Ont. CA clarifies determination of ‘material change’ and ‘material fact’ under Securities Act

Decision in two cases outlines two-step process

Ont. CA clarifies determination of ‘material change’ and ‘material fact’ under Securities Act
Craig Lockwood, Osler Hoskin & Harcourt

Two recent Court of Appeal for Ontario rulings will provide much-needed guidance on the terms “material change” and “material fact” under the province’s Securities Act, say lawyers at Osler Hoskin & Harcourt.

The appeal court’s companion decisions on two cases with similar issues “affirm the distinction between material facts and material changes,” Osler’s Craig Lockwood, Jeremy Fraiberg and Elie Farkas write in a recent blog.

“It’s always going to be tricky to distinguish changes and facts and what’s material, given it’s all so fact-specific,” Lockwood says. However, “the advantage of the decisions in these cases is that it will apply a framework that can be applied to the facts to see how things play out.”

Lockwood says the two rulings released in May clarify that a “material change” must involve “a change in the business, operations or capital” of the issuer, unlike a “material fact,” which is any fact, external or internal, that would reasonably be expected to have a significant effect on the market price or value of a company’s securities.

In Peters v. SNC-Lavalin Group Inc. and Markowich v. Lundin Mining Corporation, the appeal court endorsed a two-step analysis in determining whether a material change occurred. First, the court must consider whether the issuer has experienced a “change,” broadly defined, which includes a change in risk in an organization’s business, operations, or capital. This step does not involve an assessment of the magnitude of the change.

The second part of the court’s analysis involves considering whether the changes would reasonably be expected to significantly affect the market price of the issuer’s securities and therefore be “material.”

The two cases were heard by different panels, both including Justice Lise Favreau, who wrote the decisions. In them, she clarified that it is only at the second stage of the analysis that the court considers the magnitude or materiality of the change.

The SNC case

In the SNC case, the plaintiff wanted to leave to commence a claim based on SNC’s alleged failure to disclose the content of a Sept. 4, 2018, phone call with the Department of Public Prosecutions Services of Canada (PPSC). On this phone call, The PPSC advised SNC it would not be invited to negotiate a remediation agreement that would have resolved a pending prosecution against SNC for fraud and corruption.

The motion judge denied the plaintiff’s leave motion, ruling there was no reasonable possibility that the September 2018 call constituted a “material change” as defined under the Securities Act.

Under the Securities Act, a “material change” is “a change in the issuer’s business, operations or capital that would reasonably be expected to have a significant effect on the market price or value of any of the securities of the issuer.”

The motion judge ruled the September phone call was not a change in SNC’s business, operations, or capital because there was no change in SNC’s risk at that time. SNC faced the prospect of prosecution before the call and continued to face that prospect after the call. Investors at the time of the September 2018 call already knew the risk, and the call did not change that risk.

SNC also continued negotiating a remediation agreement with the PPSC until the PPSC confirmed on October 9, 2018, that it would not grant SNC’s request for a remediation agreement. SNC promptly disclosed this on October 10, 2018.

The plaintiff appealed the motion judge’s ruling, arguing that the judge had erred in his interpretation of “change” and finding that the September 2018 call was not a material change.

However, the appeal court dismissed the plaintiff’s appeal, finding the motion judge had ultimately adopted a very broad definition of “change” and that, even under this broad definition, the September 2018 call still could not be seen as a change in SNC’s business, operations, or capital. Justice Favreau also wrote that the motion judge correctly held that the meaning of “change” is “fact specific.”

As well, Justice Favreau wrote the motion judge correctly held, on the evidence, that there was no reasonable prospect of the September 2018 call being found at trial to constitute a change in the risk that SNC’s business faced.

Further, the appeal court ruling deemed the only limit that the motion judge placed on what constituted a “change” under the Act was that a “change” does not include external circumstances that do not result in a change in the issuer’s business, operations or capital, even if they might affect the issuer’s share price.

The Lundin case

In Lundin, the plaintiff sought leave to commence a claim based on alleged delays in Lundin’s disclosure of wall instability and an eventual rockslide at its copper mine in Chile. Lundin did not disclose these events until about one month after the rockslide occurred, after which its share price declined significantly. The plaintiff argued that these events constituted “material changes” requiring immediate disclosure.

The motion judge agreed that the plaintiff had established a reasonable chance of proving these events were “material” because of the potential impact on the market value of Lundin’s securities.

However, the motion judge ruled against the plaintiff, saying that these were not “material changes” as contemplated by the Securities Act. The motion judge ruled that neither the pit wall instability nor the rockslide constituted a “change” to Lundin’s business, operations, or capital because these are the anticipated and inherent risks in open pit mining operations that did not prevent Lundin from continuing to engage in its business of copper mining.

But the appeal court panel that heard this case reversed the motion judge’s decision and granted the plaintiff leave to proceed with its claim because there was a “reasonable prospect of success at trial,” proving there was a material change.

Justice Favreau, writing again for the appeal court, held that the motion judge in Lundin erred in interpreting the phrase “change in the business, operations or capital of the issuer” too narrowly, particularly in the context where the plaintiff needed only to demonstrate to pursue its claim that there was the reasonable possibility of success, based on a plausible interpretation of the statute and the evidence.

Operations, Justice Favreau wrote, can, for example, refer to a broad range of activities within a company. As in Lundin, a change in operations could include an interruption in production and a change in schedule due to an accident or equipment failure.

Applying this broad interpretation, the appeal court held that the plaintiff had satisfied its burden of showing a “reasonable possibility” of establishing the problems at the mine in Chile were “changes” in Lundin’s “operations.”

The appeal court in Lundin ruled the motion judge should not have limited his inquiry of “change” to whether Lundin had completely changed directions in its lines of business, stopped operating its mine, or changed its capital structure. Instead, so long as the change was not “external to the company without a resulting change in the business, operations or capital of the company,” the motion judge should have found the first “change” part of the “material change” test satisfied.

The appeal court then reiterated its endorsement of a two-step analysis for determining whether there has been a “material change.” First, the court must determine whether there has been a “change in the issuer’s business, operations or capital.” Second, the court must determine whether the change was “material” such that it could significantly impact the value of the issuer’s shares.

Justice Favreau wrote that the motion judge in Lundin erroneously read the “magnitude” requirement into the first part of this test when questions of magnitude should generally be left to the second part.

The challenge in determining material fact and material change

Lockwood points out that Issuers and advisers can find it difficult to distinguish between a fact and a change and what is deemed “material” under the statute.

An example of a material fact that is typically not a material change is in the case of merger negotiations. While the fact that there are merger negotiations can influence the price of an issuer’s securities, Lockwood says there is generally no change in the issuer’s business, operations or capital until the parties proceed with the transaction.

Lockwood says certain documents, such as a prospectus or earning report, must disclose all material facts. However, the obligation to make timely disclosure is “limited to the occurrence of a material change.”

Lockwood says it would be “unrealistic” to expect companies to immediately report, for example, an external event or “material” fact, such as bad weather impacting sales. That is generally more appropriate to include when releasing company quarterly earnings.

However, there is an obligation to tell the markets promptly about an important “material” change in a company’s operations or capital structure because the company is in “the best position to know what it’s doing or not doing.”

Lockwood notes that determining whether and when there has been a change in an issuer’s business, operations, or capital “often proves challenging.” The SNC and Lundin decisions help clarify the distinction between what is a “change” or a “fact” and, if deemed a change, whether it is “material.”

He also points to the Supreme Court of Canada’s decision in Kerr v. Danier Leather, which says the distinction between a “material change” and a “material fact” does not focus on the magnitude of the change but instead focuses on whether the change was external to the company as opposed to whether the change was internal to the business, operations, or capital of the company.

A “material fact” can be external to the company, whereas a “material change” generally cannot.

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