Canada: Supreme Court Ruling On Disclosure Obligation

Last October 12th, the Supreme Court dismissed the investors' appeal, who, by way of a class proceeding, were alleging wrongdoing on the part of Danier Leather Inc. (Danier)¹ for omitting to disclose poor intra-quarterly results before the closing of its initial public offering.

Many legal issues were ruled by the Supreme Court in this matter, but we wish to deal in particular with the conclusions concerning the Business Judgment Rule in the context of non disclosure of lower results to the results forecasted in the prospectus.

The Business Appreciation Rule is a shield often used in the defense of directors when business decisions become matters of litigation, and thus, frequently constitutes a defense in a liability proceeding against directors.

Indeed, the passage of time and ulterior events can cast doubts on some decisions taken by the board of directors.

But in accordance with the Business Judgment Rule, our tribunals show restraint toward a decision taken by a board of directors as long as that decision was taken by directors acting in an informed manner, in good faith and that the said decision was reasonable.

Thus, the tribunal should not question whether it was a "perfect" decision or the "best" decision but rather if the said decision was reasonable with regard to the context, and, in such a case, the tribunal should not substitute its opinion for that of the board of directors.

One of the issues the Supreme Court had to rule on in Danier, was related to the application of the Business Judgment Rule with regard to the disclosure requirements pursuant to the Ontario Securities Act². The argument that was put forth by the respondents was that it was required to defer to the management's expertise in terms of sales forecasts in the light of their solid practical experience.

However, the Supreme Court draws an important line and reminds us that, from a general legal standpoint, even though forecasts can constitute matters of Business Judgment Rule, fact remains that disclosure is a matter of legal obligation. Consequently, the requirements of the law with respect to disclosure cannot be subordinated to the Business Judgment Rule.

In order to arrive at such a conclusion, the Court calls to attention the basic principles of the Business Judgment Rule which are that business decisions must be taken freely by directors on the basis of their special expertise and take into account reasonable risks. That said, these justifications qualified as "traditional" for the application of this rule are not called upon in the case of decisions relating to disclosure :

"It is for the legislature and the courts, not business management to set the legal disclosure requirements." (paragraph 55 of the decision)

Thus, in the case of disclosure obligation, the Business Appreciation Rule that would require deference from the tribunals regarding decisions made by boards of directors would not apply. Disclosure must always be made pursuant to the law and all of its applicable parameters.