Part 2: The Litigator's View in Kerr and Durst v. Danier Leather Inc. 



Winter 2008 - (Lang Michener Securities Brief Winter 2007)

Lang Michener Securities Brief Winter 2007

In most commercial litigation, costs follow the event, which is to say the loser makes some significant contribution to the costs incurred by the winner in fighting the litigation. The Class Proceedings Act, 1992 (Ontario) provides in section 31 that this rule may be departed from or relaxed if the court considers that the proceeding was a test case, raised a novel point of law or involved a matter of public interest. A view, more akin to myth than analysis, had grown up that representative plaintiffs in class proceedings were at a lower risk of being required to pay the costs of the defendant if the action failed, than a plaintiff in an ordinary action.

The Supreme Court of Canada was strongly of the view that the Danier case was a standard commercial dispute, a piece of Bay Street litigation well-run and well-financed on both sides. The representative plaintiff (Durst) had argued that it was a test case, involving the interpretation of an important provision of the Securities Act. Again, the Court was unsympathetic, pointing out that the application of settled principles of statutory interpretation to particular legislative provisions is the usual fodder of commercial litigation, "…the proper interpretation of s. 130(1) of the Ontario Act has from the outset been the time bomb ticking under their case … The result was a very expensive piece of shareholder litigation, but there is no magic in the form of a class action proceeding that should in this case deprive the respondents of their costs." It did not help Mr. Durst's cause that he had actually made a profit of $1.5 million on his participation in the Danier IPO, and stood to recover an additional $500,000 had the action against the company succeeded. Having "gambled on his interpretation of s. 130(1) and lost" and having put Danier to enormous expense, Mr. Durst was required to contribute to the payment of their costs.

While the amount of the costs is not spelled out in the judgment, it appears that they exceeded the amount Mr. Durst might have recovered had the action succeeded. Given that the trial lasted 44 days, and the appeal to the Ontario Court of Appeal lasted five days, there is every possibility that the costs may take most of the $1.5 million pro­fit he had actually made from his participation in the IPO. (Although the Kerrs continued to be named on pleadings as a party to the case, they had not been approved as representative plaintiffs at the certification hearing and apparently they did not participate thereafter. On this record the Supreme Court ordered that Mr. Durst, the approved representative plaintiff, should pay the costs, but provided Mr. Durst with an opportunity to make written submissions why the costs order should also go against the Kerrs.)

In 1934, in his textbook Security Analysis, Benjamin Graham first put forward his distinction between investment and speculation.

"An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

Later, in The Intelligent Investor he wrote:

"The distinction between investment and speculation in common stocks has always been a useful one and its disappearance is a cause for concern … Ironically, once more, much of the recent financial embarrassment of some stock exchange firms seems to have come from the inclusion of speculative common stocks in their own capital funds."

While written in 1971, these words might as easily have been written yesterday. Graham was most concerned with the propensity of even professional investors to confuse speculation with investment, leading in the end to unexpected losses.

It is possible for an identical purchase of securities by two persons to be an investment by the one, and speculation by the other. The difference is whether before the purchase the person had upon thorough analysis concluded that the purchase promised safety of principal and an adequate return within a risk profile acceptable to that investor. The fact that a three-week period of public uncertainty over the ability of Danier to achieve its quarterly numbers, which in the end it did, was said to have impaired the value of the shares suggests that the participants in the class action had speculated and not invested. Any business can be expected to have variations from plan during the course of a year, and this is a factor an investor would have to consider in determining whether the security did indeed qualify as an appropriate investment.

The unrealistic expectation that businesses will meet or exceed their projections on a quarterly basis leads to pressure on management to smooth results. Had the class action succeeded, the effect would have been to make the purchasers who stuck with Danier pay the purchasers who bailed out, since in the end the money would have had to come out of Danier's retained earnings. While this point was not discussed by the Supreme Court, the costs award against the represent­ative plaintiff also gives the investors in Danier some relief from the costs incurred by Danier that would otherwise have come from retained earnings.

In his participation in the Danier litigation, if not his participation in the IPO, it appears that the representative plaintiff failed to make this important distinction between investment and speculation.

By Charlotte A. Morganti and Peter Wells