On June 3, 2021, Justice Andrew Borrok of the Supreme Court of the State of New York, Commercial Division, granted a motion to dismiss a putative securities class action against a Canadian cannabis company (the "Company"), certain of its officers and directors, and its underwriters, alleging violations of Sections 11 and 15 of the Securities Act of 1933 (the "Securities Act"). Leung v. Hexo Corp., et al., No. 20-cv-150444 (N.Y. Sup. Ct. Jun. 3, 2021). Plaintiff alleged that the Company's offering documents misled investors regarding one of the Company's key supply agreements. In dismissing the complaint, the Court held that plaintiff failed to adequately allege contemporaneous facts indicating that the Company knew at the time of the offering that issues would arise with respect to that agreement. In so holding, the Court cited a March 9, 2021 decision by Judge Naomi Reice Buchwald of the Southern District of New York, in which Judge Buchwald granted a motion to dismiss a first-filed action in federal court asserting similar claims against the Company, certain of its officers and directors, and its underwriters, relying on the same allegations.
As discussed in our previous post, following the legalization of cannabis in Canada, the Company entered into a supply agreement in 2018 with a Canadian government-run dispensary (the "Dispensary"). Under the agreement, the Dispensary committed to purchasing a certain amount of cannabis within the first year of legalization. The agreement contained a "take-or-pay" ("ToP") provision under which the Company could demand payment even if the Dispensary did not order the full amount. The Company completed an IPO in January 2019. On a March 2019 earnings call, the Company acknowledged lower-than-expected demand but stated that it remained optimistic that demand would increase and that the Dispensary would meet its purchase obligation. In its March 2020 Form 6-K filing, however, the Company announced that it had released the Dispensary from the ToP provision in order to preserve the business relationship. The Company's stock price dropped after the disclosure.
In considering the Company's motion to dismiss, Judge Borrok noted that "whether a statement is materially false or misleading is viewed at the time such statement is made—not retroactively, in hindsight." The Court held that the complaint "fail[ed] to identify any contemporaneous facts showing the defendants knew, at the time of the offering, of the subsequent issues that arose" with respect to the Dispensary, thereby failing to adequately allege a violation of the Securities Act. In support of its holding, the Court cited Judge Buchwald's recent decision dismissing "substantially similar claims against the same defendants arising out of the same offering," in which Judge Buchwald held that plaintiffs failed to allege defendants knew at the time the Company's prospectus was issued that the Dispensary would be unable to meet its purchase obligations under the supply agreement and that the prospectus was issued shortly after legalization and "it was reasonably difficult to anticipate demand."
Judge Borrok further held that even if plaintiff had identified alleged misrepresentations in the offering documents, those claims would be "barred under the bespeaks caution doctrine as the offering documents contained ample cautionary statements." In so holding, the Court observed that the offering documents clearly contained adequate cautionary language, which stated that should the Dispensary or any other government-run dispensary decide "to purchase lower volumes of products" than expected, or "alter...its purchasing patterns at any time with limited notice or decide...not to continue to purchase" at all, then the Company's "revenues could be materially adversely affected."
The Court also held that plaintiff failed to state a claim under Regulation S-K because the complaint "fail[ed] to identity any facts which were known or should [have been] known [that] rendered the offering documents materially misleading at the time they were issued." Finally, after noting that it found plaintiff's remaining arguments "unavailing," the Court dismissed the section 15 claim having found no predicate liability under section 11, and denied plaintiff's application for a stay in the alternative as moot in light of Justice Buchwald dismissing the first-filed federal action.
The decision is one of an increasing number of recent decisions from the Commercial Division of New York Supreme Court following the Supreme Court's decision in Cyan v. Beaver County Employees Retirement Fund, 138 S. Ct. 1061 (2018), which affirmed state courts' concurrent subject matter jurisdiction over class actions alleging claims under the Securities Act.
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