NEWS ON COMPANY LAW

On May 7, 2004, the Ontario Superior Court of Justice issued a highly anticipated decision in a shareholder class action under the Ontario Securities Act ("OSA")(1).

Corporate defendant, Danier Leather Inc. ("Danier"), designs, manufactures, distributes and sells leather clothing and accessories. It operates retail stores and outlets across Canada under the business style "Danier". Danier was a privately held corporation prior to its IPO in May 1998. It was founded by Irving Wortsman, who was President and Chief Executive Officer until approximately 1995, when his son, Jeffrey Wortsman ("Wortsman"), took over these roles.

Defendant Wortsman was, at the relevant time, a director and the President and Chief Executive Officer of Danier. He owned shares in Danier prior to the IPO. Defendant Bryan Tatoff ("Tatoff") was the Chief Financial Officer and Secretary of Danier. Both Wortsman and Tatoff were signatories to the certificate of Danier contained in its prospectus dated May 6, 1998, stating that there was "full, true and plain disclosure of all material facts relating to the securities offered".

The final prospectus was dated May 6, 1998. On May 20, 1998, Danier completed the offering of 6,040,000 subordinate voting shares at $11.25 per share, for a total gross proceeds of $67,950,000. Approximately $27.5 million of the proceeds went to the Wortsman Family Trust. The balance went to other preferred shareholders, to retire certain bank indebtedness, and to working capital.

The Prospectus contained a forecast of financial results for the fourth quarter of 1998 and the fiscal year ending June 27, 1998. This forecast included, inter alia, forecast revenue, earnings before interest, taxes, depreciation and amortization ("EBITDA"), and net earnings (loss).

On June 4, 1998, two weeks after the IPO closed, Danier issued a press release entitled "Danier Revises Fiscal 1998 Forecast", in which Danier announced that it had revised its forecast for its fourth quarter and 1998 fiscal year downward. The press release stated that the "unseasonably warm weather in most of its markets" was the cause of the revision and that the revised forecast anticipated that "recent warm weather trends will continue in June, impacting leather apparel sales and profits." The revised forecast reflected the adverse impact of unseasonably warm weather on Danier's fiscal fourth quarter.

The revised forecast differed significantly from the original forecast. Revenues were lower and EBITDA was now expected to be a loss of approximately $1 million instead of a positive $445,000. Following the press release, the share price declined significantly, reaching a low of $8.25 on June 9, 1998, three trading days after the revised forecast was announced.

Actual revenue fell short of the original forecast, but exceeded the revised forecast. Danier's actual net earnings (loss) exceeded the revised forecast, and almost reached the original forecast.

In a shareholder class action, the Court had to determine whether the financial projections relating to Danier Leather Inc.'s fourth quarter results for its 1998 fiscal year ending June 27, 1998 were inaccurate and overstated in the Prospectus dated May 6, 1998 as of the closing of the initial public offering on May 20, 1998, such as to constitute misrepresentations under section 130 of the Securities Act and, if so, is any one or more of the Defendants liable for such misrepresentations?

The Court held that the forecast included in the prospectus constituted a "material fact" within the meaning of the OSA and that the "cautionary language", i.e. the caution that the assumptions used in the preparation of the forecast may prove to be inaccurate and that actual results may vary, was not sufficient to negate the materiality of the forecast.

The Court also held that Inside directors with intimate knowledge of corporate affairs and of the particular transactions will be expected to make a more complete investigation and have more extensive knowledge of facts supporting or contradicting inclusions in the registration statements than outside directors. Similarly, accountants and underwriters are expected to investigate to various degrees. Each must undertake that investigation which a reasonably prudent man in that position would conduct. Their liability approaches that of the issuer as guarantor of the accuracy of the prospectus. The "circumstances of the particular case" for inside directors and those with intimate knowledge of corporate affairs, such as Wortsman and Tatoff, point to a stringent standard of reasonableness.

The Court indicates that there was an immediate market response to the disclosure in the June 4^th press release. Danier shares were issued at $11.25 per share, and on June 2, 1998, the last day Danier traded before the press release, Danier's share price closed at $11.65. Within three trading days of the announcement of the press release, Danier's share price had fallen to $8.25.

The Court finds that, under s. 130 of the OSA, the issuer, Danier, is liable for misrepresentation.  Wortsman and Tatoff are similarly liable under s. 130 as they failed to conduct such reasonable investigation as to provide reasonable grounds for a belief that there had been no misrepresentation.     Viewed on any objective basis, their failure to make any kind of adequate analysis of the poor financial results experienced as of May 20, 1998, and what was causing them, is not a reasonable investigation required of a prudent person in the circumstances of this case. This failure cannot support any reasonable belief that the forecast remained achievable. Moreover, their failure to consult with any of the professional advisors regarding the impact of this information on the forecast and its potential impact on the price of the shares does not reflect a standard of conduct expected of senior management.

_______________

(1) Kerr et al v. Danier Leather Inc., Irving Wortsman, Jeffrey Wortsman, Bryan Tatoff, 2004 CanLII 8186 (On S.C.), 98-CV-158675, 7 May 2004, Honourable Justice Lederman.