OCTOBER 11, 2013 q
THE LAWYERS WEEKLY
Focus
13
BUSINESS LAW
The limits of entrepreneurial liability Negligent misrepresentation of directors and officers focus of recent appeal ruling
John Chapman Adam Stephens uch ink has been spilled on M the issue of director or officer liability to shareholders for misrepresentations in connection with their share purchases. In the context of reporting issuers, the provisions of the Ontario Securities Act (and comparable legislation) deal both with personal liability in securities issued by way of a prospectus, and with trades in the secondary market. Additionally, in order to avoid defences or “damage caps” contained in the legislation, plaintiffs often allege that the directors and officers have liability under the common law tort of negligent misrepresentation. The case law at the pleadings/certification level on that issue has been split. The practical result to date has been uncertainty and confusion leading to enhanced legal costs and settlements. There has been much less law on personal liability in connection with trades of securities that do not trade on an exchange. In some ways this is surprising given that we are told that the exempt market offerings raised $26 billion in Ontario last year and dwarf the fundraising for securities on stock exchanges. Into this under-examined area of the law steps a recent appellate case, Hogarth v. Rocky Mountain Slate Inc. [2013] A.J. No. 122, in which leave to appeal was refused. There, two dozen investors had invested sums ranging from $25,000 to $200,000 in a small, limited partnership that was to operate a slate quarry. It appears no prospectus was issued. One presumes some exception to a prospectus applied. Instead, the investors’ decision to invest was based on a written business plan and on numerous face-to-face meetings with the officer-promoters of the venture. The business failed. The investments became worthless. Eventually it was found as a fact that the business plan had misrepresented the experience of its management team, and that the investors would not have invested but for the misrepresentation. As the issuer had failed, there was no practical recourse against it. The practical question became whether the individual directors and officers who had assisted in preparing
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the (misleading) business plan and in making the sales pitches could be held personally liable for negligent misrepresentation. At trial it was held they were liable. Following the trial, one defendant settled for $1.7 million. Others did not appeal. One lonely defendant persisted — the former chief operating officer who had taken the lead role in preparing the business plan and who had personally made oral presentations to the investors, succeeded on his appeal. The majority’s rather terse decision chose to follow a line of caselaw that stated that for personal liability, there was a need to show actions that were “themselves tortious” or that exhibited a “separate identity” from the issuer. It was noted that the officer at all times had acted “for the purposes of raising funds for the corporation and for its benefit.” The fact that he personally had a financial interest in the issuer was not enough to translate into a “separate identity.” Everything done by the COO had been in his capacity as a corporate officer. The concurring judgement by Justice Frans Slatter sought to explore at a deeper level exactly why a rule that limits personal liability should exist. “One of the core purposes of a corporation,” he wrote, is “to combine small amounts of capital into the large amounts needed for complex undertakings.” Because of this, the corporation should be presumptively liable. Personal liability should be “exceptional and secondary.” Creation of a duty that undermined the viability of the limited liability business structure raised a legitimate policy concern. Although some cases had given “lip service” to this, there had to date been little real recognition of this important concern. On the facts, the investors knew they were buying units from the
Entrepreneurs should be allowed to use those structures…even though negligent misrepresentations might creep into some of the promotional materials used. Justice Frans Slatter Alberta Court of Appeal
issuer. They voluntarily contracted with a limited liability enterprise. There was nothing that amounted to any personal covenant or acceptance of personal responsibility. Any reliance by an investor on an individual’s personal involvement was unreasonable. There was no dishonesty. The investors were all sophisticated. The promoters had legitimately selected a limited liability entity. “Entrepreneurs should be allowed to use those structures…even though negligent misrepresentations might creep into some of the promotional materials used.” Creating personal liability would undermine the ability to raise capital. It would be a misstatement to say that a single concurring decision by one appellate judge must be taken to be the law in this notoriously difficult area. Some may disagree with the entrepreneurial-friendly philosophy that animates the decision. Still, it is refreshing that at least one judge is willing to openly explore the policy reasons why we may not want to create common law personal liability in this area. John Chapman and Adam Stephens are partners with Miller Thomson in Toronto, specializing in commercial litigation.
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It’s no joke, judge resigns A municipal judge in South Hackensack, New Jersey, resigned his position last month after the state’s Supreme Court ordered him to stop doing entertainment work, according to news reports. Vince Sicari, who appears on stage as Vince August, had appealed a 2008 state ethics board ruling that he give up a comedy and acting career that predated his appointment to the part-time position that year. “The judge’s acting and comedy career is incompatible with the Code of Judicial Conduct and therefore he may not serve as a municipal court judge while continuing with that career,” said the court in a unanimous 7-0 decision. “In the course of his routines, Sicari has demeaned certain people based on national origin and religion and has revealed his political leanings.” Sicari said he respected the court’s ruling. “As long as this is a rule, I won’t sit on the bench again in New Jersey,” he told ABC News Online. “That is, unless someone wants to offer me a judge TV show.” — STAFF
