In Reasons released on September 26 in Badeesha v. Cronos Group Inc., the Court of Appeal for Ontario unanimously overturned a decision refusing to grant leave to proceed with a misrepresentation class action against a cannabis company under Part XXIII.1 of the Securities Act. In doing so, the Court of Appeal found that the Superior Court judge below had erred in characterizing the proposed class action as involving 7,449 misrepresentations and in requiring the plaintiff to show that each of these separate misrepresentations materially contributed to a loss in share price during the relevant period in order to obtain leave to proceed.
By way of background, the defendants in the proposed class action are a Canadian company involved in the cultivation, manufacturing and marketing of cannabis and cannabis-derived products for both the medical and recreational markets and members of its management. In the proposed class action, the plaintiff alleges that :
“[D]uring the class period, Cronos and other public cannabis issuers were under pressure to show increasing revenues and sustainable growth. Faced with that pressure, Cronos allegedly “orchestrated a scheme to inflate its reported revenue figures” by entering “into simultaneous transactions with third parties to both sell to them cannabis dry flower and to purchase back cannabis resign and tinctures, transactions that were concluded in contemplation of one another.” The claim alleges that Cronos then improperly “booked these sales as revenue” rather than “properly accounting for these transactions at the carrying value of inventory transferred by Cronos”
It was alleged that these misrepresentations affected the share price and that, when the misrepresentations were corrected in a March 2020 press release, the subsequent drop in the share price caused damages attributable to those misrepresentations for which the defendants are liable. The defendants disputed this, saying that there were other causes for the drop in share price, including the impacts of the COVID-19 pandemic and an announcement of the delayed U.S. distribution of a new product called PEACE+.
On the initial motion, Superior Court Justice Edward Morgan declined to grant leave to proceed under Part XXIII.1 of the Securities Act, under which a purchasers of securities on the secondary market (i.e. the stock market) are required to show a reasonable possibility of success at trial to obtain leave to proceed with a claim. In this case, Mr. Justice Morgan referenced “…a litany of what he characterized as separately and independently actionable misrepresentations committed by Cronos and the individual Defendants during 2019. …When one tallies it all up, there are allegations of just under 8,000 misrepresentations covered by the Plaintiff’s pleading.” In finding that the leave test was not met, Justice Morgan cited the likely impact of the COVID-19 pandemic and found that the plaintiff had not shown that each separate misrepresentation had materially contributed to a loss in share price during the relevant period.
The Court of Appeal fundamentally disagreed with Justice Morgan’s characterization of the claim as being based on 7,449 misrepresentations and found that this approach to the claim tainted his analysis. Rather, when viewed properly:
“…the claim alleges one central misrepresentation, namely that Cronos misrepresented its revenues for 2019 Q1 and Q3 by treating transactions involving the exchange of cannabis products with a third party as generating revenue …. Cronos ultimately corrected those documents and line items. The issue of whether this core misrepresentation should be broken down and treated as several misrepresentations for the purpose of calculating damages is to be decided at trial and not at this early stage of the proceedings.”
In deciding that leave to proceed should be granted, Justice Favreau on behalf of a unanimous panel, reiterated past cases’ prescription that in order to obtain leave to proceed a plaintiff must be able to show that there was a misrepresentation, which is defined under the Securities Act as “an untrue statement of material fact.” Material fact is defined as “a fact that would reasonably be expected to have a significant effect on the market price of value of the securities.” As explained by the Court of Appeal citing the Supreme Court of Canada’s 2015 Theratechnologies decision, the test for leave is meant to be “more than a speed bump” but is not a mini-trial. A plaintiff must be able to offer both a plausible analysis of the applicable legislation and some credible evidence to support the claim.
In this case, it was found that the court below made a palpable and overriding error in characterizing the action as involving 7,449 misrepresentations rather than “…a core allegation that Cronos and the other defendants misrepresented their revenues by characterizing the exchange transactions as generating revenue.” The Court of Appeal found that the motions judge’s analysis in the court below tipped “into the realm of a mini-trial” and, finding that “the evidence in support of the claim is well beyond de minimus,” it overturned the decision below and granted leave for the plaintiff to proceed.
The issue of certification of the action as a class action was not decided but, rather, remitted back to the Superior Court for a decision.
This case is just the latest example of how the courts continue to wrestle with the application of the leave test under Part XXIII.1 of the Securities Act. Seven years after the “more than a speed bump but not a mini-trial” directive of the Supreme Court of Canada in Theratechnologies, courts continue to be challenged when applying that directive – and other appellate guidance – to the complex situations that arise in Canada’s capital markets.