Canada: Superior Court Of Justice Makes Unilateral Amendment To Plan Of Distribution In Class Action Settlement

On August 27, 2013, Justice Perell of the Ontario Superior Court of Justice released a decision in Zaniewicz v Zungui Haixi Corporation approving a class action settlement, but which varied the proposed plan of distribution based on a class member's objections.1 Justice Perell had sufficient leeway to make the modifications because the settlement was not conditional upon approval of the particular plan of distribution proposed by class counsel. Furthermore, the defendants were largely indifferent to the issue as the settlement was for a fixed amount that would not revert to them in any circumstances. While these facts limit the potential significance of the decision for other types of settlements, the case is still notable because Justice Perell held that it would not be "fair and reasonable" to release the claims of some class members who had suffered damages without including those persons in the distribution of benefits.

The case involved Zungui securities that were listed on the TSX Venture Exchange following an IPO in December 2009. On August 22, 2011, the Zungui shares dropped 77 percent in value after Zungui announced that Ernst & Young (E&Y) had suspended its audit of the company's 2011 financial statements. Before the opening of trading on the following day, the shares were cease-traded and never traded again.

Additional disconcerting facts came to light thereafter. On September 22, 2011, Zungui's chief financial officer and all independent members of the board of directors resigned, in part because they felt the investigation into E&Y's concerns was being stymied. The following day, E&Y resigned as the company's auditor and advised that all its prior audit opinions could no longer be relied upon.

One of the key issues for the class action commenced in respect of these facts was the division of compensation as between different groups of purchasers. The proposed class included those who had purchased the Zungui shares in the IPO, those who received Zungui shares prior to the IPO in exchange for securities of a subsidiary, and those who purchased Zungui shares in the secondary market. In order to determine a fair distribution as between these three groups, the plaintiffs conducted extensive negotiations in which each group was separately represented by counsel. The result was a complex scheme that would determine compensation to class members based on: (i) the particular group to which a class member belonged; (ii) when the Zungui shares were acquired or sold; and (iii) the net loss suffered by the class member.

Notably, the proposed plan of distribution would have provided no compensation to class members who purchased shares after Zungui's disclosure that E&Y was suspending its audit. However, the settlement would have released any claims that those purchasers would have otherwise had against the defendants.

Like all class members, persons who purchased Zungui shares on August 22, 2011, had the opportunity to opt-out of the settlement. However, one class member who bought a significant block of Zungui shares on August 22, 2011, chose instead to challenge the fairness of the plan of distribution at the settlement approval hearing. The shareholder argued that the August 22, 2011, disclosure did not tell shareholders enough to correct all prior misrepresentations:

While it is true that the announcement indicated that Ernst & Young suspended procedures until Zungui "clarifies and substantiates its position with respect to issues pertaining to the current and prior year" this does not clearly foreshadow the events that followed, which turned out to be devastating to the investors who held the stock and represented a "worst case scenario"[.]2

These submissions proved to be persuasive, as Justice Perell ultimately modified the distribution plan in accordance with the objector's suggestions. In particular, Justice Perell held that it was inappropriate to include August 22, 2011, purchasers in the class (to provide the defendants with a broad release) but prevent them from obtaining any benefits:

Notwithstanding that it was the Defendants who urged that these purchasers be included as Class Members as part of the bargaining for the settlements, once Class Counsel and the Representative Plaintiffs agreed to the joinder of these Class Members, it was unfair and inappropriate for Class Counsel and the Representative Plaintiffs to advocate a theory of the case that August 22, 2011 purchasers were not eligible for any compensation at all.3

Accordingly, Justice Perell included August 22, 2011, purchasers in the plan of distribution, but discounted their claims for the increased investment risk.

Although the modifications to the distribution plan in Zungui will likely have a minor impact on the compensation payable to other class members, the decision does raise questions for future cases – particularly for cases where a judicial modification could have a greater effect on other class members.

For example, unlike most class action settlements in Canada, the right to opt out of the Zungui settlement expired before the settlement approval hearing. In making the decision whether to opt, class members in Zungui could have considered whether the compensation available through the settlement was greater than that available by bringing an individual claim. An objector who successfully challenges the fairness of a proposed distribution plan in a case that proceeds similarly may undermine the value of other class members' opt-out rights by changing the benefit calculus after the fact. It is an open question whether fairness would dictate that affected class members be provided with further notice and an opportunity to object to the modified plan.

A further problem could arise in cases where the total quantum of the settlement is small, but the class to be certified includes many members with nothing more than nuisance-value claims. Defendants are not likely to settle unless the claims are released, but the inclusion of those claims in the plan of distribution may dilute the settlement to the point that it risks not being approved.

While the likely reach of the Zungui decision is limited, further guidance from the courts may be necessary where judicial modification of a distribution plan raises these kinds of collateral fairness concerns.


  1. Zaniewicz v Zungui Haixi Corporation, 2013 ONSC 5490 (Sup Ct).
  2. Ibid., at para. 67.
  3. Ibid., at para. 87.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Christiaan A. Jordaan
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