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New law lets shareholders play hardball

From Monday's Globe and Mail

On New Year's Eve, Windsor lawyer Harvey Strosberg lifted his glass in a toast to a much anticipated new law that will make it far easier for shareholders to sue companies and their executives.

For lawyers like Mr. Strosberg who specialize in class-action lawsuits, Jan. 1 ushered in a new era in Ontario. For the first time, investors will have a legislated legal right to recoup losses that occur when firms make misrepresentations in documents or public comments.

Until this year, the law was so narrowly defined that it could rarely be used. Investors had only a legislated right to sue over misrepresentations in proxy circulars for issues of new securities, excluding most common corporate documents. Now lawsuits can be based on almost any public communication, including inaccurate financial statements, misleading press releases and even misrepresentations in public speeches.

“Jan. 1 is a new year, and we're looking forward to it,” Mr. Strosberg said in a recent interview. “You know that song, ‘She cheated, she lied, she said that she loved me.... Oh what can we do?' Now we know what we can do. We can sue.”

Ontario's legal community is buzzing with anticipation about how Bill 198 will change the landscape for investors and corporations. There is much debate about how the new legal powers will be used, how lawyers will fight the new cases through the court system, and how the courts will treat the unique parts of the legislation.

Here are some of the key questions being pondered by legal experts who are awaiting the first cases in the new year.

Who will use the new powers?

Business lawyer Wes Voorheis, who has represented many large shareholders, believes the initial cases will be launched by plaintiffs' lawyers on behalf of ordinary retail investors.

Although there is a danger that individuals could be forced to pay the other side's huge legal costs if they lose the case, Mr. Voorheis says he is unaware of any situation in which the courts have burdened a non-institutional client with crippling legal costs. As a result, he thinks individuals will leap forward much more quickly than large institutional investors.

With the legislation capping the size of awards, he says the big players will likely wait to see whether there are large enough payouts to cover their losses and justify the huge legal costs.

“If this legislation works — and the jury is still out on that — I think you'll see institutions in Canada gradually stick their noses into this,” he says.

But lawyer Paul Bates, who specializes in business litigation, argues there is no reason to believe Canadian institutions will hesitate to use the new bill. He says some large institutional investors have been willing to sue interlisted Canadian firms in the United States to recover losses, such as Nortel Networks Corp. and Biovail Corp.

“There's no reason to think that institutional investors who proceeded in the U.S. would sit back in Canada,” he says.

Claude Lamoureux, chief executive officer of the giant Ontario Teachers Pension Plan, says Teachers will pick when to launch suits in Ontario and when to continue to sue companies in the United States, depending on the size of its losses and the likelihood of recovering them in Ontario.

“We were very much in favour of this bill. We think it's essential,” he said. “And I don't see why we would not use it.”

How will lawyers launch a case?

There appear to be as many legal strategies as there are lawyers.

Some lawyers say they will launch cases under Bill 198 in tandem with claims using the old system of class-action suits, in which victory is difficult but there are no payout caps. The idea is to try to recover part of the loss under the easier Bill 198 claim, and then try to recover more under the other system.

Mr. Strosberg, for example, says he would not launch a lawsuit under Bill 198 alone. He would start with a claim under the old common law system, alleging negligent or fraudulent misrepresentation, then seek leave to amend the suit to also assert a claim under Bill 198 legislation. The same motion could then be approved as a class action under both systems, he says.

But Mr. Bates thinks investors want quick, targeted lawsuits that will move rapidly through the court system to recoup their losses. To do that, he says, the best strategy is probably a narrowly focused one using Bill 198 alone.

“I think what institutional investors want is fast, focused, efficient recovery of legitimate sums, not one of those scorched-earth, torture-to-death cases that goes on forever,” he says.

Will leave applications become the new battleground?

Under the new legislation, investors must receive permission or leave from the court before they can launch a lawsuit. The provision was added to the act to try to prevent U.S.-style strike suits, which are typically launched in a flurry immediately after a company announces bad news in the hopes of extracting quick settlements.

Lawyers in Ontario are waiting to see whether a typical leave application will entail a quick review by the courts to ensure there is evidence of a reasonable claim, or whether the leave process will turn into a protracted battleground, leading to a mini-trial before the actual trial.

The expectation is that many companies will fight the leave process tooth and nail to try to shut down lawsuits before they begin. Under the gloomiest scenarios, leave applications could wind through the courts for years.

Mr. Voorheis thinks leave applications could be a key battleground because success will be seen as a signal that a judge thinks the case can be won, which will give a plaintiff “tremendous momentum” to insist on a hefty settlement.

“I think what they have there as a precaution to protect companies could well backfire on them,” he says. “Once they get across the threshold, [plaintiffs] are going to say, ‘I'm going to win this case.'”

Why will proving knowledge become so essential?

The liability limits for individuals disappear under Bill 198 if the plaintiffs can prove that they knowingly made a misrepresentation, so many cases will hinge on this critical question.

Mr. Voorheis says many investors will decide whether or not to sue based on whether they think they can recover a significant proportion of their losses, and that will often mean they have to prove knowledge to lift off the liability caps.

“In the absence of knowledge, my guess is that there are not going to be many lawsuits,” he says. “These cases are very quickly going to become about knowledge.”

He says it is not too difficult for lawyers to predict in advance which cases are candidates to prove knowledge because there are typical warning signs. For example, he says if insiders sell a large amount of stock shortly before positive earnings are released, and it turns out they were misrepresented, it suggests someone knew the truth. Similarly, if bad news unfolds shortly after a company issues positive earnings, it can be a red flag that they were knowingly misstated.

Will the new system work?

There appears to be a wide expectation that shareholders will more easily be able to launch successful class-action lawsuits under the new rules. Under the old common law system, class actions rarely succeeded in Canada.

But lawyers have very different opinions about how much shareholders should be celebrating the advent of the new system.

Mr. Voorheis said he doesn't support the principle motivation behind Bill 198, which is structured to ensure that liability is capped, allowing lawsuits to send a message to companies to deter misrepresentations without necessarily ensuring investors recoup all their losses.

“I don't really think that shareholders are going to sue to make issuers behave themselves. They're going to sue because they want to get their losses back,” he says.

But Mr. Strosberg says the new system will open the door for lawsuits that were virtually impossible in the past. He is still fighting to recover even small sums for investors following Canada's most famous fraud case: the failure of Bre-X Minerals Ltd. in 1997.

“We get a lot of calls from people who are investors who want to sue,” he says. “And up until now, you've had to discourage it because there really wasn't the ammunition.”

© The Globe and Mail

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