At the same time, it provides consolation to successful defendants in a class action that they may not have to bear the price of a plaintiff’s failure to do so.
Finally, the decision provides clarification regarding limitations periods for collecting costs awards and for enforcing continuing guarantees. First, it illustrates that (a) a cause of action concerning costs does not crystallize until costs are granted, and (b) a claim to collect on an interlocutory costs award against a non-party may not crystallize until the conclusion of the litigation, due to the practical reality that costs awards will be set-off against each other until the matter comes to an end. This should provide comfort to successful defendants who, faced with insolvent representative plaintiffs, are able to rely on a guarantee. In addition, it confirms that the limitation period for an action to enforce a continuing guarantee will not run until a demand is made (in the case of a demand guarantee) or until the debtor defaults.
A copy of Justice Nishikawa’s decision can be found here.
British Columbia Becomes More Plaintiff Friendly With Adoption of the Class Proceedings Amendment Act
The Government of British Columbia’s amendments to the Class Proceedings Act (the Act) recently received Royal Assent and will come into force on October 1, 2018. The adoption of these proposed amendments will make British Columbia a friendlier jurisdiction for plaintiffs in class proceedings.
Summary and Background
On April 23, 2018, the Government of British Columbia introduced Bill 21, which contained several proposed amendments to the Act. Bill 21 received Royal Assent on May 17, 2018 and will come into force on October 1, 2018. The amendments are largely based on the ULCC’s Uniform Class Proceedings Amending Act, which has already been adopted by Saskatchewan and Alberta. Unlike the current law in British Columbia, the ULCC’s model allows courts to certify multi-jurisdictional class proceedings on an opt-out basis.
As a result of these amendments, British Columbia will change from an “opt-in” jurisdiction to an “opt-out” jurisdiction for non-residents of the province. Additionally, the certification of multi-jurisdictional class proceedings will be permitted and addressed in the Act.
The Amendments in Brief
Unlike most Canadian provinces, British Columbia is an opt-in jurisdiction for non-residents of the province, which requires non-residents to actively opt into class proceedings or else be excluded from the class. As of October 1, 2018, non-residents will automatically be considered part of a class proceeding unless they opt out.
The amendments will also broadened the Act’s reach, allowing it to capture multi-jurisdictional class proceedings, which are class proceedings that involve both residents and non-residents of British Columbia. Under the new law, the following considerations will need to be taken into account:
Bill 21 also contains transitional provisions, which contemplate proceedings that span the period before and after the amendments come into force. All class proceedings certified before the amendments come into force will be subject to the previous provisions of the Act. However, upon application by a party to the proceeding, a court can amend any certification order to include non-residents as members of the class. All class proceedings certified after the amendments come into force, regardless of when they were commenced, will be subject to the amendment provisions.
Despite these amendments, the Act will continue to prohibit courts from awarding costs against any party with respect to any stage of a class proceeding. British Columbia is among four Canadian provinces that employ this “no-costs” regime, where costs will only be awarded on dismissed certification motions in rare and exceptional circumstances. Maintaining the current “no-costs” regime while eliminating the numerous steps previously required for a non-resident to be considered part of a certified class has made British Columbia a friendlier jurisdiction to plaintiffs in class proceedings. As a result, the province should see an increase in class action litigation going forward.
The amendments will also provide courts in British Columbia with guidance when considering multi-jurisdictional certification applications. This guidance will help to ensure that class proceedings are being advanced in the most preferable and appropriate jurisdiction.
For further information on class actions and class action litigation in Canada, please contact Timothy Pinos, Brigeeta Richdale, John M. Picone, Jessica Lewis or any other member of our Class Actions Group.
The authors of this article gratefully acknowledge the contributions of summer student Grace Wu.
Rejection of Reasonable Investigation Defence in Securities Class Action Stands: Supreme Court Denies Leave to Appeal
The Ontario Court of Appeal has the final word in a securities class action in which it permitted a statutory secondary market misrepresentations claim to proceed under Part XXIII.1 of the Securities Act notwithstanding the assertion of the reasonable investigation defence.
Court of Appeal Decision Stands
On May 31, 2018, the Supreme Court of Canada denied the application by SouthGobi Resources Ltd. for leave to appeal a decision of the Court of Appeal which provided further guidance and clarification regarding the test for leave to proceed with a secondary market misrepresentation claim under section 138.8(1) and the defence of reasonable investigation under section 138.4(6)(a) of the Securities Act.1
The Court of Appeal held that on a motion for leave, the motion judge has an obligation to critically assess the evidence and where there are contentious issues of credibility or gaps that cannot be resolved on the evidentiary record, the motion for leave should be granted.
The Court of Appeal highlighted that leave motions are not to be treated as mini-trials, that the evidence before the court and the evidence not before the court must both be considered, and that the court’s analysis and decision should be animated by the fundamental public policy principles underlying the regulation of the capital markets, and in particular disclosure.
If you have any questions concerning this case or class actions generally, please contact Wendy Berman, John M. Picone, Danielle DiPardo or any other member of our Class Actions Group.
Time to Face(book) the Music: Class Action Against Facebook Proceeds in British Columbia Following Failure of Jurisdictional Challenge
The Supreme Court of Canada (the SCC) has ruled that a breach of privacy class action can proceed in British Columbia notwithstanding a forum selection clause favouring California. In doing so, the SCC has upheld a decision of the Court of Appeal for British Columbia (the BCCA), which upheld the certification of a class proceeding against Facebook based on an alleged breach of privacy legislation and allowed the chambers judge significant leeway to adjust the class definition and common issues.
Summary and Background
On a motion before the Supreme Court of British Columbia (and subsequently on appeal before the BCCA and the SCC), Facebook sought to rely on its forum selection clause to argue that the class action should be stayed in British Columbia and be heard in California.
While all but one member of the SCC held that the forum selection clause was prima facie valid, clear, and applicable, the majority ultimately held that there were strong public policy factors present which militated against enforcement of the forum selection clause in the circumstances. Accordingly, the SCC declined to stay the class action, and the case was allowed to proceed in British Columbia.
A review of the case and the foreseeable implications of this particular issue to both consumers and shareholders were discussed in our previous article.
In addition to the jurisdictional issue, Facebook sought to attack the chambers judge’s decision to certify the class action on a number of other bases, including by citing errors relating to:
• exceeding her role in revising the class definition and the common issues;
The BCCA found that the chambers judge had properly exercised her discretion as a certification judge in revising the class definitions and common issues, properly certified the common issues, and properly exercised her discretion in determining the proper procedure for the proceeding. However, it agreed with Facebook that certain aspects of the class definition were unworkable, and remitted the matter back to the lower court to ensure class members were notified and made aware they had opt-out rights.
This case may have significant implications for corporate defendants who deal with consumers using contracts that include forum selection clauses. Even where such clauses are valid, there remains a risk that they will not be enforced by the courts for reasons of public policy. This case also serves as a reminder of the power that a certification judge has in certifying a proceeding. Counsel are reminded that when describing the class and defining the common issues, it is important to use language that does not give rise to uncertainty to avoid court intervention in these matters.
The authors of this article gratefully acknowledge the contributions of summer student Erin Minuk.
Living in a Material World: Materially Drives Dismissal of Motion for Leave to Commence Statutory Misrepresentation Claims Under the Ontario Securities Act
The Ontario Superior Court of Justice recently refused to grant leave to commence a statutory secondary market misrepresentation claim in a proposed class action pursuant to Part XXIII.1 of the Securities Act. The Court in Paniccia v. MDC Partners Inc. agreed with the defendants’ submissions that the plaintiff had failed to demonstrate any reasonable possibility that the putative class would be successful at trial and reaffirmed the important gatekeeper role of the court in securities class actions. A link to the decision is here.
Summary and Background
MDC Partners Inc. (MDC or the Company) is a dual-listed issuer, with its head office and investor relations group in New York. MDC is a leading global provider of marketing and communications services through subsidiaries referred to as "agency partners" or "partner firms." Over a thirty-year period, MDC acquired a network of fifty-one "agency partners," and grew into one of the largest and most successful marketing and communications firms in the world. MDC's shares trade on the NASDAQ and also traded on the TSX until November 11, 2015, when MDC voluntarily delisted due to the extremely low Canadian trading volume. An unknown number of shareholders reside in Canada and they hold between 0.8% and 2.6% of MDC shares.
In 2015, the proposed representative plaintiff commenced a global class action in Ontario, advancing both common law negligent misrepresentation claims and statutory misrepresentation claims under Part XXIII.1 of the Securities Act on behalf of all purchasers on the TSX and the NASDAQ. The plaintiff then amended the claim in 2017 to abandon the global class and limit the class to Canadian-resident purchasers on the TSX and the NASDAQ. The proposed class action sought damages from the Company and certain of its current and former officers on the basis of alleged misrepresentations of material facts and failure to disclose material changes in its financial and other disclosure filed between October 29, 2014 and March 2, 2015 that were allegedly corrected (or partially correctly) on April 27, 2015 (the Statutory Leave Period).
The plaintiff argued that the defendants had materially misrepresented certain facts with respect to: (1) the existence of an SEC subpoena and the commencement of an SEC investigation; (2) the commencement of an internal investigation related to the SEC subpoena; (3) the Company’s non-GAAP earnings disclosure (EBITDA); (4) the CEO’s compensation; and (5) MDC’s decision with respect to how it grouped its partner firms into financial reporting units. The defendants collectively argued that none of the disclosures contained any misrepresentations and, even if they were any, none of them were material.
The United States District Court for the Southern District of New York dismissed a parallel class action in the US with prejudice on September 30, 2016.
Under the Securities Act leave test for statutory misrepresentation, the plaintiff must satisfy the court that there is a reasonable possibility that the action will be resolved at trial in favour of the plaintiff. The leave test requires more than a superficial examination of the evidence. It is intended as a robust deterrent screening mechanism requiring a reasoned consideration of the evidence. Moreover, leave must be granted in respect of each misrepresentation alleged by the plaintiff. Evidence of materiality is key to satisfying the court that a statutory cause of action under Part XXIII.1 of the Securities Act should proceed.
Justice Perell analyzed each of the five alleged misrepresentations referred to above, with primary focus on the fact that the financial statements were not required to be recalled or restated either by the SEC or by the Company’s independent auditors. He ultimately found that none of the alleged misrepresentations were material.
(a) SEC subpoena
The plaintiff argued that the receipt of a subpoena from the SEC in October of 2014 relating to an investigation of certain financial disclosures and accounting practices of the Company was a material fact that the Company was required to disclose and that by not disclosing it in a timely manner, the Company was falsely representing that it was not under investigation. The Company disclosed the SEC subpoena and the results of its internal investigation on April 27, 2015.
Justice Perell held that the mere service of a subpoena, or the mere existence of a regulatory investigation, without more, does not trigger a duty to disclose. In fact, premature disclosure of an investigation can adversely harm share values even where it later turns out that there was no wrongdoing. A reasonable investor would not expect a company to disclose a subpoena or a regulatory investigation (and in Canada, regulatory investigations are usually confidential). Instead, a reasonable investor would expect the company to respond to the subpoena, cooperate with the investigator, conduct an internal investigation and determine whether there is a material fact to correct or a material change to report to its investors. Justice Perell concluded that the defendants did just that. Finally, he noted that the SEC took no issue with the timing of the Company’s disclosure regarding the SEC subpoena and internal investigation (described below).
(b) Internal Investigation
Once MDC received the SEC subpoena, it set up a special committee and commenced an internal investigation. Following the findings of the internal investigation, MDC publicly disclosed that it was taking steps to strengthen and improve its internal controls over financial reporting (ICFR). The plaintiff argued that failing to disclose the fact of the internal investigation was a material misrepresentation and that the Company materially misrepresented the effectiveness of its ICFR (as evidenced by the admission that such controls required improvement and strengthening).
Justice Perell held that there was no misrepresentation. He noted that the Company’s auditors had not withdrawn or restated their clean audit opinion and had not required the Company to restate its financial statements. Justice Perell further noted that the plaintiffs’ expert acknowledged that external auditors will not provide a clean audit opinion with respect to the effectiveness of ICFR where they have identified any material weaknesses in ICFR. Further, he noted the SEC never required the Company to restate any of its financial disclosure, including its disclosure relating to the effectiveness of its ICFR. Moreover, neither the plaintiff nor its expert could identify any particular weaknesses in the company’s ICFR.
(c) EBITDA Disclosure
The plaintiff argued that the Company’s disclosure contained misrepresentations because it did not make clear that the SEC requested that the Company use the term “adjusted EBITDA.”
Justice Perell disagreed. First, EBITDA is a non-GAAP measure for which there is no standard formula and MDC accurately reported its formula for calculating EBITDA. Second, evidence demonstrated that MDC did publicly disclose its exchange of correspondence with the SEC in which the SEC requested that the Company use the term “adjusted “EBITDA.” Moreover, this alleged misrepresentation and the correspondence between the Company and the SEC occurred before the statutory leave period so it could not properly form part of the plaintiff’s claims.
(d) CEO Compensation
Justice Perell concluded that none of the public statements contained any false statements about the CEO’s compensation and the amounts were immaterial in any event. Moreover, the CEO repaid all of the amounts improperly expensed (as determined by the Company’s internal investigation). The SEC did not require a restatement of any of the previously issued financial statements, and on April 27, 2015, MDC announced that it did not expect there would be any impact to its previously issued financial statements.
(e) Reporting Units
Justice Perell found that MDC’s decision to change its grouping of partner firms into four reportable segments instead of two reportable segments was not material. In any event, this decision was made after the statutory leave period and was prompted by communications with the SEC, which also occurred after the statutory leave period.
Motions for leave provide a real opportunity for defendants to knock out a proposed class action in appropriate circumstances. Courts take the gatekeeper function of the leave test seriously and closely analyze evidence of materiality before allowing a proposed claim to proceed. In cases involving alleged financial disclosure misrepresentation, the absence of any restatement requirement by a regulator and/or the company’s independent auditors or any other amended disclosure is a powerful fact in establishing that any alleged misrepresentations are not material.
Wendy Berman, Lara Jackson, and Stephanie Voudouris of the Cassels Brock Class Actions Group represented one of the individual defendant officers, the Company’s Senior Vice President and Chief Accounting Officer, on the motion for leave.