Due Diligence for Due Diligence for DirectorsDirectors

Martin Elliott KovnatsJeffrey Kyle Merk

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Principal SourcesPrincipal Sourcesof Liability for Directorsof Liability for Directors

1) Prospectus Offering; and

2) Secondary Market.

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Prospectus Offering: Prospectus Offering: Director’s Liability underDirector’s Liability under

a Prospectusa Prospectus

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Liability for MisrepresentationLiability for Misrepresentation

1) Common Law liability for Misrepresentation; and

2) Statutory liability for Misrepresentation.

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Statutory LiabilityStatutory Liabilityfor Misrepresentationfor Misrepresentation

Paragraph 130(1)(c) of the OSA provides that where a prospectus contains a misrepresentation, a purchaser of a security offered during the distribution period has a right of action for damages against every director of the issuer at the time the prospectus was filed, without regard to whether the purchaser relied on the misrepresentation.

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Misrepresentation Misrepresentation

Section 1.1 of the OSA provides that a misrepresentation is made where there is an untrue statement of material fact, or an omission to state a material fact that is necessary to make a statement not misleading in light of the circumstances in which the statement was made.

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DefencesDefences• Section 130 of the OSA contains a number of

defences that could, depending on the circumstances, be relevant to directors.

• Subsection 130(5) of the OSA provides the “Due Diligence” defence.

• The “Due Diligence” defence provides that a director will not be liable for a misrepresentation in a prospectus if the director conducted such reasonable investigation so as to provide reasonable grounds for the belief that there has been no misrepresentation.

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Standard of Reasonableness Standard of Reasonableness for Due Diligence Defencefor Due Diligence Defence

• Standard of reasonableness is that of a prudent person in similar circumstances.

- This objective standard may result in the application of different standards between directors, i.e. inside vs. outside directors.

• Key to reasonable investigation is the independent verification of information.

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Tips to Establish Tips to Establish Due Diligence DefenceDue Diligence Defence

To help establish the Due Diligence defence in a public offering, directors should:

• Become familiarized with all aspects of the issuer’s business;

• Independently check and verify information with management and with experts;

• Attend board meetings approving the prospectus and have issuer’s counsel attend to describe due diligence that issuer’s counsel conducted;

• Monitor the issuer’s performance;

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Tips to EstablishTips to EstablishDue Diligence Defence Due Diligence Defence (cont’d)(cont’d)

• Attend all due diligence meetings, including such meetings before filing the prospectus;

• Read proofs of the prospectus;• Ensure directors are addressees to reports

and opinions provided by experts; • Maintain written records of investigations

and meetings where difficult business decisions are made; and

• Investigate and follow-up on all matters of concern until satisfied.

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Limits on Director’s LiabilityLimits on Director’s Liability

1) Monetary Limits

a) Subsection 130(8) of the OSA provides that the amount recoverable shall not exceed the price at which the securities were offered to the public; and

b) Subsection 130(7) of the OSA provides that the amount recoverable shall not exceed the depreciation in value of the securities as a result of the misrepresentation, where provable.

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Limits on Director’s Liability Limits on Director’s Liability (cont’d)(cont’d)

2) Time Limits – Section 138 of the OSA provides that no action for a misrepresentation in a prospectus shall be commenced:

a) Three years from the date of the transaction giving rise to the cause of action; or

b) 180 days after the purchaser first had knowledge of facts giving rise to the cause of action.

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Secondary Market:Secondary Market:Director’s Liability in the Director’s Liability in the

Secondary MarketSecondary Market

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Liability for MisrepresentationLiability for Misrepresentation

1) Common Law liability for Misrepresentation; and

2) Statutory liability for Misrepresentation.

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Statutory Liability for Statutory Liability for MisrepresentationMisrepresentation

Part XXXIII.1 of the OSA provides three instances where an investor has a right of action in particular time periods for:

1) Misrepresentation in public document;2) Misrepresentation in public oral

statement; and3) Untimely disclosure.

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DefencesDefences• Section 138.4 of the OSA contains a number

of defences that could, depending on the circumstances, be relevant to directors.

• Subsection 138.4(6) of the OSA provides “Due Diligence” defence.

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Defences Defences (cont’d)(cont’d)

• The “Due Diligence” defence provides that a director will not be liable for a misrepresentation if: (i) before the release of the document or the making of a public oral statement the director conducted a reasonable investigation and at the time the document was released, or the public oral statement was made the director has no reasonable grounds to believe that the document or public oral statement contained a misrepresentation; or (ii) before a failure to make timely disclosure first occurred the director conducted a reasonable investigation and the director had no reasonable grounds to believe that the failure to make timely disclosure would occur.

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Standard of Reasonableness Standard of Reasonableness for Due Diligence Defencefor Due Diligence Defence

Subsection 138.4(7) of the OSA provides that a court shall consider all relevant circumstances in determining reasonableness, including:• Nature of the issuer;• Knowledge, experience and function

of director;• Presence of another relationship with

the issuer;

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Standard of Reasonableness Standard of Reasonableness for Due Diligence Defence for Due Diligence Defence

(cont’d)(cont’d)

• Existence and nature of a system designed to ensure continuous disclosure obligations met;

• Reasonableness of reliance on disclosure compliance system and others’ duties;

• Period of time within which disclosure was required;

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Standard of Reasonableness Standard of Reasonableness for Due Diligence Defence for Due Diligence Defence

(cont’d)(cont’d)

• Extent a director knew or should have reasonably known content and medium of dissemination of document or oral statement; and

• Role and responsibility of a director in preparation and release of document or statement or in a decision not to disclose the material change.

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Tips to Establish Tips to Establish Due Diligence DefenceDue Diligence Defence

To help establish the Due Diligence Defence for secondary market liability, directors should:• Perform many of the same due diligence

actions described in the context of a public offering;

• Assist in establishing, maintaining and having the issuer comply with a formal corporate disclosure policy with respect to the review and release of written and oral information and the timely disclosure of all information;

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Tips to Establish Tips to Establish Due Diligence Defence Due Diligence Defence (cont’d)(cont’d)

• Assist the issuer in creating a formal disclosure committee and consider participating as a member of the disclosure committee;

• Assist or ensure that all scripts for public speaking engagements of the issuer are reviewed prior to dissemination;

• Rely on experts, such as lawyers, to review and assist in the preparation of public documents and review the above mentioned scripts; and

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Tips to Establish Tips to Establish Due Diligence Defence Due Diligence Defence (cont’d)(cont’d)

• Review the treatment of “forward-looking” information and ensure that all “forward-looking” information contained in the document and included in public oral statements contains reasonable cautionary language identifying the forward-looking information and identifying material factors that to cause results to differ and ensuring that there is a reasonable basis for the forward-looking information.

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Limits on Director’s LiabilityLimits on Director’s Liability1) Procedural/Monetary Limits:

a) Subsection 138.8 of the OSA provides that leave of court must be obtained to commence an action;

b) Subsection 138.6 of the OSA provides that, generally, liability of directors is proportionate, not joint and several; and

c) Section 138.5 of the OSA provides for monetary limits on the amount of damages.

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Limits on Director’sLimits on Director’sLiability Liability (cont’d)(cont’d)

2) Time Limits – Section 138.14 of the OSA provides that no second market liability action shall be commenced:

a) Three years from the date on which a misrepresentation was made or on which the requisite disclosure was required to be made; or

b) Six months from the issuance of a news release disclosing leave granted to commence action for secondary market disclosure liability.