Article by Larry Lowenstein Mark Gelowitz Lawrence Ritchie Allan Coleman
Originally published December 16, 2005
On December 15, 2005, the Ontario Court of Appeal released its highly anticipated decision in Kerr v. Danier Leather, reversing the first trial decision in a shareholder class action for an alleged prospectus misrepresentation. TheKerr v.Danier Leather decision is of great importance to issuers and their officers and directors, both in its direct impact on the scope of statutory civil liability for prospectus misrepresentation, and on the guidance or direction it may provide in relation to the new regime for statutory civil liability for secondary market disclosures, in effect in Ontario as of January 1, 2006.
The trial judge had found Danier, its chief executive officer and its chief financial officer liable to the shareholder under section 130 of the Securities Act (Ontario) on the ground that Danier had failed to disclose material facts occurring after the date of its prospectus that made its earnings forecast contained in the prospectus objectively unreasonable as of the date of closing. The Court of Appeal allowed the appeal and dismissed the action, finding that the trial judge erred in:
- concluding that Danier had a continuing obligation to disclose material facts occurring between the date of its prospectus and the date of closing;
- concluding that Danier’s prospectus contained an implied representation that the earnings forecast was objectively reasonable; and
- failing to give any deference to the business judgment of Danier’s senior management in determining the reasonableness of the earnings forecast and in failing to take into account that the earnings forecast was, in fact, ultimately substantially achieved.
The Court of Appeal’s decision in Danier Leather is very significant for issuers and their senior management because it confirms that issuers do not face statutory liability under section 130 of the Securities Act for failing to disclose material facts that arise after the date of a prospectus but prior to closing, provided that such facts do not amount to a "material change" within the meaning of the Securities Act. The decision also clarifies that an earnings forecast included in a prospectus will not, in most cases, amount to a representation that the forecast is objectively reasonable, but only that the forecast represents management’s best judgment, that it was prepared using reasonable care and skill and that management subjectively believes the forecast to be reasonable.
In May 1998, Danier made an initial public offering of its shares through a prospectus. In addition to providing the company’s actual results for the first three quarters of its 1998 financial year, Danier’s prospectus also contained an earnings forecast for the company’s fourth quarter ending in June 1998. The final prospectus was filed on May 6, 1998, and the offering closed on May 20, 1998, without any actual results for the fourth quarter being incorporated into the forecast or otherwise communicated to the public. The shares were issued at a price of $11.25 per share. On June 4, 1998, less than two weeks after the distribution under the prospectus had closed, Danier issued a press release announcing that it had revised its earnings forecast for the fourth quarter downward due to unseasonably warm weather in most of its markets, which had negatively impacted its sales of leather apparel. Following the press release, the share price of Danier shares declined significantly to a low of $8.25 on June 9, 1998. On July 6, 1998, Danier released its actual fourth quarter results, announcing that it had substantially achieved its original earnings forecast.
The Trial Decision
The trial judge found that, as of the date of the filing of the prospectus, the earnings forecast did not contain a misrepresentation. However, between the date of the filing of the prospectus and the closing of the distribution, senior management came into possession of information concerning the company’s actual fourth quarter results to date that made the earnings forecast objectively unreasonable. The trial judge concluded that although this information about the fourth quarter results did not amount to a "material change" requiring an amendment to the prospectus under section 57 of the Securities Act, the information was a material fact and section 130 of the Securities Act imposed a separate and continuing obligation on the company to disclose any material facts arising after the date of the prospectus but before closing. The failure to disclose the information concerning the actual fourth quarter results therefore caused the earnings forecast to amount to a misrepresentation.
The trial judge awarded damages based on the depreciation in the price of the security caused by the misrepresentation. He calculated the damages to be $2.35 per share, based on the difference between the prospectus share price and the price of Danier’s shares after the market had absorbed the effects of the misrepresentation, without any requirement for individual shareholders to demonstrate an actual loss caused by the misrepresentation.
The Decision of the Court of Appeal
The Court of Appeal found that the trial judge had made three errors, each of which provided sufficient grounds to allow the appeal and set aside the trial decision.
Danier had no obligation to disclose material facts which occurred after the date of the final prospectus
The trial judge had held that section 130 of the Securities Act imposes a continuing obligation on issuers to disclose material facts that occur after the date of the prospectus but prior to the date of closing. The Court of Appeal disagreed, concluding that sections 56 and 57 of the Securities Act constitute a complete code of prospectus disclosure obligations, both for the purpose of statutory compliance and for statutory civil liability. These sections impose an obligation on reporting issuers to disclose "material changes" occurring after the date of the prospectus but prior to closing, but do not require disclosure of "material facts" that occur during the same period. The Court of Appeal stated that section 130, a remedies section, does not impose an obligation to make continuous disclosure that is not expressly provided for in those sections of the Securities Act that address prospectus disclosure obligations. The Court of Appeal also noted that, although the securities regulators had adopted policy statements that imposed broader continuous disclosure obligations, these policy statements were not law and could not be used to ground an action for prospectus misrepresentation under section 130 of the Securities Act.
Danier did not represent that the earnings forecast was objectively reasonable
The trial judge had held that, where an earnings forecast is included in a prospectus, it carries with it the following implied factual assertions:
- the forecast represents the forecaster’s best judgment of the most probable set of economic conditions and the company’s planned course of action;
- the forecaster made the forecast with reasonable care and skill and the forecast itself is sound; and
- the forecaster generally believed the forecast, the forecaster’s belief was reasonable and the forecaster was not aware of any undisclosed facts tending to seriously undermine the accuracy of the forecast.
The Court of Appeal disagreed, stating that there was no evidence to suggest that by including the earnings forecast in the prospectus, Danier and its senior management were implicitly stating to prospectus purchasers that their best judgment as to the earnings forecast was objectively reasonable.
The business judgment of Danier’s senior management was entitled to deference
The Court of Appeal further held that, even if the trial judge’s conclusion that the earnings forecast contained an implied representation that it was objectively reasonable were accepted, the trial judge committed palpable and overriding errors by
- disregarding the fact that the earnings forecast was ultimately substantially achieved in assessing whether it was reasonable at the time it was made; and
- failing to give any deference to the business judgment of Danier’s senior management as to whether the forecast was within a range of reasonableness.
Damages and Costs
Because the Court of Appeal found that Danier was not liable under section 130 of the Securities Act, the court was not required to address the measure of damages adopted by the trial judge or his award of costs. While understandable and appropriate, this is unfortunate because the proper approach to the measure of damages in securities class actions remains unresolved. The court did, however, specifically refer to the fact that the trial judge had awarded a costs "premium" to plaintiffs’ class counsel, stating that it was "doubtful" that such a costs premium could be properly awarded in a class proceeding.
The last chapter may not yet have been written on the Danier case, as counsel for the plaintiffs have announced that they will be seeking leave to appeal the Court of Appeal’s decision to the Supreme Court of Canada.
Larry Lowenstein is the Chair of the Osler Litigation Department and Co-Chair of the Corporate Governance and Securities Litigation Specialty Group. Mark Gelowitz is a partner in the firm's Litigation Department. He is the Co-Chair of the firm's National Corporate Governance and Securities Litigation Group. Larry Ritchie is a partner in the firm’s Litigation Department and is also cross-appointed to the firm’s Pensions & Benefits Department. Allan Coleman is a senior associate in the firm's Litigation Department. He has a wide-ranging practice, with particular emphasis on corporate governance and securities litigation.
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