Summary of Contents
Author
Ward K. Branch
Branch MacMaster Barristers & Solicitors
E-mail: wbranch@branmac.com
Richard J. Berrow
Russell & DuMoulin Barristers & Solicitors
Class actions provide a powerful tool to plaintiffs and their counsel. Actions that would not have been brought prior to 1992 suddenly make sense when many small claims can be efficiently aggregated. Anyone with responsibilities to a diffuse group is now at greater risk than prior to the passage of class action legislation. Directors and officers are no exception to this rule.
Others will address this issue in greater detail. It is sufficient at this stage to note that although directors and officers owe their primary duty to the company, in certain situations they may also owe a duty to act fairly toward shareholders or employees. Through use of common law principles, the oppression remedy and other statutory obligations, directors and officers can be held to account for acts that a court finds unduly prejudicial to a class of shareholders or employees.
To proceed as a class action, the case must receive court approval. There are five statutory requirements:
There are a few important things to note about this statutory test:
Once certified, the statute creates a number of additional benefits for class members:
Actions against issuers, their officers and directors are among the most popular areas for class actions in the United States. Most common are claims of fraud under section 10(b) of the Securities Exchange Act of 1934.
If a director or officer fails to ensure that the company discloses adverse material information, they are likely to find themselves part of a class action lawsuit by shareholders who purchased in the secondary market during the period of the material non-disclosure. The action will claim the difference between the price at which the shares were purchased, and what the shares were actually worth.
These class actions are assisted by the "fraud on the market" theory, which essentially removes the necessity to establish reliance on any particular misrepresentation by the company, so long as the plaintiff can establish that the failure to disclose had an impact on the market price. Further, the court is willing to certify the class action even if the claim requires an assessment of documents produced over an extended period of time, so long as the documents were part of a common scheme to defraud shareholders. Both these principles reduce the individuality associated with the claims, and keeps the focus on the issuer’s conduct. Certification is essentially automatic in such class actions.
Defendants whose share price takes an unexpected dip will usually face a spate of actions by many different law firms. Cendant Corp. alone was hit with 70 different lawsuits in 1998. Usually the various plaintiff’s counsel will eventually congeal around one lawsuit. In other cases, the courts have ordered an auction for the right to represent the class.
Defendants faced with such actions find it difficult to maintain a defence on the merits. The resources required to defend the lawsuit and the negative impact on the company’s ability to raise further capital (coupled with class counsel’s willingness to resolve claims for cents on the dollar) create an environment that is very conducive to settlement (or "blackmail" depending on your position).
So many class actions were filed in the early 1990s that legislators came to believe that remedial legislation was required. Congress passed the Private Securities Litigation Reform Act in 1995. This legislation:
The desire to shift control of securities class action litigation to institutional investors was a driving force behind the enactment of the legislation.
Has the legislation succeeded in deterring securities class actions? The answer is clear from the following headline at Stanford’s Securities Class Action Clearinghouse website:
"SECURITIES FRAUD LITIGATION SETS RECORD IN 1998
Companies Sued at a Rate Close to One-A-Day"
It is generally accepted that the legislation has failed. Class actions continue unabated.
Congress has responded to this failure by passing the Securities Litigation Uniform Act of 1998. This legislation creates further restrictions by attempting to ensure that the U.S. federal court is the exclusive jurisdiction for these types of actions. Evidence suggested that class counsel were seeking to circumvent the new federal requirements by filing actions in state courts rather than federal court. It remains to be seen whether this new effort will have any effect.
Canadian directors or officers have been sued in the following Ontario class actions:
Maxwell v. MLG Ventures
An action based on alleged misrepresentations in an offering circular was certified, and a settlement subsequently achieved on behalf of investors. The class included all former shareholders of Maple Leaf Gardens Ltd. who had tendered their shares pursuant to the defendant’s offer. The settlement required the offeror to substantially increase its initial offer. Certification was assisted by the fact that the Ontario Securities Act provides for deemed reliance on the contents of an offering circular. This provision removes one otherwise difficult individual issue.
Millgate v. National Trust Company
This claim concerns debentures that were issued by National Trust as corporate trustee. Other defendants named in the action include corporations and senior executives who were alleged to have stripped a company of assets after it sold an issue of the debentures.
Class certification was not granted, based on the defendants’ agreement to be bound by a resolution of certain legal issues determined in one action. Certification may be revisited after a resolution of these individual issues.
Barbara Jack v. Saxton Investments, Allen Eizenga, James Sylvester, Laurentian Bank of Canada
This action alleges that a Burlington investment firm and its principals misappropriated funds from its clients. The case has not yet been certified as a class action.
Fischer v. Tee-Comm Electronics Inc.
This action claims that business reverses suffered by the defendant were not adequately disclosed to investment advisors at Nesbitt Burns, who in turn recommended the stock to their clients. The action has not yet advanced to the certification stage.
Carom v. Bre-X Minerals
The action includes pleas of misrepresentation and conspiracy against the Bre-X insiders. Brokerage houses involved in selling Bre-X shares are also named. Given that several of the directors are not opposing certification, the case will likely be certified, at least in part.
In an earlier pleadings motion, the court specifically declined to import the U.S. "fraud on the market" concept. The court held that the Supreme Court of Canada’s judgment in Hercules Management means that reliance must be established in every case alleging negligent misrepresentation.
If the wrong done by the director or officer is a wrong to the corporation, a class action is unnecessary - a derivative action should be sufficient. However, where the shareholder has suffered a personal wrong, a class action may be of assistance. The limit on this principle is that the action cannot be too "personal." The wrong must be sufficiently similar amongst members of the class to allow the court to usefully try certain issues together.
In cases based on misrepresentations in a prospectus or takeover bid circular, this standard will usually be met. The court need only analyze a single document. The single document will have been delivered to all shareholders.
However, where the alleged misrepresentations are to the secondary market as a whole, it may be difficult to justify certification. The negligent misrepresentation tort is intensely personal - it begins with an analysis of exactly what was said to each individual, and it ends by requiring confirmation that each person relied on the particular statement challenged. The only question is whether the court will be willing to pull out the middle part of the negligent misrepresentation test - negligence - and analyze that question in the abstract, disjointed from evidence as to the misrepresentation itself. Mr. Justice Winkler’s decision in Carom v. Bre-X Minerals Ltd. will shortly answer that question.
There remain other tools to achieve certification against officers and directors. For example, the conspiracy cause of action arguably contains components that can be effectively analyzed independent of any evidence from individual shareholders. Further, an Ontario court recently agreed to certify claims seeking remedies under the statutory oppression remedy.
In terms of obligations to employees, courts in Quebec have certified class actions against directors to assist in the enforcement of their responsibility for wages on a company’s dissolution.
Two new developments may dramatically increase exposure for Canadian Directors:
The Canadian Securities Commissions are considering legislative changes which will facilitate bringing class actions against officers and directors.
Secondary market investors will have a civil right to sue issuers for withholding information or for releasing misleading information that causes losses which could have been prevented, had complete information been made available.
Given the market capitalization limits, the incentive is to pursue larger companies. The limits may also encourage plaintiffs’ counsel to double up: invoke the statutory remedies to ensure certification, while maintaining the common law claims to ensure that the company continues to face exposure for the complete loss suffered by shareholders.
Mismanagement of a company’s Y2K affairs that results in a loss to the company, could attract a negligence action against the company’s present or former directors, directly or as a derivative action.
Failure to Adopt an Adequate Remediation Plan
If a corporation’s competitors are assessing and addressing the Y2K problem or if its competitors are already Y2K complaint, the directors and officers of a corporation who have not addressed the problem may have failed to meet the applicable standard of care. Similarly, adoption of an inadequate or tardy remediation plan could attract liability.
Failure to Monitor Third Party Compliance
Directors and officers may be held to account for failing to determine whether the corporation’s key suppliers are Y2K complaint, and whether their data interfaces are compatible so that a corporation’s compliant systems will not be "reinfected" by a third party’s failure to be Y2K compliant and/or to have compatible data.
Targets of Mergers and Acquisitions
If a company merges or acquires a company that has substantial Y2K problems, litigation may result. The Y2K compliance of merger targets as well as joint venture partners should be reviewed to determine whether the corporation is receiving a "fair" deal. Suitable representatives and warranties should be sought from merger and joint venture candidates.
The publication of the Call for Action document by the Year 2000 Task Force in February 1998 may be among the key dates used to assess the standard of care. However, certain commentators report that U.S. litigators are referring to an earlier "Dilbert" standard, in light of the fact that "Dilbert" cartoons discussing Y2K were apparently published as early as 1995.
U.S. companies have been told by their regulators to discuss Y2K issues as part of compliance with continuing disclosure obligations. In Canada, the Canadian Securities Administrators have also recommended disclosure. Failing to provide proper and prompt disclosure will provide class action counsel with an easy (or at least a tempting) target.
If a company’s share price falls after public disclosure of Y2K problems, investors may seek a remedy against the company itself as well as its directors, officers, and advisors. The claim will allege that the company painted an excessively rosy picture of its Y2K compliance.
Bill Lerach is the leading securities class action counsel in the United States. He has stated his intention to attack any management team that fails to ready its company’s computer systems for Y2K and suffers financial consequences as a result:
"If the company’s operations are affected, and the company has not adequately disclosed that, there’s no question that a suit can be filed for failing to disclose the material fact ... Similarly, if a company’s management fails to address the issue, it’s absolutely clear that if something bad happens, they can be sued for breach of fiduciary duty."
There should not be any class actions in relation to injuries to the company itself, since the company would be the only plaintiff. However, derivative actions are likely. A derivative action has been commenced against the principals of the software company Medical Manager flowing from the exposure to the company in a class action by software purchasers (which the directors agreed to settle).
Beyond derivative actions, there will be investor class actions. Y2K-related securities class actions have already begun in the United States. Medical Managers’ directors and officers have been sued by shareholders on the basis that they misrepresented the life span of the software in an initial public offering in 1997.
Bill Lerach’s firm has filed a class action against PRT Group Inc. alleging the the company overstated its Y2K remediation business. A tentative settlement has been reached in the action. A similar lawsuit filed against Command Systems Inc. was settled for $5.75 million. The settlement fund less attorney’s fees will be distributed to shareholders who purchased the common stock between March 12, 1998 and April 29, 1998.
Another lawsuit by Lerach’s firm against Micro Focus alleges that as part of its merger with Intersolv. Inc., Micro Focus intentionally withheld information regarding the defection of members of its Y2K staff. Micro Focus offers Y2K products and operations. The price of the shares dropped when it was announced that the sales of the merged company would be below expectations as a result of the loss of the key personnel. Peritus Software, a Y2K remediation software manufacturer, and certain of its officers and directors have been hit with a class action for failure to disclose certain facts regarding a takeover target.
On October 6, 1998, Industry Minister John Manley rejected the possibility of legislative changes to specifically make directors and officers of Canadian companies liable for Y2K problems caused by their companies.
The government indicated that while it is important that directors of federally-incorporated businesses recognize Y2K compliance as an explicit responsibility, current legislation such as the Business Corporations Act already provides the necessary legal basis for liability:
Present corporate governance statutes give directors responsibility to manage the business and affairs of the corporations they oversee, with a view to the best interests of the corporation and with care, diligence and skill of a reasonably prudent person in comparable circumstances...The Department of Justice has advised that this duty requires directors to take into account such major issues as Year 2000 problems.
The rejection of specific amendments to the Business Corporations Act to create specific liability for Y2K compliance is of little comfort given the government’s confidence that existing remedies will suffice.
The Class Proceedings Act evens the playing field between directors and shareholders. More than ever, directors avoid their obligations at their peril. Canadian class counsel are learning from their American counterparts. Canadian legislators are learning from their American counterparts. Canadian directors will soon face the same hazards as their American counterparts.
