Canada’s top court dismisses shareholder class action against Danier Leather but rejects Business Judgment Rule as a defence in securities cases

Last week, Canada’s Supreme Court upheld the dismissal of Canada’s first-ever securities class action judgment in favour of investors relating to alleged misrepresentations on an initial public offering.

The class action in Kerr v. Danier Leather was brought under s. 130 of the Ontario Securities Act, which allows initial purchasers of securities to recover damages where the issuing company has made a misrepresentation in its prospectus. Initial purchasers of shares are deemed to have relied upon a company’s misrepresentation. In his decision on behalf of a unanimous court, Mr. Justice Binnie made it clear that when looking at a statutory remedy such as that under s.130 of the Securities Act, the courts must simply interpret the statute and refrain from citing external principles and considerations to either broaden or narrow its scope.

This case involved Danier’s failure, after issuing its prospectus, to release revised financial forecasts reflecting lower leather sales due to a warm spring.  The trial judge held Danier liable primarily on the basis that the revised forecasts were a material fact that both made its original prospectus inaccurate and gave rise to a disclosure obligation that Danier had not met.

What won the day for Danier in both the Ontario Court of Appeal and the Supreme Court of Canada was a simple exercise of statutory interpretation: under the Securities Act there was no obligation to disclose material facts but, rather, to disclose much more significant corporate events called material changes. As such, a failure to disclose only material facts and could not breach the Securities Act and could not result in liability.

The decision of Binnie J. makes it clear that a statutory action must be brought within the four corners of the statute.  Common law concepts will not be used to either broaden the basis for statutory liability or excuse a statutory breach.  For example, Binnie J. rejected the Ontario Court of Appeal’s citation of the business judgment rule (in which courts refrain from second-guessing management decisions made reasonably) as one of the reasons for overturning the trial judgment.  In his words, disclosure under the Securities Act is not a matter of business judgment but a legal obligation, and the business judgment rule “should not be used to qualify or undermine the [statutory] duty of disclosure.” 

Despite the fact that it had no impact on the ultimate result in this case, the Supreme Court’s refusal to show any deference to management decisions on issues of statutory compliance is a significant finding.  Previously, public companies had trumpeted the Court of Appeal’s decision in Danier as a vindication of management decisions that are made reasonably but may not comply with the strict letter of the statute.  The Supreme Court of Canada has now made it clear that that is not the case – a corporation has either complied with the legislation or it has not and the issue of whether management acted reasonably or in good faith is not relevant to that determination.

In the result, the class action was dismissed and the representative plaintiff was ordered to pay the defendants’ legal costs; a liability estimated at more than $1 million.  In making the costs order against the plaintiff, Binnie J. observed that “protracted litigation has become the sport of kings in the sense that only kings or equivalent can afford it.  Those who inflict it on others in the hope of significant personal gain and fail can generally expect adverse cost consequences.”

Published October 17, 2007