Superior court green-lights IMAX secondary market securities class action; accepts relatively low thresholds for granting leave and certification

April 5, 2010

Silver v. IMAX Corporation et al., [2009] O.J. Nos. 5573 and 5585
Ontario Superior Court of Justice | Justice van Rensburg | December 14, 2009

Background

Securities class actions are relatively new to Canada. Governed by provincial rather than federal law, they were difficult, if not impossible, to bring prior to the adoption of modern class actions legislation (which occurred in the 1990s in most provinces) and even then were difficult to pursue in the “secondary market” context. This changed on December 31, 2005 with the adoption of the liberalized secondary market liability provisions of Part XXIII.1 of Ontario’s Securities Act (OSA) (since replicated in nearly all other Canadian jurisdictions). Nevertheless, in contrast with the extensive U.S. jurisprudence in this area, the ground rules of Canadian secondary market class actions remain a work in progress.

The issues

Two December 2009 rulings in a class action against IMAX Corp. (the TSX and NASDAQ-listed entertainment technology company) address important procedural issues surrounding secondary market liability claims under Part XXIII.1 and its counterparts in other provinces. The plaintiff shareholders are suing with respect to a decline in share value that they argue was rooted in alleged misrepresentations in IMAX’s 2005 Form 10-K, in its 2005 Annual Report and in press releases issued in early 2006. Justice Katherine van Rensburg of the Ontario Superior Court of Justice ruled on two threshold issues: the plaintiff shareholders’ application for leave to proceed with their secondary market liability claim and their concurrent application for the certification of their class action. “Leave” and “certification” are statutory hurdles – in the first case under the Part XXIII.1 secondary market liability provisions and in the second case under class actions legislation, known in Ontario as the Class Proceedings Act, 1992.

As detailed below, Justice van Rensburg granted both certification and leave in these two concurrent rulings, interpreting the various threshold requirements of each – e.g. duty of care, reliance, good faith and “reasonable possibility of success” – in a manner that will generally be well received by potential securities class action plaintiffs. Among other things, these rulings are significant because – pending appeal – they appear to mark at least a small step in the evolution of Canadian business and shareholder disputes toward the historically more litigious U.S. model. Multinationals based in the U.S. and other foreign jurisdictions should be aware that it is possible that they may be subject to Canadian secondary market class actions even if they do not trade publicly in Canada.

Certification ruling

While both the common law claim and the statutory secondary market liability claim required certification to proceed to the class action stage, the defendants chose to focus their opposition to the Part XXIII.1 secondary market claim on the concurrent leave application, agreeing to accept certification in the event that leave were granted. Thus the certification hearing was largely confined to the common law aspect of the claim, which focused mainly on misrepresentation, the dominant issue being whether that cause of action was properly asserted under the Canadian common law test, i.e. whether a duty of care had been established (by showing a “special relationship”) and whether the plaintiff had reasonably relied on the misrepresentation. The plaintiffs argued (i) that IMAX and the individual defendants owed a duty of care to the investing public in releasing its disclosure documents and (ii) that the “efficient market” theory could be used to establish that by the act of purchasing or acquiring IMAX securities the plaintiffs relied on the misrepresentation.

Duty of care

Justice van Rensburg found that a duty of care may have been owed in the circumstances, as the intended recipients of the documents containing the misrepresentation were the investing public, including the plaintiffs and proposed class members, and that IMAX issued the documents for the purpose of attracting and informing shareholders. Importantly, Justice van Rensburg refused to limit or restrict the alleged duty of care based on public policy concerns or concerns of indeterminate liability.

Reliance

With respect to reliance, the defendants argued that the plaintiffs’ assertion that reliance was established by the act of purchasing or acquiring IMAX securities was insufficient as there was no pleading that the proposed class members individually relied on the misrepresentations in making their investment decisions. The defendants maintained that the “efficient market” theory put forward by the plaintiffs was akin to the American “fraud on the market” theory, which is not recognized in Canada.

Justice van Rensburg acknowledged that no case asserting the “efficient market theory” has gone to trial. However, she held that there was a conceivable claim in this case, based on the plaintiffs’ pleading of the “efficient market theory” to establish reliance. In other words, instead of alleging individual reliance (in the traditional sense) on the part of each class member, it would conceivably be sufficient that the plaintiffs were alleging that the market for IMAX’s shares was efficient (i.e. that the share price reflected all public information) and that they therefore relied on the misrepresentations in virtue of having acquired their shares during the period that the misrepresentations remained public and uncorrected. In so holding, Justice van Rensburg appears to have accepted that the “efficient market” theory can be applied in Ontario, at least at the pleading or certification stage. (Exactly how “efficient market” theory relates to the U.S. “fraud on the market” doctrine is something that may be further clarified on appeal.)

Size of the class

In certifying a global class (consisting of all persons who acquired securities of IMAX during the proposed Class Period and who held some or all of those shares at the end of trading on August 9, 2006 when IMAX released its press release announcing an SEC investigation), Justice van Rensburg ruled that the fact that a similar proceeding had been commenced (although not certified) in the United States was inconsequential to the Ontario action. She added that any conflict of laws concerns would be premature until a statement of defence had been filed alleging reliance on laws of other jurisdictions.

Leave ruling

The second of Justice van Rensburg’s two concurrent rulings focused on whether the plaintiffs should be granted leave to proceed with the misrepresentation claim under the secondary market liability provisions of Part XXIII.1 of the OSA. Section 138.8 of the OSA requires that the Court grant leave where the plaintiffs are acting in good faith and there is a reasonable possibility of success at trial. As this case was the first to consider these leave requirements, Justice van Rensburg’s ruling marked an important first step – given the high likelihood of an appeal in this case and further refinements in subsequent litigation – in clarifying both branches of the test.

Good faith

The defendants maintained that the plaintiffs bore the burden of establishing good faith, arguing that this required them to establish (i) that the action has been brought for the benefit of the corporation and not for the plaintiffs’ benefit and (ii) that they hold a reasonable belief in the merits of their claim. Justice van Rensburg rejected this characterization of “good faith” in favour of the alternative view that the plaintiffs are required only to establish that they brought the action in the honest belief that they have an arguable claim and for reasons that are consistent with the purpose of the statutory cause of action and not for an “oblique or collateral purpose.”

Justice van Rensburg found that the plaintiffs brought the action to permit shareholders to recover damages and to hold the defendants accountable for the company’s alleged misrepresentations (while deterring others from doing the same). In her opinion, this was consistent with the statutory scheme of Part XXIII.1. Therefore, the good faith requirement was satisfied.

Reasonable possibility

With respect to the “reasonable possibility” requirement, both sides agreed that a preliminary consideration of the merits of the case would be required. Needless to say, they did not agree about the applicable threshold. The plaintiffs contended that it was sufficient to show that there is at least some evidence that, if accepted by the court, would be consistent with the allegation of misrepresentation, while the defendants argued that, given that the purpose of the leave requirement is to deter unmeritorious claims and “strike suits”, the threshold should be high and (among other things) would require the plaintiffs to show that they could overcome the statutory defences raised by the defendants – “reasonable investigation” and “expert reliance”.

Justice van Rensburg held that the plaintiffs must submit evidence with respect both to the alleged misrepresentation and to the conduct of IMAX’s officers or directors in relation to it. However, in her opinion, “reasonable possibility” requires only “something more than a de minimis possibility or chance that the plaintiff will succeed at trial”, reflecting the view that the leave requirement was intended only to prevent abuses of process and purely speculative claims. In reviewing the evidence, Justice van Rensburg found that the plaintiffs had satisfied this “low threshold”, other than with respect to two defendants who had been outside directors of IMAX. While the statutory defences could be considered, Justice van Rensburg found that they could affect the result of a leave application only if they would demonstrably foreclose the reasonable possibility of success at trial for the plaintiffs. In this case, neither of the Part XXIII.1 statutory defences raised by the defendants – the due diligence defence and the expert reliance defence – met the test.

Appeal

As leave to appeal Justice van Rensburg’s ruling has been sought, it is unlikely that these rulings will be the final word on these issues.

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