For the first time, the Ontario Superior Court of Justice released a decision that considered issues of statutory misrepresentation in an offering statement under the Credit Unions and Caisses Populaires Act 1994.(1) Polla v Croatian (Toronto) Credit Union also provides extensive guidance on issues of directors' and officers' liability more generally. There is limited jurisprudence in this area, with this landmark decision expected to provide valuable guidance to boards and insurers on risk prevention. This article provides a high-level overview of the decision.
The plaintiff, Ferdinando Polla, invested CA$5 million in the Croatian Credit Union (CCU) after the struggling credit union filed an offering statement in order to raise funds. The process was heavily supervised by:
- the CCU's regulators;
- the Deposit Insurance Corporation of Ontario (DICO); and
- the Financial Services Commission of Ontario (FSCO).
However, as a result of various transactions that followed the investment in which Polla was personally involved, as well as Josip Vinski (the CCU's former chief executive officer), the credit union was put into administration by DICO and subsequently liquidated.
Following liquidation, additional and separate issues were discovered at the CCU involving a fraudulent mortgage scheme. Polla commenced an action against the CCU's board of directors under Section 82(3)(c) of the act, which provides a direct cause of action if a misrepresentation in the offering statement can be proved. Over the course of the trial, Polla abandoned his original claims of misrepresentation and negligence against the defendants and sought an amended statement of claim at trial that added a new allegation that the defendants had misrepresented the CCU's lending services in the offering statement. Ultimately, the remaining issue was whether the description of the CCU's lending services, as being based on a property's appraised value in the offering statement, was a material misrepresentation.
Polla brought his claim against the board under Section 82(1) of the act, which provides that:
if an offering statement… contains a misrepresentation, a purchaser of a security shall be deemed to have relied upon the misrepresentation if it was a misrepresentation when the purchase was made.
Section 82(3) granted Polla the right to pursue action against the board.(2) Section 82(6) of the act defines a 'misrepresentation' as:
- an untrue statement of material fact; or
- an omission to state a material fact that is required to be stated or is necessary to make a statement not misleading in light of the circumstances in which it was made.
If such a misrepresentation is established, Section 82(5) of the act states that there will be no liability if it can be demonstrated that the defendants did not believe, nor had any reasonable grounds to believe, that there had been a misrepresentation.
Common law negligence – high threshold
Polla failed to establish that the directors, in their individual capacity, owed him a duty of care, which is necessary for a successful claim for common law negligence. The court affirmed that the threshold to commence such a claim against directors is extremely high, and arises in instances where the directors' conduct is tortious or exhibits an interest that is separate and distinct from the entity's.(3)
The court relied on evidence that showed:
the Board was not involved in the day-to-day operations of CCU,… obtained reasonable assurances from various sources and experts, received and reviewed numerous reports from numerous entities and audits.
It also sought to address concerns raised by such reports. The court found that the board had acted diligently and that the claim against the directors in common law negligence could not proceed.(4)
Statutory misrepresentation
Significant issues that evolved in this case were:
- whether the offering statement contained a misrepresentation with respect to CCU's lending services; and
- whether the defendants were liable for misrepresenting the CCU's lending policies and practices.
Polla submitted that the defendants had known that mortgages were being approved without third-party appraisals and that it was misleading for the offering statement to provide that mortgage loans were limited to 75% of the appraised value of the property if no appraisal had been obtained. In addition, Polla asserted that because the offering statement referenced undisclosed policies, the defendants were liable under the act because it would be unfair to require a complainant to enquire about unspecified policies.(5)
The court disagreed with Polla and found that there had been no material misrepresentation pursuant to Section 82(1), given the expansive nature of what constitutes an appraisal in the contextual circumstances. Further, it would be impossible and undesirable for there to be an obligation that all day-to-day operations and policies be specifically disclosed in an offering statement.(6)
The trial judge further acknowledged that even if there had been a misrepresentation, the board could avail itself of the statutory defence established under Section 82(5) of the act for the following reasons:(7)
- Preparation of the offering statement had been supervised by lawyers, auditors and regulators, including DICO and FSCO.
- The board could rely on the oversight of the external auditor, lawyers, DICO and FSCO, such that these parties would not have approved the offering statement if it had contained a material misrepresentation.
- The evidence indicated that the parties involved in drafting the offering statement had been committed to making full, true and plain disclosure in compliance with the act.
Although the trial judge took note of the statutory framework's objectives, she ultimately assessed what was fair and reasonable for the board, given the practical realities of preparing the offering statement, especially given the massive oversight role undertaken by third-party experts and regulatory bodies. The following are key takeaways for directors and insurers arising from this case:
- If allegations of specific misrepresentation are not pursued early on by a plaintiff, such allegations may be statute-barred, as each misrepresentation forms a separate cause of action.
- The statutory regime makes it necessary that defendants rebut the presumption of deemed reliance available to plaintiffs under the regime. However, once successfully rebutted, the burden of proof then shifts to the plaintiff who must establish that the board of directors have no reasonable grounds to believe that there was a misrepresentation.
- It is important to establish multiple sources of information and review within the corporation, including separate and distinct roles for directors and officers, in order to demonstrate that the directors have obtained reasonable assurance.
- Similarly, layers of oversight by third parties, such as experts and regulators, demonstrate that the directors obtained reasonable assurance in the circumstances.(8)
Endnotes
(2) Supra note 1, Section 82(3)(c).
(3) Supra note 2, Paragraphs 183 to 184.
(8) The full judgment is available here.
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