Putting the Action into Class Actions

We have seen a marked increase in the number of securities class actions filed under the Bill 198 secondary market liability provisions across Canada over the past three years. Driven by several factors, including weakened financial markets and a greater focus on corporate disclosure, this increase only heightens the risks for companies, their corporate officers and their directors.

According to NERA Economic Consulting (NERA), there were 15 new securities class actions filings in Canada in 2011, nine of which were what we commonly call “Bill 198” claims, or secondary market liability claims. Since the inception of the secondary market liability regime, we have seen a total of 35 actions filed. Eleven actions have settled to date for a total amount of nearly $100 million (excluding defence costs). In most cases, these settlements were funded by a combination of corporate contribution and insurance. In many instances, they were funded by insurance proceeds alone.

In the cases that settled, defendants paid an average of $10 million, with a median settlement of $6.2 million, according to NERA. Collectively this appears to show a trend: settlements amount to approximately 10.7% of the total damages set out in the claim itself. This may seem small when compared to the amounts claimed, but this number does not include defence or other administrative costs. We have seen instances in which those amounts can equal the amount of the settlement itself.

Case Law Inconclusive

The first Bill 198 case is still before the courts. In IMAX, Ontario Superior Court Justice Katherine van Rensburg set a low standard for plaintiffs, ruling that plaintiffs only have to show there is a reasonable possibility for the action to succeed and that it is brought in good faith. She certified a class action based on common law claims and the secondary market civil liability sections of the Ontario Securities Act, allowing a global class of investors to be captured by the Ontario proceeding.

Unfortunately, the bar is so low that a plaintiff can easily receive leave to proceed. Worse still, it has been upheld on appeal: Ontario’s Divisional Court held that there was not “good reason to doubt the correctness” of the earlier decision. The application for appeal was denied and thus the decision stands.

In a departure from IMAX, the Ontario Superior Court in McKenna v. Gammon Gold refused to certify the plaintiff’s common law negligent misrepresentation claim. In rendering this decision, the court held common law claims for misrepresentation are not appropriate for certification, since each class member is required to prove reliance on the alleged misrepresentations. The plaintiffs appealed. The Divisional Court subsequently ruled that with respect to the common law claim of negligent misrepresentation, “there is no reason to conclude that the motion judge erred on his assessment of the case law on this subject. In fact, it is because of this that the legislature came up with a statutory remedy for secondary market shareholders,” namely Bill 198.

IMAX and Gammon Gold are somewhat conflicting decisions in Canada. It is still early days in terms of the development of the law in this area. We will have to wait and see how the law will ultimately be interpreted.

Round v. MacDonald, Dettwiler and Associates Ltd. (MDA) was the Supreme Court of British Columbia’s first reported decision on the test for leave to bring a secondary market liability claim under that province’s statutory regime. MDA put forth three distinct arguments in opposing the leave application:

• The material facts Lesley Round outlined in her petition before the court all began and concluded before the statutory cause of action existed in British Columbia.

• The shares Round owned were not acquired on the secondary market, but were instead distributed by treasury.

• Round neither acquired nor disposed of any shares during the material period complained of.

These arguments were compelling and led to the rejection of the submissions of the applicant’s counsel. But they were not as helpful in setting a precedent standard for the leave test in British Columbia. The court’s decision is clear that from an evidentiary perspective, the applicant failed on any level to meet the statutory conditions for leave and demonstrate any chance of possible success at trial.

Defence counsel will be quick to extol the virtues of this decision in future leave applications. But equally competent plaintiff counsel will attempt to distinguish the MDA decision on the facts. They will no doubt point out that the court indicated the discussion on the test itself was not strictly necessary due to the factual failings of the case.

For now, we have learned two things: 1) poorly constructed applications without any merit or sound statutory foundations will continue to be summarily dismissed by Canadian courts; and 2) when it comes to the proper standard for the leave test in secondary market liability cases, the final word is still awaiting us down the road (how far down that road is anyone’s guess).

Implications for Directors and Officers

What does this mean for directors and officers and their insurance needs? Two significant developments on the horizon need to be closely monitored. The first is the number of claims and the corresponding losses and settlements paid by insurance. With carriers now paying out on a repetitive basis, and with losses mounting, it is only a matter a time before carriers start to look for ways to reduce their exposure. This will typically mean three things: a reduction in coverage grants; tighter terms and conditions; and higher prices. The amount of competition in the marketplace may help slow this process, but it seems inevitable that change will occur.

The second major development is related to the nature of the coverage and litigation itself. Given that carriers have added many new policy wordings into the marketplace in the past 18 months, we will finally see the policies tested for coverage. It is inconceivable that this will happen without litigation over the terms and conditions of these policies: carriers will try to protect their losses through tight coverage opinions and their insureds will fight diligently for the coverage they need to resolve these claims. As a result, Canada will finally have a body of case law surrounding the application of directors and officers’ insurance policies in relation to securities class actions, in much the same way that a vast supply of case law on the subject has been built in the United States.

Only time will tell how all of these matters play out. However, it can certainly be said we are at the beginning of a compelling time for both officers and directors and those who serve to protect their interests.