By: Matthew Epp
The United States has long had a legal culture of shareholders and investors quickly suing when problems arise. In this article we consider whether, and why, this phenomenon has crept north to Canada, and what you can do in response.
Canada and the U.S. legal worlds apart
It is generally acknowledged that there is a greater climate of litigiousness in the U.S. than in Canada. The U.S. sees more litigation overall, more cases are decided by juries, and the monetary awards tend to be much larger.
The underlying reason for the difference may come down to the question of who pays at the end of the day. Some commentators argue that Canada’s ‘loser pays’ system (whereby the party who loses the lawsuit pays the costs) has served as a deterrent to litigation by aggrieved individuals and companies. By comparison, the ‘American Rule’ (where each party bears its own costs) allows even the most indigent plaintiff to sue when something goes wrong. The Plaintiff bears the up-front costs of the lawsuit, hoping to recover them if successful.
Also, contingency fee structures may be more common in the U.S. as a result of the larger monetary damages awarded by American juries. These amounts can be extraordinarily large and may raise the possibility of a significant windfall for litigants.
Is Canada becoming as litigious as the U.S.?
In the securities context, Canadian investors are quickly catching up to those in the U.S. when it comes to a willingness to bring their grievances to court. Some examples:
- In the U.S., it seems that litigation now accompanies nearly every public company merger or acquisition transaction. Some commentators have gone as far as to call U.S. shareholder activism ‘endemic.’
- In Canada, shareholder activism (both institutional shareholders and individuals) is increasing with the number of proxy battles in Canada doubling in 2012.
- Shareholder litigation in the U.S. seems to trend towards conflicts of interest cases and improper related party transactions. The damages awarded in one of these cases totalled $1.3 billion USD, a sum that Canadian Courts have not matched.
- Securities class actions in Canada are on a sharp upwards trajectory. As of February 2012, more than 28 securities class actions were being considered in Canada, representing more than $15.9 billion in claims.
Litigation seems to be on the rise in Canada, but what is causing this change?
Why are we becoming more litigious?
At a high level, one factor which may explain the increase in litigation is the overall economic climate. As the economy faltered in 2008–2010, investors saw their investments suffer.
Relatedly, in some areas the property market in Canada has not been as strong as it was five to eight years ago. As the market slows, those who invested at the height are seeing their equity shrink as they incur significant upkeep costs. Many investors have commenced actions against the property developers for misrepresentation in financial reports and forecasts.
The law itself may also have an impact. Beginning in 2006, the various Provincial and Territorial Securities legislators amended their legislation to include a so-called ‘deeming provision’ in the secondary market regime. This meant that shareholders did not need to prove that they had read prospectuses, continuous disclosure or financial reports in order to sue for losses from misrepresentation. At common law, plaintiffs in securities class actions would have to prove that they had relied on the representations of an issuer which was often difficult. These deeming provisions reduce the challenges associated with pursuing a negligent or fraudulent misrepresentation claims against an issuer. Class action claims became more numerous after these provisions came into force.
Finally, so called third party funding arrangements may become more common. Recently, in the Ontario Superior Court case Dugal vs. Manulife Financial Corporation, the Court approved a third-party funding arrangement. The Justice in that case commented negatively on the Canadian ‘loser pays’ system, stating that it reduces the likelihood that a class representative will come forward.
The grim reality is that no person in their right mind would accept the role of representative plaintiff if he or she were at risk of losing everything they own. No one, no matter how altruistic, would risk such a loss over a modest claim. Indeed, no rational person would risk an adverse costs award of several million dollars to recover several thousand dollars or even several tens of thousand dollars.
This decision has already been mentioned with approval once in Alberta and may encourage similar arrangements between potential plaintiffs and third-party funders. It should also be noted that third-party funding in securities class actions may have opposing results: If the financing aids those who would not otherwise be able to sue, there may be an increase in claims. However, if the third-party financiers properly assess these claims, the unmeritorious claims may be weeded out before the class action is commenced. This may reduce the number of claims. It will be interesting to monitor the results of this type of financing in the future.
The dual nature of litigation in Canada
As the securities landscape in Canada is regulated both by the Courts and the various Provincial Regulators (i.e. the Securities Commissions); an increase in civil litigiousness can lead to Regulators taking notice and increasing regulatory prosecutions. The Alberta Securities Commission has even linked the number of regulatory hearings to the general litigious climate in Alberta. Further, while the correlation is heavily economically dependent, the numbers of hearings have generally been increasing over the past ten years.
What can be done?
It can seem that defending yourself in either the civil or regulatory realm can be a cost of doing business. However, there are steps that can be taken to minimize the chances of being caught up in litigation:
1 ) Proper training of staff
Properly trained staff will make fewer mistakes and will be more likely to spot errors before they become problems.
2) Proper disclosure
The Securities Act and other statutes are complex pieces of legislation that require a variety of types of disclosure and filings.
3) Retain professional advisors to keep abreast of new and ever-changing rules
Professional advisors may be expensive, but these costs usually pale in comparison to the costs associated with civil or regulatory litigation.
4) Follow the rules
This may sound like a simple proposition, but there are a great number of complex rules related to business in general and the trading in securities in particular. Spotting and fixing problems before they occur is essential.
5) Ensure Directors & Officers insurance in place where possible
D&O insurance coverage is an important but complicated area. Companies should speak to their legal counsel or insurance broker about the necessity and scope of the coverage needed. One commentator wisely put it this way:
This is not an area to be penny wise and pound foolish, as the stakes have undoubtedly risen given the new paradigm of global securities litigation, regulation and enforcement activity.
Canada’s legal landscape is starting to look more and more like that in the U.S. with respect to the willingness of individuals to litigate. Given the associated costs, it is best to spot and address issues early to avoid having to resort to, or defend, litigation.