On December 15, 2005 the Ontario Court of Appeal released its reasons in Kerr v. Danier Leather Inc ("Danier Leather") reversing the trial judge’s award of approximately $15 million in damages to investors who alleged that Danier misrepresented material facts in its prospectus related to its fourth quarter forecast.
On appeal, Justices Laskin, Goudge and Blair found that:
- although Danier had an obligation to disclose material changes, it did not have a continuing obligation pursuant to section 130(1) of the Securities Act (Ontario) to disclose material facts prior to closing;
- the law does not require financial forecasts to be "objectively reasonable" and there was no implied representation that the forecast was objectively reasonable; and
- trial judges must take the business judgment of senior management into account in assessing whether an executive’s belief in a forecast’s achievability was within a range of reasonable alternatives open to business people in senior management’s position, knowing what they knew and facing the circumstances they faced.
When Danier issued its final prospectus on May 6, 1998 it contained financial results for the first three quarters and a forecast for the fourth quarter financial results (the "Forecast"). The Forecast contained a warning that although the assumptions underlying the Forecast were considered reasonable by Danier at the time they were prepared, they may prove to be inaccurate. The Forecast also warned that actual results may vary and there was no guarantee the Forecast would be achieved in whole or in part. On appeal, neither party argued the Forecast was unreasonable as of May 6, 1998. However, before the closing date on May 20, 1998 Danier’s management had calculated actual revenues to May 16, 1998 which revealed that Danier was 24% behind store budget projections, and estimated earnings showed a loss of $240,000, rather than the Forecast of $259,000 in profit.
Danier executives Irving Wortsman and Bryan Tatoff both testified that on May 20, 1998 they were confident the Forecast was achievable since there were two major sales planned, an annual Victoria Day sale and a June sale, which had not taken place the previous year. After the Victoria Day sale, sales were 30% lower than the previous year and Danier executives became concerned that if the weather remained unseasonably warm in June 1998, the Forecast would have to be revised. On June 4, Danier released a material change report, which assumed that the warm weather would continue, and restated its projected 1998 fiscal year revenues and earnings at levels which were $4.7 million and $800,000 below those contained in the Forecast. Following this announcement, Danier’s share price declined in value from $11.25 to $8.90 per share. Despite the restatement, Danier substantially achieved the results predicted in its original Forecast after the weather cooled and the June sale was "a huge success".
The Court of Appeal found the distinction drawn in the Securities Act between a material change and a material fact to be significant. A material change is defined as "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". Whereas a material fact has a much broader definition: "a fact that would reasonably be expected to have a significant effect on the market price or value of the securities." The Court held that material changes must be reported and disclosed after the Commission issues a receipt for a prospectus and before distribution is complete pursuant to section 57(1) of the Act, but that there was no corresponding requirement to report and disclose material facts. Section 130(1), which creates a statutory cause of action for prospectus misrepresentations, was not intended to create any new disclosure obligations for the issuer. In this case, the trial judge.s finding that .unseasonably warm weather. was not a material change was not under appeal. Therefore, the Court of Appeal found that Danier was not obliged to report the unseasonably warm weather or its possible consequences prior to the end of the distribution period on May 20, 1998.
In addition, the Court of Appeal found that although a prospectus does contain implied representations that a forecast is prepared using reasonable care and skill, and that management believes the forecast is reasonable, forecasts are not required to be objectively reasonable. Although the trial judge relied on an American case for the proposition that forecasts are required to be objectively reasonable, the U.S. legislation specifically provides that a forecast may be actionable if it is not reasonably based. In the absence of Ontario or Canadian legislation that deems a forecast to carry such an implied representation, or any evidence to suggest that the Forecast being put forward was .objectively reasonable., the Court of Appeal held there was no basis to support the trial judge.s finding.
Finally, the Court of Appeal found that by failing to give weight to Danier.s ultimate achievement of the Forecast, the trial judge committed a clear and overriding error. In considering whether the Forecast was reasonable on May 20, 1998 it was appropriate for the trial judge to view the achievement of the Forecast as some evidence of its reasonableness. Moreover, the trial judge should have considered whether management.s honest belief in the Forecast was within a range of reasonable alternative opinions open to business people in their position, knowing what they knew and facing the circumstances they faced. In other words, in assessing the reasonableness of forecasts, the business judgment of management must be considered.
Securities Litigation/Broker Liability Group Leaders:
James D. G. Douglas (National Group Leader); John D. Blair; Georges R. Thibaudeau; Carole J. Brown; David Di Paolo and Gordon R. Johnson
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