III. LEGISLATIVE AND OTHER DEVELOPMENTS

III. LEGISLATIVE AND OTHER DEVELOPMENTS2017-03-03T18:33:22+00:00

A.        Canada

1.            Canada Business Corporations Act

The 2001 amendments to the CBCA that came into force on November 24, 2002 changed the regime of joint and several liability among co-defendants to modified proportionate liability regime with respect to certain financial information of a CBCA corporation. Under the CBCA, subject to some qualifications, a defendant who is found responsible for a financial loss that arises out of an error, omission or misstatement in financial information that is required by the CBCA is liable to the plaintiff only for the portion of damages corresponding to the defendant’s degree of responsibility for the loss.[4] 

 

The proportionate liability scheme in the CBCA is limited in several ways. First, the 2001 amendments apply only to misconduct in relation to the CBCA, and accordingly not to securities law breaches.[5] Secondly, joint and several liability continues to apply in cases of fraud.[6] Third, in situations where one of the defendants (such as the issuer company) is insolvent, financially limited or unavailable, there is a provision for the court to apportion that defendant’s liability to the other co-defendants up to a cap equal to 50% of the amount originally awarded against the co-defendant.[7]

 

Certain plaintiffs are specifically excluded from the proportionate liability regime, including Crown corporations, certain charitable organizations, unsecured trade creditors in respect of goods and services that the creditor provided to the corporation and individual plaintiffs whose investment is less than $20,000.[8] These individuals or organizations may not or do not have the wherewithal to make well-reasoned risk assessments or investment decisions or may suffer unduly from financial loss. Such plaintiffs can continue to collect under the joint and several liability scheme. Finally, courts have the option to award joint and several liability where it is just and reasonable to do so.[9]

 

 

What are the advantages and disadvantages of the CBCA model to liability? 

Is the exception for fraud reasonable? 

What is the appropriate role of judicial discretion in apportioning liability? 

Is the policy rationale for excluding specifically enumerated plaintiffs from the liability regime sound?

 

 

2.            Ontario Securities Act

On December 31, 2005, the Ontario Securities Commission amended its Securities Act to create new statutory causes of action in favour of the “secondary market” against directors, officers and “experts” for misrepresentation and failure to comply with disclosure obligations.[10] The statutory civil liability provisions provide for damages to be limited in three ways. First, the damages must be calculated in accordance with the formulae set out in the Securities Act. Second, the court is required to fix the proportionate share of those damages payable by each defendant found liable, recovery against each defendant being limited to its respective share of the total damages assessed for all plaintiffs. Third, the amount payable by each particular defendant found liable may be further limited, provided that they did not have knowledge of the misrepresentation or fail to make timely disclosure of a material change, to various liability limits specific to each category of defendant.

 

A company’s liability may not exceed the greater of $1 million and 5% of its market capitalization. The liability of an individual (other than an expert) is limited to the greater of $25,000 and 50% of his or her total compensation from the company and its affiliates during the preceding 12 months (including the value of any options, pensions benefits and stock appreciation rights granted during that period). An expert’s liability is limited to the greater of $1 million and the fees earned by the expert from the company and its affiliates during the preceding 12 months.

 

The liability limits and the proportionate liability provisions do not apply to a defendant (other than the company) if the plaintiff proves that the defendant knowingly authorized, permitted or acquiesced in the making of the misrepresentation or the failure to make timely disclosure of a material change. In such cases, defendants are jointly and severally liable for the full amount of damages assessed in the action.

 

In addition to the new statutory scheme for secondary market liability, the common law cause of action of misrepresentation continues to be available to plaintiffs. Under the common law, joint and several liability still exists and there are no caps on damages. Similarly, the joint and several liability regime continues for prospectus misrepresentations under the Securities Act.

Participants at the Roundtable suggested that, although the reforms under the Ontario Securities Act took a number of years to enact, the practical effects were modest. A number of procedural restrictions are built into Part 23.1 of the Securities Act, which are seen to favour defendants; most significantly, the requirement to obtain leave or assert a cause of action.

 

In order to satisfy the requirement for leave, an evidence-based merits test must be met. In cases where a plaintiff must prove fraud or negligence, meeting this requirement may be difficult given the lack of access to information by the plaintiff. Moreover, given the number of potential defendants contemplated by the Securities Act, there is a concern that the number of affidavits that will be filed and the process of cross-examination that must be met before the leave application will be reviewed, creates a lengthy and costly process, which may be unnecessary. For example, under the capped-proportionate liability scheme, if a defendant is an expert and therefore liable up to a limit of $1 million, it may not be economically prudent to spend upwards of $2 million on leave applications and weeks of cross-examining each director when the most it will cost is $1 million. These procedural restrictions, in addition to what was regarded by one participant as ineffectively low liability limits, means that the practical effects of the changes to the Securities Act were modest at best.

 

a)    Trends in Canadian Securities Class Actions

 

Since the enactment of the secondary market liability regime in Canadian securities regulation, there have been an increasing number of securities class actions.  Most notable in 2009 are the decisions of the Ontario Superior Court of Justice certifying three securities class actions, and the decision in Silver v. IMAX Corp.(“IMAX”)[11] granting leave for the plaintiffs to pursue claims under Part XXIII.1 of the new OSA.[12]  The IMAX decision is the first ruling on an application to proceed with claims under the new secondary market liability provisions of the provincial Securities Acts.

 

A 2009 report by NERA Economic Consulting[13] suggests that, although the new statutory civil remedies for secondary market misrepresentations are expected to make it easier for class actions to proceed, the statutory limits on damages provide an incentive for plaintiffs to simultaneously plead common law negligent (and/or reckless and/or fraudulent) misrepresentation.[14]

 

The report also notes that as of January 2010, there were more than $14.7 billion in outstanding plaintiffs’ claims in Canadian securities class actions.[15]  Settlements in 2009 were significantly below the $890 million in total settlements observed in 2008.  In 2008, there were a number of settlements involving payments of more than $20 million: Portus Alternative Asset Management Inc. ($661 million), Biovail ($141 million), Hollinger ($46 million), and Atlas Cold Storage ($40 million).[16]  By contrast, the largest settlement in 2009 was the Aurelian settlement for $15.6 million.

 

Six cases were settled in 2009 for approximately $51 million in total payments by defendants. This is an average of approximately $8.5 million per settlement, and a median settlement of $9 million, which is roughly the median settlement amount for securities class actions in the U.S.  The 2009 settlements averaged 13.7% of the total amount of damages claimed by plaintiffs (excluding punitive damages).[17]

 

As at the end of 2009, there were 23 pending cases representing more than $14.7 billion in claims.  The $10 billion claim against CIBC represents about 70% of these outstanding claims.  Eight of these cases (including the CIBC case), that together represent more than $12.1 billion in claims, have corresponding actions filed in the U.S.[18]

 

 

3.            Ontario Business Corporations Act

Unlike the CBCA, the OBCA has not been amended to create a statutory scheme of proportionate liability for co-defendants such as directors, auditors and lawyers for errors, omissions or misstatements in financial information that is required by the OBCA. As a result, the joint and several liability regime continues under the OBCA and a plaintiff can seek recovery for payment of the full amount of damages from any of the co-defendants.

 

 

What possibilities for conflict are created by the different models of liability in the CBCA, the OSA and elsewhere? 

What is the impact of these liability regimes on private litigation generally as well as litigation strategy, settlements and outcomes?

 

 

 

4.            Canadian Context and Jurisprudence

Some stakeholders would suggest that the issue of joint and several liability and its potential reform should not be debated without considering the larger context of substantive auditor liability and the difficulty of finding that a duty of care is owed by auditors to shareholders or other investors.   The Supreme Court of Canada addressed the issue of the auditor’s duty of care in the context of a negligence claim in Hercules Management Ltd. v. Ernst & Young.[19] The Court concluded that auditors can reasonably foresee reliance on their reports by many different people, including shareholders, creditors, and other investors.  However, Mr. Justice La Forest added that “in the general run of auditors’ cases, concerns over indeterminate liability will serve to negative a prima facie duty of care”.  The policy considerations are pragmatic – open-ended and unpredictable liability would give rise to “socially undesirable consequences”, including increasing costs of insurance and litigation, reduced availability of audit services, and potential decreased vigilance by third parties.

 

Based on this reasoning, the auditor (in a statutory audit) may owe a duty of care to the shareholders as a group because the audit report is made for the specific purpose of guiding shareholders, as a group, in supervising or overseeing management.  However, if a shareholder chooses to rely on the audit report in making investment decisions, he or she does so at his/her own risk.  However, in cases in which the audit report is prepared for a wider audience (for example, included in a prospectus), the policy considerations may well be different.  In cases where the defendant knows the identity of the plaintiff (or class of plaintiffs) and where the defendant’s statements are used for the specific purpose or transaction for which they were made, policy considerations surrounding indeterminate liability will not be of any concern since the scope of the liability can readily be circumscribed.

 

 

In Waxman v Waxman[20]  the Ontario Court of Appeal reaffirmed that auditors will not be liable to individual shareholders of their corporate client unless the mandate of the auditor has been specifically expanded beyond its usual role. A plaintiff must show that the auditor (i) knew that the shareholder would be relying upon the auditor for a purpose other than the customary audit retainer; and (ii) agreed to such an expansion of its mandate. Framing a claim as a ‘failure to warn’, or trying to distinguish the situation because the company is closely held, or the auditor-client relationship is of long standing, will not exempt a plaintiff from this burden of proof.

 

 

Is there a relationship between the substantive proof of a negligence against an auditor or other professional and recovery by way of joint and several liability? 

 

 

5.            Limited Liability Partnerships

Another notable development has been the advent of limited liability partnerships (“LLPs”) in Canada.  Prior to the establishment of LLPs, accountants, lawyers and other professionals practising in partnership structures across Canada were personally liable for the negligence of their partners.  LLP legislation was first enacted in the United States in the late 1980s and early 1990s, partly as a response to the savings and loan crisis.  In Canada, LLP legislation was first enacted in Ontario in 1998, followed by other provinces in subsequent years.  LLPs limit the liability of professionals who practice in partnerships such that a partner in, for example, an accounting firm is no longer personally liable for the negligence of his or her co-partners.  The partner is, however, still personally liable for his or her own negligence as well as anyone under his or her supervision or control.

 

 

B.        Other Jurisdictions
 

1.            United States

 

A modified form of proportionate liability (proportionate capped liability) was adopted at the federal level in the U.S. with the passage of the Private Securities Litigation Reform Act of 1995.[21] The Act retains joint and several liability for defendants who knowingly violate securities laws and in relation to claims made by small investors. A small investor is defined as a plaintiff whose net worth is $200,000 or less and whose share of the damage award is equal to at least 10% of his or her net worth. For all other claims, proportionate liability replaces joint and several liability. 

 

Where a defendant is insolvent or otherwise unavailable and a plaintiff is unable to collect the defendant’s share, each of the remaining defendants is further liable for the uncollected shares provided that the additional liability is not more than 50% of the remaining defendants’ proportionate share. The Act also contains a contribution right which allows any person required to contribute more than his or her proportionate share to proceed against other persons who bear responsibility.

 

Much of the impetus for reforming the joint and several liability regime came from a perceived insurance crisis. Municipal governments, in particular, were targeted as “deep pocket” defendants with relatively minor degrees of fault and argued that joint and several liability was the root cause of higher taxes and service reductions.[22] The majority of states in the United States have modified the rule of joint and several liability in favour of some form of proportionate liability.  Some states have adopted full proportionate liability in all circumstances.  Others apply full proportionate liability but exclude cases involving intentional torts or strict liability. Some jurisdictions have instituted proportionate liability where the defendant’s fault falls below a specified percentage, while others apply proportionate liability if the plaintiff is contributorily negligent or where the plaintiff’s fault exceeds a specified degree.

 

2.            United Kingdom

The issue of professional liability has been given extensive consideration in the United Kingdom, stimulated by an increase in the number of negligence claims against auditors and the increasing costs of indemnity insurance. A number of major reports and documents have been produced in recent years.

The Likierman Report[23], published in 1989, examined the liability problems associated with three professions, namely, auditors, the construction profession and other surveyors.

The second report was issued following an investigation by the Common Law Team of the Law Commission entitled “Feasibility Investigation of Joint and Several Liability”, published in 1996. The objective of this investigation was to determine whether a full Law Commission project on the issue of joint and several liability should be undertaken.

The third report was a consultative document issued by the Department of Trade and Industry in December 2003 entitled “Director and Auditor Liability: a consultative document”. This document, which was part of the process in reforming corporate law in the U.K. sought the opinions of interested parties on auditor and director liability.

The topic of professional liability was also considered by the Company Law Review Steering Group (the “Steering Group”), which was established by the government and charged with investigating how company law should be reformed. The Steering Group produced a final report in 2001, “Modern Company Law For a Competitive Economy”, wherein it considered and specifically rejected proportionate liability as a matter of principle because it was seen to leave innocent parties bearing some of the loss they incurred. 

 

The UK Companies Act 2006 allows auditors to limit their liability by contract with their company clients, subject to shareholder approval (to address the tort liability) and subject to “such amount as is fair and reasonable in all the circumstances”. These reforms, however, were counterbalanced by the following provisions: (1) a new criminal offence introduced for an auditor who “knowingly or recklessly” includes any matter which is misleading, false or deceptive in the audit report or who omits information which results in the audit report being misleading, false or deceptive; (2) auditors may be required to disclose their terms of appointment – e.g. engagement letter; (3) the audit report must be signed by a named partner – the senior statutory auditor; (4) in the case where the auditor ceases to act for a named company, he or she must file a statement on the circumstances connected with his or her departure with the appropriate audit authority.

 

3.            Australia

 

In the wake of the corporate scandals in 2002, Australia introduced Corporate Law Economic Reform Project (Audit Reform and Corporate Disclosure) Act 2004 (Cth) (CLERP9), which expanded the duties imposed on auditors and thereby increased auditors’ potential exposure to greater claims of negligence by third parties. CLERP 9 became effective in July 2004, amidst a professional indemnity insurance crisis and ongoing debate about the introduction of a statutory cap to auditor liability. A solution was sought to balance the claims for greater auditor accountability against the threat of auditors leaving the profession because of a greater threat of litigation and exposure to liability. 

 

In response, the Australian government introduced two measures in CLERP 9 to mitigate auditor liability: (1) proportionate liability for pure economic loss arising from misleading or deceptive conduct; and (2) a framework allowing for auditors to incorporate and thereby limit their liability through the corporate structure. The Government also legislated to allow for a national approach to a statutory cap for auditor liability through the Treasury Legislation Amendment (Professional Standards) Act 2004 (Cth).

 

4.            European Union

 

On January 18, 2007, the European Commission launched a public consultation on the issue of auditor liability and invited stakeholders from across Europe to provide their views on four possible options for reforming auditor liability: (1) fixed monetary cap at the European level; (2) a cap based on the size of the audited company; (3) a cap based on a multiple of the audit fees; (4) a principle of proportionate liability implemented either by (a) having Member States change their laws to allow courts to award damages only for the portion of loss corresponding to auditor’s degree of fault (proportionate liability by statute); or (b) having Member States allow proportionate solutions between the company and its auditors to be negotiated and enshrined in contractual arrangements (proportionate liability by contract).

 

In identifying the overarching preferred trends in limiting liability, the European Commission found that the preferred approach for the audit profession was to limit auditors’ liability by capping, whereas the respondents from other professions favoured the implementation of proportionate liability. Those respondents who preferred a hybrid approach considered that proportionate liability was an appropriate mechanism for avoiding plaintiffs using the audit firms as a way to compensate any financial deficiencies of the audited company, but, at the same time, believe that it is not enough to prevent an audit firm disappearing due to a possible catastrophic claim. It was thought that a cap would provide additional protection for audit firms in the case of such claims.

 

While the European Commission’s public consultations focused primarily on auditor liability, the concerns and potential solutions are transferrable to other professions. As the report noted, professional bodies and associations welcomed the consultations and recognized a general consensus that the unlimited liability that could result from a joint and several liability approach produces undesirable distorting effects in the capital market, generating an expectation gap due to the “deep pocket syndrome”.

 

 

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