Court paves way for professional accountant regulator to pursue claim against former corporate director who settled securities class-action lawsuit

The governing body regulating chartered accountants in Ontario has the right to pursue action against a former chief financial officer and director of Sino-Forest Corp., despite the fact that the former company official reached a settlement in a shareholders’ class-action lawsuit alleging misrepresentation, an Ontario court recently ruled.

Court records indicate that Sino-Forest – which was established in 1994 and operated forest plantations China – had “seven public offerings of securities, comprised of four note offerings and three share offerings.”

In June, 2011, Sino-Forest’s share price dropped 71.3%. A short seller alleged, among other things, that Sino-Forest had made some false claims. Later that same month, several plaintiffs proposed a class-action lawsuit, alleging the firm made “misrepresentations” in various public statements. Those allegations have yet to be proven in court. In 2012, Sino-Forest applied for court protection, from creditors, under Canada’s Companies Creditors Arrangement Act.

The defendants in the securities class-action lawsuit included David Horsley, a former chief financial officer of Sino-Forest. The plaintiffs include a pension fund of a Canadian local of the Washington, D.C.-based International Union of Operating Engineers, which represents operators of cranes, backhoes, bulldozers and heavy equipment. The case is cited as The Trustees of the Labourers’ Pension Fund of Central and Eastern Canada v. Sino-Forest Corporation.

In 2014, the plaintiffs settled with Horsley. His insurers (ACE Ltd. and The Chubb Corp. – who have since merged) agreed to pay $4.2 million, wrote Mr. Justice Paul Perrell, in a decision released in October, 2015.

However, the Chartered Professional Accountants of Ontario is seeking a $75,000 penalty on Horsley, and to ban Horsley from practising accounting for two years. CPAO alleges that while employed as CFO of Sino-Forest, Horsley “failed to perform his professional services with due care.” That allegation has yet to be proven.

Horsley asked the Ontario Superior Court of Justice for an order declaring, among other things, that any allegations made by CPAO against him “have been fully, finally, irrevocably and forever released and discharged pursuant to” the order settling the shareholders’ lawsuit. He also asked the court to declare that CPAO “is enjoined from commencing or continuing any disciplinary proceeding” against him.

But Horsley’s request was denied by Mr. Justice Geoffrey Morawetz, in a decision released Feb. 19.

“The allegations of professional misconduct are not claims against [Sino-Forest] or a claim against Mr. Horsley in his capacity as officer and director,” Justice Morawetz wrote. “The CPAO allegations are with respect to his professional conduct as a chartered accountant.”

Justice Morawetz ruled that Horsley’s settlement “does not affect the right or ability of the CPAO to bring, continue or prosecute” allegations against Horsley.

Horsley took the position that the court “has the jurisdiction to release the CPAO proceeding” under CCAA. He also pointed to a clause from the settlement order stipulating that “any and all Horsley Claims shall be fully, finally, irrevocably and forever compromised, released, discharged, cancelled, barred and deemed satisfied and extinguished as against Mr. Horsley and in accordance with section 11.2 (c) of the Plan,” and that the release “shall be binding according to its terms on any Person.”

That “plan” refers to the Sino-Forest Plan of Compromise and Reorganization.

CPAO argued that its action against Horsley “does not give rise to any monetary or financial claim” against Sino-Forest.

When insolvent companies seek protection from creditors, a directors’ and officers’ liability policy “can become the only tangible source of potential recovery for shareholders and it can get interesting then in how officers and directors are dealt with in that context,” Shara Roy, a partner with law firm Lenczner Slaght Royce Smith Griffin LLP, told Canadian Underwriter earlier. Roy, whose practice areas include insolvency and securities regulatory actions, was commenting on D&O liability in general before the court released its decision in favour of CPAO.

In ruling last month against Horsley, Justice Morawetz cited a Supreme Court of Canada decision, released in 2012, in favour of AbitibiBowater Inc., now known as Resolute Forest Products. In 2009, the Newfoundland and Labrador government issued pollution cleanup orders against AbitibiBowater, which was undergoing bankruptcy proceedings in Quebec under CCAA. The Newfoundland and Labrador provincial government was unsuccessful in its argument that the cleanup orders were claims.

Canada’s Bankruptcy and Insolvency Act stipulates how a trustee determines whether a “contingent” or “unliquidated” claims is a “provable claim.”

“There must be a debt, a liability or an obligation to a creditor,” Madam Justice Marie Deschamps, then of the Supreme Court of Canada, wrote in 2012 in AbitibiBowater. “Second, the debt, liability or obligation must be incurred before the debtor becomes bankrupt. Third, it must be possible to attach a monetary value to the debt, liability or obligation.”

Ontario’s Chartered Accountants Act “does not give rise to any financial liability on [Sino-Forest], nor does it impose liability on its officers and directors, in their capacities as such, for legal obligations of the debtor corporation which they manage and direct,’ Justice Morawetz wrote. “In addition, the focus of the disciplinary process of the CPAO is on the professional conduct of the member as articulated by the Rules and it is in this capacity that the allegations of misconduct are made as against Mr. Horsley.”

He added the CPAO action is not yet at the “enforcement” stage.

Part XXIII.1 of Ontario’s Securities Act, which took effect 10 years ago, “creates a statutory cause of action for misrepresentation in the secondary securities market in favour of any person who acquires or disposes of the securities of an issuer between the time the document containing the representation was released and the time the misrepresentation was corrected,” noted Mr. Justice George Strathy – then of the Ontario Superior Court of Justice – in a decision released in 2012.

The Supreme Court of Canada ruled last December that in order to obtain commence an action for misrepresentation in the secondary securities market, under the Ontario Securities Act, there must be “a reasonable possibility that the action will be resolved at trial in favour of the plaintiff.”

In that ruling, the Supreme Court of Canada issued three separate decisions. It heard appeals from three corporations – the Canadian Imperial Bank of Commerce, electronics equipment maker Celestica Inc. and cinema vendor IMAX Corp. – in shareholders’ class-action misrepresentation lawsuits.

Insurance Bureau of Canada (IBC) had intervener status in CIBC’s appeal, due to the impact on D&O liability insurers.

IBC “took the position that the test for granting leave should be an onerous, rigorous test so that only cases with merit should be allowed to proceed to the starting line in Ontario, and on that point, the Supreme Court of Canada agreed with us,” Alan D’Silva, a Stikeman Elliot lawyer representing IBC, told Canadian Underwriter in December.