Court of Appeal Clarifies Availability of Defences Based on Clear and Credible Evidence at Securities Leave Motions

15 September 2017

By Khrystina McMillan
In a decision released last Monday, September 18, 2017, the Ontario Court of Appeal overturned a decision to deny leave to proceed against individual defendants to a misrepresentation claim under Part XXIII.1 of the Ontario Securities Act (“OSA”). In Rahimi v SouthGobi Resources Ltd., the plaintiff sought leave to pursue an action against SouthGobi Resources Ltd. (“SGR”) and five current and former SGR directors and officers for alleged misrepresentations in SGR’s financial statements between 2010 and 2012. The defendants challenged the plaintiff’s motion for leave, relying in part on the defence of reasonable investigation. Although the Rahimi decision confirms that courts will consider and evaluate defences at the leave stage, the Court of Appeal emphasized that leave will not be denied where there is a lack of a clear record in support of the defence.
 
Background: On November 8, 2013, SGR issued a press release announcing, among other things, that the company was restating its financial statements from 2010 – 2012 and investigating potential “material weaknesses” in its internal financial and disclosure controls and procedures that gave rise to the restatement. A subsequent news release on November 14, 2013 advised that SGR had identified such a material weakness.

In the days following the November 8 press release, the SGR share price dropped dramatically (about 18%). Class actions were filed in New York and Toronto. The parties to the Toronto action agreed that the class action certification motion should be decided after the leave motion was decided. 
 
On the motion for leave,  leave was granted as against SGR but not the individual defendants. The motion judge held that the plaintiff had established a prima facie case for misrepresentation given the express acknowledgment in the restatement of reporting errors (misrepresentations) in its prior financial statements. However, based on his review of the evidence, the motion judge stated that he had no difficulty concluding that the reasonable investigation defence had been made out by the individual defendants. 
 
Leave to appeal was granted to both SGR and the plaintiff. SGR appealed the decision to grant leave for the claim to proceed against it and the plaintiff appealed the decision to deny leave against the individual defendants. As described below, the Court of Appeal upheld the decision by the motion judge to grant leave as against SGR but overturned the decision to deny leave as against the individual defendants.
 
The Test for Leave: Under section 138.8 of the OSA, a plaintiff must obtain leave of the court to commence an action under the OSA for civil liability for misrepresentation in the secondary securities market. The OSA sets out a two-part test for leave: (1) the action must be brought in good faith; and (2) there must be a reasonable possibility that the action will be resolved at trial in favour of the plaintiff.  To satisfy the second part of the test, a plaintiff must offer both a plausible analysis of the applicable legislative provisions, and sufficient credible evidence to convince the court that there is a reasonable possibility that the action will be resolved at trial in the claimant’s favour. 
 
Defence of Reasonable Investigation on Leave Motions: Pursuant to section 138.4(6) of the OSA, a person or company is not liable in a statutory misrepresentation action if that person or company proves two things: (1) that it conducted or caused to be conducted a reasonable investigation before the document was released; and (2) that it had no reasonable grounds to believe at the time of the document’s release that the document contained the misrepresentation.
 
The test for the statutory defence of reasonable investigation on a motion for leave asks whether there is a reasonable possibility that the defendant will not be able to establish one or more of the branches of the defence at trial. This analysis requires some weighing and scrutiny of the evidence proffered by both parties on the motion for leave. But, as the Court of Appeal explained in Rahimi, a motion judge’s duty to scrutinize the entire record is not restricted to a review of the evidence filed on the motion. The motion judge is also obligated to consider what evidence is not before her:
 
[The motion judge] must be cognizant of the fact that, at the leave stage, full production has not been made and the defendant may have relevant documentation that has not been produced or relevant evidence that has not been tendered. Consideration of these evidential limitations of the leave stage is important because they can work to the prejudice of the plaintiffs who have potentially meritorious actions.

In addition, motion judges must thoroughly examine the state of the evidence on the motion record to determine whether there are contentious issues of credibility that impact on the decision whether to grant leave. Where such credibility issues are extant and cannot be resolved on the existing record, the proper course for a motion judge is not “to do the best he [can] on the available record”. 

Here is where the Court of Appeal stated the motion judge made his primary error; in treating the leave motion like a mini-trial in which he resolved “significant credibility issues” raised in the record before him. As the Court of Appeal noted, the narrative presented by the individual defendants was not only unsupported by documentary evidence, but was also at times contradicted by the evidence in the motion record. Such lack of a clear record, according to the Court of Appeal, “makes it evident” that leave must be granted because there is no certainty that the defence will succeed (i.e. there is a reasonable possibility that the defendant will not be able to establish the defence at trial). 

The Takeaway: Defendants seeking to raise a statutory defence at the leave stage of a misrepresentation claim under section 138.8 of the OSA should carefully consider what evidence to include (and what not to include) in their motion records. The Rahimi decision indicates that, to be successful, defendants must proffer a clear and credible record in support of the asserted defence. A court may refuse to deny leave if the record contains evidentiary gaps and/or raises credibility issues.

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