COURT FILE NO.: CV-20-00649680-00CL
DATE: 20210521
SUPERIOR COURT OF JUSTICE – ONTARIO
(COMMERCIAL LIST)
RE: CLARUS SECURITIES INC., CANACCORD GENUITY CORP., CORMARK SECURITIES INC. HAYWOOD SECURITIES INC. and INFOR FINANCIAL INC., Applicants
AND:
aPHRIA INC., Respondent
APPLICATION UNDER Rules 14.05(3)(d) and 14.05(3)(h) of the Rules of Civil Procedure, O. Reg 194
BEFORE: S.F. Dunphy J.
COUNSEL: David Di Paolo and Teagan Markin, for the Applicants
Sarit Batner, Adam Ship and Selina Mamo, for the Respondent
HEARD at Toronto: May 14, 2021
REASONS FOR DECISION
[1] This application raises a relatively narrow point: does the normal indemnity given to underwriters of a public securities issue require the issuer to pay the underwriters’ costs of defending a claim that alleges intentional wrongdoing by the underwriters?
[2] This application arises in the comparatively early innings of a class action securities claim in which all of the parties to this application are named defendants. None of the allegations in that proceeding have been proved. The parties are still at the certification phase of the proceeding. As with most duty to defend cases, I am concerned at this stage with what is alleged and not necessarily with what may ultimately be proved. Should my reasons below fail to make it clear that I am considering the realm of what may be true rather than the realm of established facts, I wish to make the point clearly at the outset for the avoidance of doubt.
Background facts
[3] A very short background of the securities claim is necessary in order to place the issues in this case in context.
[4] The applicants in this case are a group of five underwriters. Some or all of these underwriters acted together on two related securities transactions: A January 18, 2018 “bought deal” transaction between two of the five underwriters and Nuuvera Inc. and, five months later, a $225 million “bought deal” transaction involving a syndicate of all five of the underwriters and the respondent Aphria Inc. on June 12, 2018 which saw the issuance by Aphria, the purchase by the underwriters and the distribution by them to the public markets of 18.99 million shares of Aphria.
[5] The fact that links these two transactions together is this: the January 18, 2018 Nuuvera transaction was followed ten days later by a further transaction whereby Aphria merged[^1] with Nuuvera through an arrangement dated January 28, 2018 and announced to the public the next day. As I shall shortly describe, the class-action law suit was recently amended to allege that two of the underwriters acted in concert to manipulate the market for Nuuvera shares prior to the January 28, 2018 arrangement transaction resulting in a higher value for Nuuvera on the books of Aphria which fact it is alleged was both material and undisclosed when the syndicate of underwriters (including the two who had acted on the Nuuvera transaction) certified Aphria’s prospectus five months later to contain full plain and true disclosure of all material facts.
[6] The proposed class action suit was commenced by a statement of claim dated February 7, 2019. As mentioned, it has yet to be certified. The defendants named are the five underwriter applicants plus Aphria and three former directors and senior officers of Aphria.
[7] The claim contains several distinct causes of action, including claims related to the adequacy of other disclosure to the public markets as against Aphria or the former officers and directors that do not involve the underwriters. The sole basis for the plaintiff’s claim as against the applicant underwriters is for alleged misrepresentations in the Aphria prospectus pursuant to s. 130 of the Securities Act., R.S.O. 1990, c. S.5.
[8] Section 130 of the Securities Act permits a purchaser of securities offered by prospectus to sue both the issuer and the underwriter for damages where the prospectus contains a misrepresentation upon which the purchaser relied in purchasing. In the case of a suit against underwriters, the mechanism for attaching liability under the prospectus to the underwriter flows from the requirement of s. 59 of the Securities Act for the underwriter to sign a certificate which forms part of the prospectus. Pursuant to that certificate, the underwriters represented to purchasers of the offered Aphria shares that, to the best of their knowledge, information and belief, the prospectus and included documents constituted full, true and plain disclosure of all material facts relating to the Aphria shares being offered for sale.
[9] The alleged misrepresentations in the prospectus that are relevant to this case included failure to disclose facts relevant to the value of the Nuuvera shares acquired by Aphria in late January 2018 which the claim alleges were worth only a fraction of their disclosed value by reason of its lack of earnings history, paucity of assets and other pleaded factors.
[10] The statement of claim was amended on December 5, 2019. Among the additions made was an allegation in paragraphs 55 and following that the prospectus also failed to disclose that the value of the Nuuvera shares contributed to the arrangement “was the product of manipulation of Nuuvera’s share price by the Underwriters in anticipation of the January 28 Aphria/Nuuvera Arrangement Agreement”.
[11] The amended claim provides particulars of the alleged market manipulation and further particulars of the allegations were provided in an expert report delivered by the plaintiff in the course of the certification proceedings. What is relevant for the purposes of this motion is that the character of the allegations. The actions alleged are not matters of negligence or due diligence but of intentional actions allegedly taken by some or all of the applicant underwriters – actions which, if they occurred, would have been known to underwriters certifying the completeness of disclosure in a prospectus. The pleading makes no direct allegation one way or the other as to the state of Aphria’s knowledge of this alleged market manipulation.
[12] The underwriting agreement bears the same date as the prospectus (June 12, 2018) because such transactions are priced as close to the time the distribution of the purchased shares to the market as possible. It would have been under negotiation for days or weeks in advance while the prospectus was being drafted and the underwriters were performing their due diligence.
[13] Pursuant to the agreement, the underwriters agreed to purchase the Aphria shares, undertook the risk of finding purchasers for them and received a set fee for their services – in this case 4.75% or $12,290,663. Other clauses in the agreement authorized the underwriters to participate in the preparation of the prospectus, to approve its form and to withhold their certificate if not satisfied as to the form and substance of it although as noted, all or most of this work would already have been completed by the time it was signed.
[14] Section 13(1) of the agreement creates an obligation upon Aphria to indemnify the underwriters both for legal defence costs and ultimate liability in the following terms (pared down to the most relevant portions for this case, emphasis added by me):
(1) The Corporation and the Subsidiaries, as the case may be (collectively, the "Indemnitor"*) hereby agrees to indemnify and hold each of the Underwriters, … (collectively, the "Indemnified Parties" and individually an "Indemnified Party") harmless from and against any and all losses, claims (including shareholder actions, derivative or otherwise), actions, suits, proceedings, damages, liabilities or expenses of whatever nature or kind, joint or several, … and the reasonable fees, expenses and taxes of one counsel to the Indemnified Parties taken as a whole (collectively, the "Losses") that may be incurred in investigating or advising with respect to and/or defending or settling any action, suit, proceeding, investigation or claim that may be made or threatened against any Indemnified Party … insofar as such Claims relate to, are caused by, result from, arise out of or are based, directly or indirectly, upon the performance of professional services rendered to the Corporation by the Indemnified Parties hereunder or otherwise in connection with the matters referred to in this Agreement, and to reimburse each Indemnified Party forthwith, upon demand, for any legal or other expenses reasonably incurred by such Indemnified Party in connection with any Claim. This indemnity shall not apply to the extent that a court of competent jurisdiction in a final judgment that has become non-appealable shall determine that such Losses were solely caused by the negligence, willful misconduct or fraud of the Indemnified Party.
[15] Section 13(3) provides for the underwriters to give Aphria notice of claims, for the investigation of claims and for the retention and payment of counsel by Aphria to conduct the joint defence of the parties. However, s. 13(4) also provides for the right of the underwriters to retain separate counsel at the expense of Aphria if one of the listed circumstances is present:
(4) Notwithstanding the foregoing paragraph, any Indemnified Party shall also have the right to employ separate counsel in any such Claim and participate in the defence thereof, and the fees and expenses of such counsel shall be borne by the Indemnified Party unless:
(c) the named parties to any such Claim include both the Indemnitor and the Indemnified Parties and the Indemnified Parties have been advised by their counsel that representation of both parties by the same counsel would be inappropriate due to an actual or a potential conflict of interest; or
(d) there are one or more defences available to the Indemnified Parties which are different from or in addition to those available to the Indemnitor such that there may be a conflict of interest between the parties;
in which case such fees and expenses of such counsel to the Indemnified Parties shall be for the Indemnitor's account.
[16] The underwriters gave Aphria notice of their intention to retain separate counsel at Aphria’s expense pursuant to s. 13(4) of the agreement on April 30, 2019 and this arrangement continued for some time without objection from Aphria. The arrangement continued until the plaintiff in the class action proceeding delivered an expert report in June 2020 in connection with the certification proceedings. The report detailed particulars of the market manipulation claim in the amended statement of claim. After it was delivered, Aphria told the underwriters that it would not reimburse any expenses associated with the market manipulation allegations.
[17] This application soon followed.
Issues to be decided
[18] While there had been some skirmishing between the parties regarding payment for outstanding invoices of defence counsel reflecting defence of the non-market manipulation claims, I am assured that those issues have now been resolved. Payment either has been made or will shortly be made and will continue in future. Aphria asks only that fees and expenses relating to the market manipulation claims continue to be tracked separately in a reasonable manner and says it will continue to pay the remainder of the defence costs.
[19] The issue to be decided here is thus whether a true construction of s. 13 of the agreement requires Aphria to pay the applicants’ defence costs in respect of the alleged market manipulation claims.
Position of the parties
[20] Aphria was paying the applicant’s costs of defending this shareholder action pursuant to s. 13 of the agreement before the market manipulation claims were made and particularized in an expert’s report. Did the market manipulation claims modify Aphria’s obligation to indemnity defence costs arising from the shareholder suit as it claims?
(i) Position of the applicant underwriters
[21] For the underwriters, the answer to the question is that neither the amendments to the statement of claim nor the expert report filed have any impact on the obligation of the respondent to fund their defence costs.
[22] They say that the indemnity is a purely contractual one and it is the terms of the contract, properly construed, that must be applied. A plain reading of s. 13(1) of the agreement requires payment of defence costs from shareholder actions based directly or indirectly on the underwriters’ professional services or otherwise connected to the matters referred to therein. The sole basis of liability attributed to the underwriters by the plaintiff is material misrepresentation in the prospectus pursuant to s. 130 of the Securities Act. That liability is in turn arises from the underwriters authorizing the inclusion in the prospectus of their certificate representing to the purchasers that the prospectus and associated documents, to the best of their knowledge, information and belief, constituted full, true and plain disclosure of all material facts relating to the Aphria securities being offered. The provision of the certificate being a central feature of the underwriters’ duties under the agreement, the claim was and still is one that is directly or indirectly one based on the professional services rendered by the underwriters or otherwise arising in connection with the matters referred to in the agreement.
[23] They also say that s. 13(4) of the agreement is even broader in its creation of an unqualified obligation to pay on-going defence costs.
[24] In the applicants’ view, the amended claim did not alter the basis of the alleged liability of the underwriters in the statement of claim but simply added another particular as to why the underwriters’ certificate is claimed to have been false and why the exclusions from liability in s. 130 of the Securities Act are allegedly unavailable to them. Such allegations retain the character of relating directly or indirectly to the professional services rendered by the underwriters under the agreement. The exclusion from the indemnity contained in the last sentence of s. 13(1) of the agreement is only applicable when and to the extent that “a court of competent jurisdiction in a final judgment that has become non-appealable” has determined that the loss was “solely caused by the negligence, willful misconduct or fraud” of the underwriters. No such determination has been made and unless and until that event occurs, defence costs must continue to be paid and without interruption. At all events, the underwriters say that the “fraud exclusion” in s. 13(1) does not apply to defence costs that must be paid pursuant to the independent provisions of s. 13(2) and s. 13(4) of the agreement.
[25] The applicants conclude that the plain language of the indemnity requires payment of defence costs and that there is no overriding rule of public policy that precludes such payment.
(ii) Position of the respondent Aphria
[26] The respondent Aphria takes a very different view of matters. For Aphria, the market manipulations as particularized and expanded upon in the expert report are claims that are quite outside the intended scope of the indemnity negotiated by the parties.
[27] The respondent’s interpretation of s. 13 of the agreement begins with a consideration of the commercial context of the underwriting agreement. Section 130 of the Securities Act imposes liability upon an issuer and underwriter of securities sold by prospectus for material misrepresentations, the latter having a defence to liability under s. 130(4) as long as the underwriter conducted a reasonable investigation sufficient to ground a reasonable belief in the truth of the representation and as long as the underwriter did not believe that there was a misrepresentation. In the normal case, it is the issuer who is fixed with the knowledge of matters that might potentially result in misrepresentation claims. This is not the case with misrepresentations of the type alleged to arise from the sort of market manipulation the revised claim pleads. The nature of such matters would be within in the unique knowledge of the alleged market manipulator and not the purchaser of securities at values allegedly influenced by that manipulation. In negotiating the indemnity, the parties clearly did not contemplate requiring the issuer to indemnify the underwriters for the consequences of actions taken by them without the issuer’s knowledge and prior to their engagement by it. The interpretation proposed by the applicants, in this context, leads to a commercially absurd result. The “fortuity principle” consistently re-affirmed by our courts precludes the beneficiary of insurance from claiming to be insured against the consequences of intentionally inflicting the very harm covered and the duty to defend does not extend to claims not indemnified. In this context, the indemnity provision of the agreement is functionally similar to a contract of insurance and similar considerations apply to its interpretation.
[28] The respondent says that the class action claim has evolved such that the market manipulation claim has become the “main event” and accounts for the bulk of the time and thus fees being devoted to this case. Focusing solely on s. 130 of the Securities Act and the underwriters’ certificate, the respondent says, is to fail to distinguish the form of the claim from its true substance. While the misrepresentation allegedly contained in the certificate of the underwriters is the last step in the chain of facts giving rise to the claim against the underwriters by the plaintiff, the preceding steps alleged are all instances of intentional conduct allegedly within the direct knowledge of the applicants. This alleged conduct was not on behalf of Aphria but aimed at it and preceded the prospectus and the underwriting agreement by several months.
[29] Market manipulation, if proved, also constitutes a stand-alone offence under s. 126(1)(a) the Securities Act which prohibits anyone from engaging in actions reasonably known to contribute to or cause an artificial price for a security. The respondent says that the market manipulation claims are the “true nature” of this claim and were entirely beyond the contemplation of the parties to the underwriting agreement.
[30] The professional fees attributed to this aspect of the claim have been and can readily continue to be tracked and it is only those fees that the respondent claims need not be covered by its indemnity.
Analysis and discussion
[31] Despite the able argument of Aphria’s counsel, I find that I must ultimately side with the applicants and largely for the reasons expressed by them.
[32] I begin the process of contractual interpretation by placing the underwriting agreement and the indemnity provisions of it in their commercial context. Where the respondent focuses upon the question of the distinction between facts known uniquely to the issuer and those known solely by the underwriter, I start at a somewhat higher level of analysis.
[33] The underwriting agreement reflects a commercial bargain. Absent overriding principles of public policy or statute, it is that bargain they struck that I must strive to discern, and I must do so in light of the words the parties have chosen to express it.
[34] The respondent would set the stage for determining the reasonable expectations of the parties by reference to a portrait of the “normal” case underwriting. The portrait painted depicts an issuer who knows the material facts that need to find their way into the prospectus. The underwriter is the gatekeeper guarding access to the capital markets. An issuer wishing to pass through the gate must first be subjected to the level of rigorous due diligence from knowledgeable underwriters that is considered “reasonable”. The underwriters as gatekeepers are held to perform this important task carefully by the ever-present risk of shareholder actions under s. 130 of the Securities Act if they fall short. The portrait so described is not an unfair one, but it is incomplete and does not place section 13 of the underwriting agreement in its full context.
[35] The underwriters are doing more than acting as gatekeepers by policing the contents of the prospectus (and they do not discharge that obligation alone – auditors and other professionals also play an important role). In this underwriting agreement, the underwriters undertook the risk of a “bought deal”: buying the offered securities at a negotiated fixed price subject to recouping their investment by re-selling the securities into the market. Their fee for providing these services and undertaking the litigation risk associated with underwriting a public offering of securities was capped at less than 5% of the issue price. Their potential liability, on the other hand, is capped by statute at 100% of the price paid by them. By contrast, the issuer runs a similar degree of risk of shareholder suits but retains 95% of the price of the securities issued (using rounded figures from the present case as an example).
[36] Parties involved in this marketplace bear the risk of litigation, including class-action s. 130 litigation. The risk of such litigation cannot be forecast in advance but if and when a claim arises it will be expensive to defend regardless of where on the spectrum from meritless to well-founded it may ultimately be found to lie. In the real world, such suits seldom proceed all of the way to trial and judgment. Costs of litigation – to both sides – play a significant role in determining whether or when such cases settle.
[37] None of this is to suggest that the merits of a claim are irrelevant so much as to recognize the commercial reality of such litigation viewed from the perspective of two parties sitting opposite each other at the bargaining table and considering the question of what indemnity if any ought to be given to the underwriters. The indemnity constructed by s. 13 must be viewed in light of this overall commercial context.
[38] In this light, the construction placed upon s. 13 by the applicants commends itself as being both consistent with the plain words of the agreement itself and the commercial context in which those words are to be found.
[39] Section 13(1) of the agreement applies to “Losses” which may arise from described “Claims” – including shareholder actions – in terms broad enough to encompass defence costs, costs of enforcing the indemnity, settlement costs and damages awards. This broad indemnity is subject to an overriding limitation expressed in the last sentence thereof: it does not apply to the extent a court of competent jurisdiction issues a final, non-appealable judgment determining that the Losses “were solely caused by the negligence, willful misconduct or fraud of the Indemnified Party”.
[40] It is to be noted that this exclusion is tightly constrained both as to the type of loss excluded and as to timing. First, the type of losses excluded are those “solely” caused by the Indemnified Party from its negligence, willful misconduct or fraud. Second, the exclusion only comes into play after a final determination of that fact has been made by a court of competent jurisdiction. “Losses” arising from “Claims” (as defined) are indemnified subject only to this exclusion. There are no other applicable exclusions.
[41] Those two defined terms in s. 13(1) of the agreement must therefore be examined in the light of the claims advanced in the litigation at issue here.
[42] The first general point to be noted is that both terms are defined using broad and inclusive language. A purposive approach is called for in interpreting such intentionally broad language.
[43] The term “Losses” is broadly defined to include “shareholder actions” and the “reasonable fees, expenses and taxes of one counsel to the Indemnified Parties taken as a whole” in addition to settlement costs. There can be no question that the defence costs the applicants seek to have paid by Aphria are “Losses” within the definition of s. 13(1) of the agreement.
[44] However, to be indemnified, the “Losses” must also arise in respect of a “Claim”. It is the construction of this definition that lies at the root of the issue before me.
[45] A “Claim” is a loss incurred “in investigating … defending or settling any action, suit, proceeding … that may be made … against any Indemnified Party … insofar as such Claims related to, are caused by, result from, arise out of or are based, directly or indirectly, upon the performance of professional services rendered to the Corporation by the Indemnified Parties hereunder or otherwise in connection with the matters referred to in this Agreement”. These words are broad and inclusive and qualified only by the narrow “fraud exception” described above.
[46] The respondent’s argument hinges upon adopting what it describes as a substance over form search for the “true nature” of the claim for which indemnity is sought. That true nature, for the respondent, is a market manipulation claim of which Aphria is the victim and the parties cannot have intended Aphria to indemnify underwriters for intentional actions of which it was the victim.
[47] The respondent’s focus is on the wrong thing in my view. It is the nature of the plaintiff’s claim against the underwriters that I must consider. The sole nexus between the plaintiff advancing the claim and the underwriters is s. 130 of the Securities Act and the fact that the underwriters collectively certified to the plaintiff that the prospectus contained full plain and true disclosure of all material facts in relation to the securities offered. The plaintiff alleges that the certificate was false in fact. The amended claim adds an additional particular of other material facts allegedly not disclosed or misrepresented – in this case another set of facts going to an already-pleaded claim that the value of Nuuvera was over-stated.
[48] The plaintiff does not allege a violation of s. 126 of the Securities Act nor does the plaintiff allege that Aphria was the victim of such conduct. The plaintiff’s claim is not a derivative claim. It is for misrepresentation in a prospectus on behalf of a purchaser of shares. It may or may not be true that such a violation occurred – all that can be said is that conduct that may amount to such a violation has been alleged.
[49] There can be no question that the defence of the claim is one that is captured by the plain language terms of s. 13(1) of the agreement. It is a shareholder action that names the underwriters as defendants. The only reason they are named as defendants is because they acted in that capacity on the issuance of Aphria’s shares and permitted the release of a prospectus containing their certificate. These things are the core subject-matter of the underwriting agreement. The claim clearly arises directly or indirectly from the services provided by the underwriters under the agreement or otherwise in connection with it.
[50] The relationship created by the agreement is the condition sine qua non of any claim by the plaintiff against the underwriters. There is no distinction between “intentional” acts and other types of acts by the underwriters either in the definition of “Claims” or of “Losses”. The language used is clear and unambiguous.
[51] The parties turned their minds quite specifically to the problem of unproven allegations advanced in shareholder claims against underwriters in respect of the shares to be distributed to the market by the underwriters. Such claims are clearly “Claims” as defined. However, the last sentence of s. 13(1) of the agreement carves out of the indemnity losses that are “solely” due to negligence, willful misconduct or fraud of the underwriters. However, it does so at a specific point in time – after a court of competent jurisdiction has made a final, non-appealable ruling. The carve-out does not come into play until after that event has occurred. It has not yet occurred and may never occur. The exclusion will not apply unless it does occur and only then.
[52] This outcome is neither absurd nor at odds with the commercial bargain the parties struck. In effect, the parties agreed that the underwriters should be considered “innocent until proven guilty” in respect of claims having the necessary nexus to the underwriting relationship and are entitled to the payment of defence costs arising until the exclusion event – a conclusive finding of fact - occurs. There is nothing contrary to public policy in such an agreement and the parties have expressed it in clear and unambiguous language of the broadest kind.
[53] Ultimately, the parties chose to treat allegations in a claim differently from proven facts providing the claim has the necessary connection to the agreement which this claim clearly does. This was an agreement the parties were free to make.
[54] I have reviewed the cases cited by the respondent, many of which arise from the insurance field, but find them of limited utility. There is no mandatory rule of public policy that prohibits the parties from agreeing to the payment of defence costs of an unproven claim which, if proven, may potentially provide grounds to invoke a coverage exclusion or even constitute a provincial offence. These cases ultimately turn upon the specific language used by the parties to express their common intention.
[55] The duty to defend insurance cases cited were of little help. On the wording of this indemnity, every claim arising out the performance of professional services rendered or otherwise in connection with the matters referred to in the agreement is covered and remains covered by the indemnity until one of the excluding conditions in the last sentence of s. 13(1) occurs. It cannot be said at this point that the indemnity does not apply to the plaintiff’s new allegations, because on the plain wording of the indemnity it does apply until the conditions bringing into play the exclusion in s. 13(1) are satisfied.
[56] None of this detracts from the gatekeeper role and the high standards expected of underwriters as described by the Securities Commission in A.E. Ames & Co. Ltd., 1972 O.S.C.B. 98 at pp. 112-113. If, at the end of the day, the allegations are proved and damages proved, such damages may well amount to be many multiples of the defence costs paid along the way or the fees earned. If any actions alleged are proved that involve provincial offences, other more severe regulatory or even criminal sanctions may also follow. There is no want of incentives to underwriters to fulfill their roles honestly and diligently. An agreement to pay defence costs of claims that may well prove to be groundless does not blunt any of them.
[57] I do not find it necessary to consider whether the indemnity of legal expenses referenced in s. 13(4) of the agreement should be considered as a stand-alone indemnity operating independently of the indemnity in s. 13(1) thereof or simply a further set of conditions attaching to the latter indemnity.
Disposition
[58] Accordingly, I find that applicants are entitled to the declaration sought in paragraph 1(a) of the Notice of Application herein that the respondent Aphria must pay all legal fees and disbursements of the applicants, on an ongoing and as-incurred basis, in defence of the action bearing Court File No. CV-19-00614086-00CP (the "Action") pursuant to the terms of the underwriting agreement between the applicants and the respondent, dated June 12, 2018. This declaration is explicitly without prejudice to the possible future application of the exclusion contained in the last sentence of s. 13(1) of the underwriting agreement.
[59] The parties advised me at the close of the hearing that they had reached an agreement on costs depending upon the decision I rendered. Would that all litigants should take the time to canvass that question before the close of a hearing. Should any further order be required from me in relation to that, I may be spoken to.
S.F. Dunphy J.
Date: May 21, 2021
[^1]: I use the term “merged” in its broader securities market sense rather than the legal term “amalgamation”. The transaction was an arrangement involving cash plus a share exchange whereby former Nuuvera shareholders received Aphria shares.