Bill 198: An Invitation to Settle?

Devastating legal battles following financial mismanagement by the U.S. companies Enron and WorldCom have caused concern in Canada, leading to an increase in D&O claims and the drafting of new legislation.

AIG Canada CEO Gary McMillan told a Toronto audience attending a panel discussion celebrating ’30 years of D&O in Canada’ that Bill 198, new legislation introduced in Ontario, is causing directors, officers and and their insurers to squirm in their seats. “It remains to be seen how many [D&O insurers] will stand the test of time [in light of] increased claims and the power of Bill 198,” McMillan says.

BILL 198: A PRIMER

The intention of Bill 198 is to improve the quality of public disclosure among Ontario corporations. The bill gives investors incentive to sue reporting issuers and other responsible individuals for misrepresentations or the failure to disclose material changes. It also addresses a perceived imbalance in the Ontario class action regime, which gave primary market investors who buy securities under a prospectus the right to sue, but gave no remedies to secondary market investors. This was an ironic situation, according to panelist Jean-Paul Bureaud, senior legal counsel at the Ontario Securities Commission. He noted 95% of all trading occurs in the secondary market, where investors decide to buy or sell based on companies’ disclosure records.

Bill 198 contains a number of safeguards designed to: 1) create incentive to sue without harming the public company and its other shareholders, and 2) prevent perils experienced in U.S. class actions [i.e. ‘strike suits,’ or non-meritorious actions brought to blackmail companies into settling claims for fear of engaging in lengthy litigation].

In order to deter the plaintiff bar from launching strike suits, Bill 198 includes provisions such as a leave requirement, liability caps, damage thresholds, and a loser-pays cost rule. Essentially, under the leave requirement, counsel cannot pursue a court action until the judge is satisfied that the action is brought in good faith and the plaintiff has a reasonable possibility of success. “The court is being asked to play the role of the gatekeeper, both in terms of allowing the action to start and then allowing the actions to be settled,” Bureaud says.

However, because Bill 198 has a lower pleading standard than in the U.S., the new legislation may actually make it easier to sue or settle in the Ontario market, panelists told the audience. The leave requirement may even allow U.S. firms to bulk up their class action.

U.S. FIRMS FLOOD THE GATES

Won Kim, partner at Roy Elliott Kim O’Conner LLP, says the leave motion will give plaintiffs’ lawyers an opportunity to make broad allegations and accusations in the affidavit filed for leave. Barbara Murray, partner at Dolden Wallace Folick LLP, says this will force defendants to rebut with their own affidavit. This in turn will leave the defendant organization, its directors and officers exposed to potentially ruinous cross-examinations.

“The strategic value of the leave motion will be much greater than a simple act of pending motion,” Kim says. “You will have broad discovery and… days and days of examination where there will be sweeping allegations of conspiracy.”

Michael Spencer, partner at Milberg Weiss Bershad & Schulman LLP, describes Bill 198’s leave process as a boon for U.S. plaintiff firms. Ordinarily, he notes, plaintiff firms can only access defendants during discovery after the pleading motion. “This (Bill 198) is a golden opportunity for plaintiffs to obtain discovery early on in the case and to learn what the defendants’ defenses are,” Spencer says.

A majority of the panelists believed aggressive U.S. plaintiffs firms will seize on the new leave requirement. “The jurisdictional basis for bringing claims to Ontario is pretty minimal,” Ken Kramer of Shearman & Sterling LLP warns. Responsible issuers do not have to be Canadian or have securities registered in Canada, Kramer says. They only have to prove a substantial and real relationship to Ontario. “If I’m a smart U.S. plaintiff lawyer, I’m going to get someone to bring a case up here [in Canada] and get all the discovery that I can’t get in the U.S.”

That is exactly what Michael Mitrovic, president of AIG Worldwide Financial Lines Claims, predicts will happen. “The plaintiff bar in the U.S. will coach, make alliances and capitalize and subsidize Canadian firms,” Mitrovic warns. U.S. plaintiff firms, he adds, will go on a “fishing expedition” to find facts that were not accessible when the suit was filed, but are nevertheless available through discovery under Bill 198.

“I’m suggesting to you that with the guidance of the American plaintiff bar and their appetite to get these huge boxcar numbers…the evolution is going to be much more accelerated than anybody could ever have anticipated.”

Spencer validated this prediction on the panel. “I am looking forward to an opportunity to litigate under the new Canadian litigation in partnership with a class-action firm here in Canada,” Spencer says. “I’ve got my New York-Toronto plane schedules taped to a wall in my office.”

SO MUCH FOR SAFEGUARDS

Spencer says well-capitalized U.S. firms are accustomed to large financial risks. In fact, such risks are often written into their budgets. As such, Bill 198’s loser-pay provision is merely another form of “accentuated financial risk,” he says.

To reduce any appetite to take such risks, Bill 198 introduced liability and damage caps. The cap on liability for misrepresentation, Bureaud reveals, is the greater of either $1 million or 5% of the market cap. Kim notes individual officers and directors are only liable for $25,000 or 50% of full compensation for the 12 months before the violation. Experts are only liable for $1 million under the legislation’s caps.

Bureaud says under Bill 198, damages are assessed on a proportionate basis: if a defendant is found liable for a certain percentage of the misrepresentation, that is the amount the defendant is required to pay.

So why take the financial risk of making a claim, when caps on damages and liability restrict the potential payout? Because, the panel seems to agree, a creative plaintiff bar can plead around the monetary caps on the basis of knowledgeable conspiracy to commit fraud on the market.

An important caveat exists to the cap rule. If the defendant authorized, permitted or acquiesced to the misrepresentation and failed to make a timely disclosure, Bureaud says, the caps no longer apply. If this happens, the individual director and board officers will be held joint and severally liable for the entire damage award.

Plaintiff’s counsel must prove the defendant was cognizant of the misrepresentation in order to kill the caps, but no such requirements exist to prove the misrepresentation caused damage to investors.

RELYING ON RELIANCE

Ontario’s new legislation says shareholders are not required to prove they relied on the public misrepresentation. Moreover, they do not even have to prove the misrepresentation induced the drop in stock price. When pleading under Bill 198, the plaintiff’s counsel must only prove that a misrepresentation occurred and that shares in the corporation dropped. The same simplicity in Bill 198 is not mirrored under U.S. legislation.

In the U.S., the plaintiff bar has strict plea requirements: they must prove the investor relied on the misrepresentation. U.S. law stipulates that a plaintiff’s counsel must prove the knowing and reckless state of mind of the defendant.

In U.S. class actions, Mitrovic says, the defense has an opportunity to rebut the reliance presumption by questioning the entire investor class to determine if they truly relied on the inaccurate disclosure. “In Canada, you don’t have that: you have presumptive reliance and then it’s over. It’s almost like a prima facie case of liability if there’s a m
isrepresentation, which I think is going to lead to earlier settlements in Canada than in the States.”

BILL 198 IN CANADA

Bureaud believes all Canadian provincial governments are committed to introducing some form of Bill 198 at some point. He guessed British Columbia, Alberta and Qubec would likely be the first provinces to introduce the legislation. “I think there’s clearly momentum in those provinces to adopt similar legislation,” he says. “B.C. recently had enacted new securities and that contained similar types of civil liability for both primary and secondary market violations. So clearly they have crossed the threshold already.”

Nationwide adoption may appear almost certain, but provinces might not see action for some time. Kim notes that while the floodgates for U.S. plaintiffs firms have been open since Dec. 31, there have yet to be any Bill 198 class actions.

“I think the doomsday scenario won’t happen,” Kim says. “I think the firms from the U.S. will trod carefully and warily, but there will be American partners in Canadian class actions.”