Canada: Ontario Superior Court of Justice certifies Securities Class Action in McKenna v. Gammon Gold - with Limitations

Justice Strathy of the Ontario Superior Court of Justice has added to the growing body of securities class actions, in the recent decision in McKenna v. Gammon Gold Inc., [2010] O.J. No. 1057 (S.C.J.). In granting certification of a prospectus-misrepresentation class action, Justice Strathy shed some light on (a) the issues surrounding the inclusion of non-residents as a part of the class; and (b) whether a plaintiff is required to prove direct reliance at the certification stage for a common-law negligent-misrepresentation claim.

The defendants were Gammon Gold Inc. , a TSX- and AMEX-traded Nova Scotia company with mining operations in Mexico (Gammon), together with its senior officers and/or directors (collectively, the Gammon Defendants), and the Canadian financial institutions who underwrote the prospectus offering, BMO Nesbitt Burns Inc., Scotia Capital Inc. and TD Securities Inc. (collectively, the Underwriters). The representative plaintiff, Ed McKenna (McKenna), alleged that the defendants made misrepresentations in Gammon's prospectus and other public filings, the effect of which was to overestimate the actual and anticipated production rate at Gammon's Mexican mines and to misrepresent the real state of Gammon's business. McKenna, who purchased Gammon shares pursuant to Gammon's public offering under a short-form prospectus dated April 19, 2007 (the Prospectus), sought to represent a class of plaintiffs who purchased Gammon shares both under the prospectus and in the secondary market during the class period of October 10, 2006 (the date of Gammon's press release, which allegedly contained misrepresentations regarding its projected mining production) to August 10, 2007 (the date on which Gammon stated for the first time that it was unlikely to meet its production projections, a disclosure that allegedly caused Gammon's stock price to drop 28% over the subsequent five trading days).

In certifying the primary market purchasers as a class proceeding under s. 130 of the Securities Act against all defendants, and an additional claim for unjust enrichment against the Underwriters, Strathy J. made some important findings related to (a) the "thorny issue of reliance" in a common-law misrepresentation class action and (b) the court's jurisdiction over non-resident class members.

Causes of Action

On behalf of the primary-market purchasers, McKenna asserted common-law causes of action for negligent misrepresentation (against all defendants), negligence (against all defendants), reckless misrepresentation (against all defendants), conspiracy (against Gammon), unjust enrichment and waiver of tort (against the Underwriters) and statutory cause of action for prospectus misrepresentation pursuant to s. 130 of the Securities Act (against all defendants). On behalf of the secondary-market purchasers, McKenna asserted all of the common-law causes of action listed above, but not the statutory cause of action under s. 130. There was no statutory cause of action pleaded pursuant to s. 138.3 of the Securities Act for misrepresentations affecting the secondary market.

In granting class certification for the primary-market purchasers, Strathy J. limited the plaintiff's causes of action significantly and certified only two claims: (1) the statutory cause of action under s. 130 of the Securities Act against all defendants and (2) the common-law cause of action for unjust enrichment and waiver of tort in connection with the prospectus against the Underwriters. The certification of the conspiracy claim was adjourned to permit the plaintiff to deliver particulars of the special damages it suffered separate and distinct from the damages arising from the underlying tort itself - a key element of a conspiracy claim that the plaintiff failed to plead. Strathy J. found the negligence simpliciter claim to be improper because it was really subsumed by the negligent-misrepresentation claim. The reckless-misrepresentation claim was also found to be improper because the plaintiff failed to plead key elements of the claim: recklessness, wilful blindness or fraud.

The Common-Law Negligent-Misrepresentation Claim

In holding that the plaintiff's common-law negligent-misrepresentation claim was both an improper cause of action and not a common issue for the class, Strathy J. dismissed the plaintiff's "non-reliance theory of misrepresentation" argument that the plaintiff is not required to establish his or her reliance upon the representation. Strathy J. cited several authorities for the generally accepted standard that a cause of action in negligent misrepresentation requires proof of the plaintiff's reliance on the misrepresentation. The need to establish such reliance is the reason "that courts have usually concluded that negligent misrepresentation claims give rise to such individual inquiries as to reliance that they are unsuitable for certification."

In concluding that there is binding authority from the higher courts that makes proof of reliance a necessary requirement of a negligent-misrepresentation claim, Strathy J. rejected the conclusion reached by Rady J. in McCann v. CP Ships [2009] O.J. No. 5182 (S.C.J.) that "the law on the issue of reliance is in a state of evolution and that in some cases the courts have been prepared to relax the requirement." Strathy J. considered the need to prove reliance was

a necessary element of negligent misrepresentation, and the inability to establish reliance as a common issue, makes the common law misrepresentation claims, in both the secondary and primary markets, fundamentally unsuitable for certification.

Specifically, Strathy J. rejected Van Rensburg J.'s conclusion in Silver v. Imax Corp. [2009] O.J. No. 5585 that a plaintiff is not required to prove direct reliance at the certification stage, and that the issue can be left for argument at trial.

Strathy J. considered his holding to be in line with the legislature's reasoning behind the enactment of s. 130 and s. 138.3(1) of the Securities Act, where the statutory primary- and secondary-market misrepresentation legislation contains "deemed reliance provisions" that allow the investing public to sidestep the onerous reliance requirement in common law, as long as elements of the statutory claim are made out.

The Proposed Class - the Issue of Jurisdiction Over Non-Resident Plaintiffs

Justice Strathy found the plaintiff's proposed class of "all shareholders who acquired Gammon securities, whether under the Prospectus or in the secondary market, at any time during the Class Period" to be overly broad and, instead, limited the class to residents and non-residents who acquired Gammon shares through "the underwriters in Canada and under the Prospectus."

In reaching his decision, Strathy J. applied the jurisdictional test, recently restated by the Court of Appeal for Ontario in Van Breda v. Village Resorts Ltd., 2010 ONCA 84, which simplified the traditional analytical process for "real and substantial connection" set out in Muscutt v. Courcelles (2002), 60 O.R. (3d) 20 (C.A.). Strathy J. found there to be a clear connection between Ontario and the plaintiff's claim and that there would be no unfairness in subjecting the defendants to Ontario jurisdiction.

In addition, Strathy J. considered whether the principles of order and fairness support the extension of the court's jurisdiction to require class members out of the jurisdiction either to opt out or to be bound by the result. As noted by Sharpe J.A. in Currie v. McDonald's Restaurants Canada Ltd. (2005), class actions have unique features, one of which is the involvement of the "unnamed, non-resident class plaintiff" who, unlike the plaintiff in a typical lawsuit, does not come to Ontario asking for access to our courts and thereby voluntarily attorning to the court's jurisdiction. In these situations, the court needs to give additional consideration to

whether the non-resident has done something that would give rise to a reasonable expectation that legal claims arising out of the activity could be litigated in the jurisdiction. The court should also ask whether it would be reasonable from the perspective of the defendant that class action litigation in the jurisdiction should finally dispose of claims of non-resident class members.

This will not be the end of the analysis, as Sharpe J.A. pointed out at paras. 23-25 of Currie. The principles of order and fairness require that, even if there is a substantial connection between the wrong and the jurisdiction and the plaintiff might have expected that his or her legal rights would be resolved in the jurisdiction, the procedures adopted must ensure that the rights of absent class members are adequately protected. This calls for consideration of appropriate representation for such class members, appropriate notice and an informed and meaningful opportunity to opt out. [emphasis added]

Based on the above-noted principles, Strathy J. found that non-residents who made purchases from the "underwriters in Canada and under the Prospectus" were to be included in the class, subject to appropriate safeguards with respect to representation and notice. Strathy J. found that the non-residents can reasonably expect that their rights would be subject to Canadian jurisdiction, since they acquired securities of a Canadian company, in Canada, and through a Canadian underwriter. However, he ordered the appointment of a separate representative plaintiff for class members located outside of Canada who purchased their shares in Canada.

Strathy J. found it inappropriate to include persons "who purchased securities from the Underwriters or their agents outside Canada" in the class, since acquiring Gammon's securities in a jurisdiction outside Canada "would not give rise to a reasonable expectation that the acquirer's rights would be determined by a court in Canada." Strathy J. also considered it inappropriate to certify the secondary-market claim. Had he done so, he "would have limited the Class to those who acquired their shares on the TSX, who, for the reasons set out above, could reasonably contemplate that their rights would be determined by the courts of the jurisdiction where the shares were acquired."

The case is one of only a handful to date to consider the new causes of action arising under the Securities Act, so only time will tell how the provisions will ultimately be interpreted and applied.

The author wishes to thank Amy Hu, Stikeman Elliott Student-at-law, for her assistance.

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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