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Court Considers Gatekeeper Role
Published in the December 2008 issue of Litigation Notes - View Article
Synopsis: Ontario Superior Court of Justice rules that in seeking leave to commence a class action based on violation of continuous disclosure obligations, the plaintiff has the onus to satisfy the Court that there is a reasonable prospect of success. The defendants are not oblige to provide evidence in response.
The Ontario Superior Court of Justice recently released a decision which provides some interesting insights into its thinking with respect to recent amendments to the Ontario Securities Act, relating to secondary market disclosure. The action is one of the first brought under part XXIII.1 of the Ontario Securities Act, which came into force in December of 2005. The action is a proposed class action by shareholders of CV Technologies Inc. (“CV”), which is the manufacturer of Cold FX products. The lawsuit is against the company, some of its officers and directors and its former auditors. The Statement of Claim alleges that CV improperly recognized sales of its Cold FX products to customers in the United States as revenue and that this did not fairly present CV’s financial results.
Section 138.8 of the Ontario Securities Act requires leave of the Court before such an action may be commenced. The section also provides that on the leave application “…the Plaintiff and each Defendant shall serve and file one of more affidavits setting forth the material facts upon which each intends to rely”. Counsel for CV’s auditors indicated that they did not intend to file any affidavit material but rather rely on facts disclosed in the Plaintiff’s motion materials. This prompted the Plaintiff to bring a motion to require the auditors to file an affidavit on which they could be cross-examined.
Justice Lax reviewed the history which led to the amendments to the Securities Act, including the work of the Toronto Stock Exchange Committee on Corporate Disclosure (the Allen Committee). She concludes that the purpose of the amendments was the adoption of a regime to deter misleading continuous disclosure by securities issuers. Deterrence and not investor compensation was the primary aim. The objective was “…to create a system of statutory liability that would contain enough checks and balances through...due diligence defences and limitations on liability by means of damage caps so that issuers ... would be deterred from inadequate or untimely disclosure without at the same time, creating a regime that would favour short-term over long-term investors. The focus on deterrence was in part a recognition that while compensation of a prospectus investor would generally involve the culpable issuer returning subscription money it received from aggrieved investors, by contrast, compensation of aggrieved secondary market investors would come at the expense of other innocent investors, particularly the issuer’s continuing shareholders”.
Section 138.8 introduced a gatekeeper mechanism which was designed to prevent “strike suits”, being “coercive and unmeritorious claims which are aimed at pressuring a Defendant into a settlement in order to avoid costly litigation”. The legislative purpose of section 138.8 was not to assist plaintiffs in prosecuting an action but rather to protect defendants from coercive litigation and to reduce their exposure to costly proceedings. “The essence of the leave motion is that putative plaintiffs are required to demonstrate the propriety of their proposed secondary market liability claim before a defendant is required to respond”.
Furthermore, on a reading of section 138.8, it is clear that the defendants are required to file an affidavit “setting forth the material facts upon which each intends to rely”. If the defendant does not have any facts on which it intends to rely there is no requirement that it file an affidavit. Consequently, the Plaintiff’s motion was dismissed.
Ainslie v. CV Technologies Inc., 2008 CanLII 63217