The Supreme Court of Canada released today its long-awaited decision in the case of Kerr v.  Danier Leather Inc. The Supreme Court dismissed the appeal and upheld the Ontario Court of Appeal's ruling that the Ontario securities regulatory scheme does not require an issuer to disclose post- prospectus filing information that does not amount to a material change.

In essence, the Supreme Court determined that full compliance with regulatory obligations is a bar to a finding of liability under the civil liability provisions of the Ontario Securities Act.  The Court held that where the legislature has declined as a matter of policy to require disclosure of "material facts" post-filing, there can be no imposition of civil liability under the Ontario Securities Act for a failure to disclose such facts. In addition, the Supreme Court confirmed that forecasts do not contain implied representations of objective reasonableness as a matter of law, and that disclosure requirements are legal obligations that are not to be subordinated to the exercise of business judgment.

The Facts

The salient facts of this class action lawsuit were summarized as follows by the Ontario Court of Appeal: 

"In May 1998, the appellant, Danier Leather Inc., made an initial public offering of its shares through a prospectus. The prospectus contained a forecast that included Danier's projected revenue and earnings for the last quarter of its fiscal year.  An internal company analysis prepared a few days before its public offering closed showed that Danier's fourth quarter revenue and earnings were lagging behind the forecasted figures.  Danier did not disclose its poor fourth quarter results before closing.  It did disclose these results after closing in a revised forecast, which precipitated a significant decline in its share price.  However, Danier's sales rebounded, and by the end of the fiscal year it had substantially achieved its original forecast."

Material Change vs Material Fact 

The Supreme Court accepted that the poor fourth quarter results constituted a material fact, but not a material change.

The Supreme Court reaffirmed that the Ontario Securities Act is remedial legislation that is to be given a broad interpretation. However, the Supreme Court confirmed that the definition of material fact is broader than that of a material change and that the disclosure obligation of an issuer under s. 57(1) of the Ontario Securities Act is limited to post-filing disclosure of a material change in cases where the prospectus is accurate at the time of filing. It is now clearly established that there is no obligation to amend a prospectus or file a report for the modification of a material fact which does not amount to a material change.

The Supreme Court came to the conclusion that changes in results of operations are not in themselves changes in the "business, operations or capital of the issuer", although they may in some instances reflect a material change in business operations. It also suggested that material changes may not include factors external to the issuer. In coming to this conclusion, it clarified its prior decision in Pezim v. British Columbia (Superintendant of Brokers), and stated that the changes in drilling results in that case were found to be material changes because those results were in themselves changes in the issuer's "assets", a term which was expressly included in the definition of material change of the B.C. Securities Act.

Forecasts Reasonableness

The Supreme Court confirmed that forecasts do not contain implied representations of objective reasonableness as a matter of law. The Supreme Court found that an implied representation existed as a matter of fact based on the language of the prospectus, but that based on such language, the implied representation extended only until the prospectus was filed.

The forecast was prepared as of April 2, and the prospectus stated that "[t]he Forecast is based on assumptions that reflect management's best judgment of the most probable set of economic conditions and the Company's planned course of action as of April 2, 1998". Likewise, the Auditors' Report, dated April 6, advised that "the assumptions developed by management are suitably supported and consistent with the plans of the Company, and provide a reasonable basis for the forecast". The prospectus further stated that the assumptions were "considered reasonable by the Company at the time of preparation of the forecast" and that "[t]he Forecast has been prepared using generally accepted accounting principles". Finally, the prospectus stated that "[t]he financial reports issued by the Company to its shareholders during the forecast period will contain either a statement that there are no significant changes to be made to the Forecast or a revised forecast accompanied by explanations of significant changes". Based on the above, the Supreme Court found that the prospectus did not promise that the forecast would be updated if and as soon as conditions changed, that potential investors should have recognized that the forecast was just a snapshot of the company's prospects as of May 6, and that the trial judge erred in evaluating the objective reasonableness of the forecast at the date of closing.

Disclosure Requirements and Business Judgment Rule

The Supreme Court disagreed with the Court of Appeal's finding on the applicability of the business judgment rule to disclosure obligations. The Court stated that while forecasting financial results is a matter of business judgment, disclosure requirements are legal obligations that are not to be subordinated to the exercise of business judgment.

Finally, in a statement which will likely constitute one of the legacies of this case, the Supreme Court articulated the following justification for the business judgment rule: "In order to maximize returns for shareholders, managers should be free to take reasonable risks without having to worry that their business choices will later be second-guessed by judges".

Please do not hesitate to call  Patricia Olasker or Ed Babin  at  our Toronto Office (416-863-0900) or Maryse Bertrand, Neil Kravitz, Louis-Martin O'Neill and Karine Péloffy  at  our Montréal Office (514-841-6400) if you would like further information on this case or to obtain a complete copy of the decision.

Davies Ward Phillips & Vineberg LLP, with over 235 lawyers, practises nationally and internationally from offices in Toronto, Montréal, New York and an affiliate in Paris and is consistently at the heart of the largest and most complex commercial and financial matters on behalf of its North American and overseas clients.

The information and comments herein are for the general information of the reader and are not intended as advice or opinions to be relied upon in relation to any particular circumstance. For particular applications of the law to specific situations, the reader should seek professional advice.