DATE: 20030109

DOCKET: C38204

COURT OF APPEAL FOR ONTARIO

DOHERTY, AUSTIN and CHARRON JJ.A.

PROCEEDINGS UNDER THE CLASS PROCEEDINGS ACT, 1992

B E T W E E N:

JOSEPH MENEGON

Margaret L. McCarthy and

John W. McDonald,

Plaintiff (Appellant)

for the plaintiff (appellant)

• and -

PHILIP SERVICES CORP., SALOMON BROTHERS CANADA INC., MERRILL LYNCH CANADA INC., CIBC WOOD GUNDY SECURITIES INC., MIDLAND WALWYN CAPITAL INC., FIRST MARATHON SECURITIES LIMITED, GORDON CAPITAL CORPORATION, RBC DOMINION SECURITIES INC., TD SECURITIES INC. and DELOITTE & TOUCHE

Benjamin Zarnett and Jessica Kimmel,

for the defendants (respondents) the “Canadian Underwriters”

J.L. McDougall, Q.C. and Michael D. Schafler,

for the defendant (respondent) Deloitte & Touche

Defendants (Respondents)

Heard: December 5, 2002

On appeal from the judgment of Justice Arthur M. Gans of the Superior Court of Justice dated March 6, 2001.

CHARRON J.A.:

[1] This appeal concerns the sufficiency of a statement of claim in a proposed representative action by an investor for damages for negligent misrepresentation arising out of the purchase of shares in the open market.

1. The appellant’s claim

[2] The appellant, Joseph Menegon, is an investor who purchased 300 shares of the defendant Philip Services Corp. (“Philip”) on November 28, 1997 in what is commonly referred to as the open or secondary market. Philip subsequently became insolvent. In 1998, Menegon commenced this action, on his own behalf and on behalf of other purchasers of Philip shares, for damages for misrepresentation under s. 130(1) of the Securities Act, R.S.O. 1990, c. S.5 and for negligent misrepresentation at common law. He claims damages against the respondents for alleged misrepresentations contained in a prospectus dated November 6, 1997 used in connection with a public offering of Philip shares during the period November 6 to 18, 1997. The audit opinion of the respondent Deloitte & Touche (the “auditors”) in respect of Philip’s financial statements for the years ending December 31, 1995 and 1996 was included in the prospectus. The remaining respondents are collectively referred to as the “Canadian Underwriters”. They underwrote the public offering and, as they are required to do under s. 59 of the Securities Act, they certified that the contents of the prospectus constituted “full, true and plain disclosure of all material facts” relating to the shares being offered for sale.

2. The proceedings before the motions court

[3] Menegon brought a motion under the Class Proceedings Act, 1992 S.O. 1992, c.6 for an order certifying his action as a class proceeding and appointing him as a representative plaintiff. He also brought a concurrent motion to amend his statement of claim under rule 26 of the Rules of Civil Procedure R.R.O. 1990, Reg. 194. The Canadian Underwriters and the auditors brought cross-motions to dismiss Menegon’s action on the basis that it disclosed no reasonable cause of action. They moved under rules 21.01(1)(a) [motion for determination of a question of law raised by a pleading] and 51.06(1) and (2) [motion for an order based on an admission of fact]. The latter motion was based on an admission by Menegon on cross-examination that he had had no personal dealings with any of the respondents.

[4] Menegon conceded before the motions judge that he personally did not have a s. 130 cause of action under the Securities Act since only purchasers who purchase shares offered by the prospectus during the period of distribution, not after, can claim under that section. Section 130(1) reads as follows:

130. (1) Where a prospectus together with any amendment to the prospectus contains a misrepresentation, a purchaser who purchases a security offered thereby during the period of distribution or distribution to the public shall be deemed to have relied on such misrepresentation if it was a misrepresentation at the time of purchase and has a right of action for damages against,

(a) the issuer or a selling security holder on whose behalf the distribution is made;

(b) each underwriter of the securities who is required to sign the certificate required by section 59;

(c) every director of the issuer at the time the prospectus or the amendment to the prospectus was filed;

(d) every person or company whose consent has been filed pursuant to a requirement of the regulations but only with respect to reports, opinions or statements that have been made by them; and

(e) every person or company who signed the prospectus or the amendment to the prospectus other than the persons or companies included in clauses (a) to (d),

or, where the purchaser purchased the security from a person or company referred to in clause (a) or (b) or from another underwriter of the securities, the purchaser may elect to exercise a right of rescission against such person, company or underwriter, in which case the purchaser shall have no right of action for damages against such person, company or underwriter.

[5] Menegon maintained that he could nonetheless be the representative for the class of purchasers who had a cause of action under s. 130. He argued that the s. 130 claim was in effect a subclass to the common law action for negligent misrepresentation. Hence, the motion turned on the viability of the action at common law.

[6] The constituent elements for the tort of negligent misrepresentation are set out by the Supreme Court of Canada in Queen v. Cognos Inc., 1993 146 (SCC), [1993] 1 S.C.R. 87 (at 110): (1) there must be a duty of care based on a “special relationship” between the parties; (2) the representation in question must be untrue, inaccurate, or misleading; (3) the representor must have acted negligently in making the misrepresentation; (4) the representee must have relied, in a reasonable manner, on the negligent misrepresentation; and (5) the reliance must have resulted in damages to the representee.

[7] The argument on the motion essentially focused on the first element, the duty of care based on a special relationship. Menegon’s pleading, even amended as proposed, does not allege any relationship between him and the auditors and, in respect to the Canadian Underwriters, contains a conclusory statement to that effect but without any material fact in support. Further, Menegon, in cross-examination, admitted that he had no personal dealings with the respondents.

[8] Menegon argued, nonetheless, that a duty of care arose as a result of the reasonable foreseeability that purchasers of shares in the secondary market, before and after the public offering under the prospectus, would rely on the document to hold, buy or sell Philip shares. He submitted that the respondents’ duty of care should not be delimited at the pleading stage on the basis of policy concerns about limitless liability.

[9] The motions judge rejected this argument. First, he found that the creation of a cause of action for the benefit of purchasers of shares in a secondary market, in the absence of a special relationship, was a matter for the legislature and not the courts. Second, he was of the view that Menegon’s argument was contrary to the analysis of the Supreme Court of Canada in Hercules Management Ltd. v. Ernst & Young, 1997 345 (SCC), [1997] 2 S.C.R. 165 where the court considered the question of duty of care in relation to a claim by individual investors based on their reliance on audit reports. The motions judge held that the reasonable foreseeability/reasonable reliance test did not determine the question of duty of care and that the court was obliged to determine whether the prima facie duty of care ought to be negatived or limited for other reasons. He was of the view that if Menegon’s argument was accepted, the Canadian Underwriters and the auditors would be exposed to liability of an indeterminate amount, for an indeterminate time, in respect to, theoretically, an indeterminate class. The motions judge therefore concluded that it was plain and obvious from the appellant’s pleading, even if amended as proposed, that the appellant could not establish a special relationship that could give rise to a duty of care. Hence, since neither the existing statement of claim nor the proposed amended pleading disclosed a reasonable cause of action, the motions judge dismissed the action, the motion to amend the pleading, and the motion for certification.

3. Menegon’s position on appeal

[10] Menegon appeals from the motion judge’s decision. His appeal was initially brought in the Divisional Court because an appeal from a refusal to certify an action as a class proceeding lies to that court under s. 30 of the Class Proceedings Act, 1992. The respondents raised a preliminary issue of jurisdiction in that court. The Divisional Court held that, before dealing with the issue of certification, the judgment dismissing the action would have to be set aside and, since the dismissal of the action constituted a final order, the appeal properly belonged in the Court of Appeal. Consequently, by order dated January 29, 2002, the Divisional Court traversed the matter to this court. In the event that the appellant is successful on his appeal before this court, it is understood by the parties that the motion for certification of the action as a class proceeding would return to the motions court for determination.

[11] Menegon argues that the motions judge erred in finding that his pleading did not disclose a reasonable cause of action. His argument on this point focussed entirely on the reasoning of Cumming J. in Mondor v. Fisherman (2001), 2001 28388 (ON SC), 15 C.P.R. (4th) 289 (Ont. Sup. Ct.), a decision released after the motion was heard in this case. In Mondor, the proposed representative plaintiffs brought a class proceeding against a number of defendants, including auditors and financial advisors, for losses suffered through purchases of shares in the secondary market. The claim, among other matters, alleged negligent misrepresentation at common law. The defendants moved under rules 21.01(1)(b) and 25.11 to strike the pleadings on the ground that it failed to disclose a reasonable cause of action.

[12] Cumming J. considered the five constituent elements of an action for negligent misrepresentation as stated in Queen v. Cognos. On the question of duty of care, he considered the pleadings in light of the principles in Anns v. Merton London Borough Council, [1978] A.C. 728 (H.L.) and in Hercules. He succinctly described the two stage analysis as follows (at paras. 39-40):

… First, a prima facie duty of care is owed when there is a sufficient relationship of proximity between two persons such that it is reasonably foreseeable by the alleged wrongdoer that carelessness on his/her part may cause damage to the other person.

Second, upon a determination of a prima facie duty of care, it is necessary to consider whether there are any factors or policy considerations which ought to negative or limit the scope of the duty, or the class of person to whom the duty is owed, or the damages for a breach of the duty.

[13] Cumming J. noted that whether a duty of care does or does not exist is a factual enquiry and concluded that “the plaintiff has pleaded material facts in support of the claim of proximity such as to give rise to a prima facie duty of care.” On the second branch of the test in Anns, Cumming J. recognized that something more had to be shown, before imposing a duty on one party to care for the purely economic interest of another, than simply foreseeability that the conduct might cause loss or damage to those interests. He was satisfied, in the case at hand, that the case was sufficiently pleaded. Among other things, he noted that it was pleaded that the defendants intended that the public would rely upon the audited financial statements when making investment decisions.

[14] On the issue of reliance, Cumming J. referred to the American “fraud on the market theory” which “has been described as a legal fiction which has the effect of overcoming the need to prove reliance.” He noted that this theory was not part of the law of Canada and that proof of reliance is a necessary ingredient of actions based upon negligent misrepresentation. He noted further that the question of whether a plaintiff has actually relied upon a misrepresentation is a question of fact that may be inferred from all the circumstances and, hence, concluded that “it would be premature to foreclose the consideration of this issue in the case at hand beyond the pleading stage.” Consequently, Cumming J. dismissed the motion to strike the pleading.

[15] Menegon submits that, if the motions judge in this case had followed the same reasoning as Cumming J., he would have reached the same conclusion and dismissed the respondents’ motions under rules 21 and 51.

[16] I disagree. The motions judge in this case followed essentially the same analytical framework as followed in Mondor, and, in my view, he followed the correct approach. The different result in this case lies not in a defect of reasoning, but in the insufficiency of the pleadings. When pressed by this court, counsel for Menegon could only refer to paragraph 46C of his statement of claim and paragraph 51 of his proposed amended claim to support his client’s contention that the respondents owed the members of the proposed class a duty of care. These paragraphs read as follows:

46C. The Plaintiff states that the persons who purchased common shares of Philip through the TSE and the MSE during the Class Period were doing so in an open and efficient capital market and they were relying upon the accuracy of the information that Philip was required to provide pursuant to their Continuing Disclosure Obligations.

51A. The claim for negligent misrepresentation is based on the following factors:

51B. The Plaintiff states that the Underwriters were negligent in stating in the Certificate of Canadian Underwriters that the Prospectus did constitute full, true and plain disclosure of all material facts relating to the common shares of Philip and that it did not contain any misrepresentations likely to affect the market value or the market price of the common shares of Philip. The misrepresentations were material and negligently made.

51C. The Plaintiff states that the Underwriters owed a duty of care to any of its [sic] clients who held and/or purchased common shares of Philip during the Period of Distribution of the Public Offering that the Prospectus did not contain any misrepresentations likely to affect the market value or the market price of the common shares of Philip. The duty of care was created by the special relationship between the Plaintiff and the Underwriters [emphasis added].

51D. The Plaintiff reasonably relied on the misrepresentations and that damages were incurred by the Plaintiff as a result of the reliance on the misrepresentations.

[51E. and 51F. then set out particulars relating to the alleged misrepresentations.]

[17] Paragraph 51, as was later acknowledged by counsel for Menegon in his argument, has nothing to do with the auditors. Further, in respect to the Canadian Underwriters, the pleading refers to two categories of plaintiffs neither of which comprises Menegon. Insofar as paragraph 46C is concerned, it becomes apparent when read in context, that it has nothing to do with either set of respondents; it is targeted solely at the defendant Philip and its directors.

[18] In my view, the pleadings in this case fall far short of setting out material facts which could give rise to a duty of care to Menegon on the part of the auditors or the Canadian Underwriters. The respondents have provided the court with a copy of the statement of claim under consideration in Mondor for the purpose of comparison. Although the question of the sufficiency of the pleadings in Mondor is not before this court and I infer no comment on the correctness of the decision in that case, it is clear from a quick review of that pleading that Cumming J. was considering quite a different situation than the motions judge in this case. In my view, Gans J. was correct in finding that Menegon’s pleading did not disclose a reasonable cause of action. I would not interfere with the result.

[19] For these reasons, I would dismiss the appeal with costs. Counsel for the auditors and the Canadian Underwriters have each submitted their bill of costs. The appellant may make written submissions in respect of the quantum of costs within 14 days and the respondents may respond, if so advised, within a further 7 days.

Released: JAN 09 2003 Signed: “Louise Charron J.A.”

“D.D.” “I agree Doherty J.A.”

“I agree. Austin J.A.”