Canada: Secondary Market Liability - The Defence Strikes Back

Copyright 2008, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Class Actions, December 2008

As previously reported, Canadian provinces – including those of Ontario, Alberta, Quebec and most recently, British Columbia – have enacted amendments to their respective Securities Acts to create civil liability for misrepresentation in disclosure documents and public or oral statements together with failure to provide timely disclosure of material changes (please refer to previous Blakes Bulletins on Securities Law – November 2002, May 2003, February 2005, August 2005, December 2006, November 2007 and October 2008 – which highlight and summarize that legislation and provide updates on developments).

Leave Applications

Under each provincially-enacted legislation as described above, the plaintiff must apply for leave of the court to commence a secondary market action which can only be satisfied where it is demonstrated that:

1. The action is being brought in good faith; and

2. There is a reasonable possibility that the action will be resolved at trial in favour of the plaintiff.

The provincial legislation provides that on a leave application, "the plaintiff and each defendant shall serve and file one or more affidavits setting forth the material facts on which each intends to rely."

Based upon the previous decision in Martin Silver et al. v. IMAX Corporation (IMAX) (as previously reported in our October 2008 Blakes Bulletin on Securities Regulation/Class Actions), the defendants (including certain proposed parties to be added as defendants), a law clerk and a proposed defence expert swore affidavits which resulted in extensive cross-examinations and a number of refusals which were subject to an application to the Ontario Superior Court of Justice. That court allowed a relatively wide latitude of cross-examination. The decision was upheld on appeal. Those decisions, as we previously predicted, had putative defendants in other cases carefully considering whether and what type of evidence should be filed at the leave stage.

CV Technologies Inc. Decision

The IMAX decision may have affected the strategy employed by the defendants in another Ontario secondary market liability action in Ainslie et al. v. CV Technologies Inc. (CV) et al. In that action, the plaintiffs commenced an action against CV and three of its former and present officers and directors including against CV's former auditors, Grant Thornton LLP (GT). The statement of claim alleges that CV, in its 2006 fiscal year and in the first quarter of its 2007 fiscal year, falsely represented that CV's financial statements were prepared and reported in accordance with GAAP. The plaintiffs allege that the financial statements improperly recognized sales of its Cold-FX® product in the United States as revenue earned which purportedly did not fairly present CV's financial results. The claim also alleges that CV's public filings contain misrepresentations and that CV and certain of its officers and directors are liable for damages. The plaintiffs also allege that GT is liable in connection with an audit performed by it of CV's financial statements for the 2006 fiscal year.

The CV defendants filed affidavits of only two expert witnesses which they intended to rely upon in opposing the leave application while GT filed no affidavits in response. Instead, GT simply indicated an intention to rely on the facts disclosed in the plaintiffs' application materials upon which they proposed to cross-examine.

The plaintiffs brought an application to compel each of the defendants to file an affidavit and, in the alternative, sought to examine each under Rule 39.03 of the Ontario Rules of Civil Procedure. On the initial point, the plaintiffs' position was that a proper interpretation of the legislation was that each of the proposed defendants was required to file an affidavit, sworn in their name, upon which they are subject to cross-examination. The defendants submitted that the plaintiffs' position was an improper attempt to dictate the evidence on which the defendants could rely in opposition to a leave motion and that such a position would afford the plaintiffs greater rights than in an action where it is unnecessary to obtain leave. They argued that it was inconsistent with the plain meaning of the legislation and improperly shifted the onus from the plaintiffs to the defendants, contrary to the legislative intent of the section. The Ontario Court of Justice agreed.

After reviewing in some detail the 1997 interim and final reports of the Toronto Stock Exchange Committee on Corporate Disclosure (more commonly referred to as the "Allen Committee"), the Canadian Securities Administrators (CSA) recommendations and other related information, it was noted by the court that the leave application was intended to be a "gate keeper mechanism" as a means to dissuade plaintiffs from bringing coercive and unmeritorious claims which are aimed at pressuring a defendant into a settlement in order to avoid costly litigation, otherwise known as "strike suits". The court noted that the latter has increasingly become frequent in security class action litigation in the United States and has led to legislative reforms there.

The court acknowledged that the legislative purpose of the leave section was not to benefit plaintiffs or to level the playing field in prosecuting such an action but rather, was enacted to protect defendants from coercive litigation and to reduce their exposure to costly proceedings. The court noted that no onus whatsoever is placed upon proposed defendants in the legislation nor are they required to assist plaintiffs in securing evidence upon which to base an action. Rather, the court noted that the essence of the leave motion is that putative plaintiffs are required to demonstrate the propriety of their proposed claim before a defendant is required to respond and the leave section must be interpreted to reflect that underlying policy rationale and intention to maintain a gatekeeper mechanism.

The court noted that the legislation indicates that while each defendant "shall serve and file one or more affidavits", the subsection continues: "setting forth the material facts upon which each intends to rely". The court rhetorically questioned that if there are no material facts upon which a defendant intends to rely (save implicitly for admissions obtained in cross-examination), how could it be that a defendant is required to file an affidavit? The court confirmed that it is the putative plaintiff who must satisfy the requirements of obtaining leave and must proffer sufficient evidence to meet that test – it was not incumbent upon a defendant to file any affidavit material.

The plaintiffs were also unsuccessful in attempting to, in the alternative, examine the named defendants under Rule 39.03 of the Ontario Rules of Civil Procedure. The court, relying upon previous jurisprudence, held that where the plaintiff intended to use any proposed examination for the improper purpose of obtaining information to commence an action against a witness, was prematurely attempting to inquire into a party's defences or otherwise commence the discovery process before the close of pleadings, that would constitute an abuse of process and such an examination would not be allowed. In addition, the court held that it would not allow the plaintiffs to do, indirectly, what it was not entitled to do directly under the legislation.

This decision is of significant assistance to the defence of leave applications in proposed secondary market actions and avoids making defendants subject to cross-examination prior to the commencement of the discovery process and prior to formulating a party's defences. The decision is also consistent with the objects of the legislation and the fact it remains the onus of a plaintiff, and not a defendant, to satisfy the leave requirements consistent with the gatekeeper function intended by the legislation.

Blakes is currently acting as defence counsel in securities class action proceedings engaging both the common law and the new legislation.

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.