TORONTO--A recent decision by the Ontario Court of Appeal is seen as a big win for the directors and officers of Canadian companies and their insurers because it reversed a lower court ruling that could have led to a substantial increase in D&O claims.

The ruling by the lower court had significantly expanded the disclosure requirements for Canadian companies and failed to give any deference to the business judgment of directors and officers, leaving them vulnerable to lawsuits challenging such judgments.

In May 1998, Toronto-based Danier Leather Inc. made an initial public offering of its shares through a prospectus, which contained a forecast that included the company's projected revenue and earnings for the last quarter of its 1998 fiscal year, which ended in June of that year.

An internal company analysis prepared a few days before its public offering closed on May 20 of that year showed that the company's revenue and earnings for the first half of its fourth quarter were lagging behind the forecasted figures.

Danier did not disclose those lagging results for the first half of the fourth-quarter before the closing of the IPO. It did disclose the results after the closing in a revised forecast, which precipitated a significant decline in its share price.

But the company's sales rebounded and, by the end of the fiscal year, it had substantially achieved its original forecast.

A lawsuit seeking class action status was filed, alleging prospectus misrepresentation.

The trial judge found in May 2004 that the company should have disclosed the results before the closing of the IPO and awarded substantial damages.

The Court of Appeal, though, found that the trial judge wrongfully determined that Danier had a continuing obligation to disclose material facts occurring between the date of its prospectus and the date of the closing of the IPO.

In reversing the trial court's decision in Kerr vs. Danier Leather, the court pointed out that there exists a distinction between material facts and material changes, and it ruled that new or revised material facts need not be disclosed unless all or several of the facts result in a material change.

"Once you've made a forecast on a certain day, you do not have to update that forecast unless there is a material change to the operation of the business," said Alan J. Lenczner, a partner with Lenczner Slaght Royce Smith Griffin L.L.P. in Toronto, which represented Danier in the case.

The Court of Appeal set a less-rigorous standard for disclosure than did the trial court in citing a hypothetical example of the type of material change that would have to be disclosed, lawyers say. According to the appellate decision, one example of a material change that would have to be disclosed under the court's reasoning is the news that a fire had destroyed all of a company's stores.

In its Dec. 15, 2005, decision, the Court of Appeal also said the trial judge erred in failing to give any deference to the business judgment of Danier's senior management and in failing to take into account that the initial forecast was substantially achieved.

Lawyers say this was one of the most important aspects of the decision, because the Court of Appeal rejected the idea that a judge can substitute his or her own judgment for the judgment of the directors and officers, even if the judge disagrees with it, provided the directors' judgment was reasonable.

"You can't have a judge who has never sold a leather coat substituting his decision for management," Mr. Lenczner said, adding that the company feels vindicated by the Court of Appeal decision.

The decision affects companies governed by the Ontario Securities Act. It also has implications for most public companies across Canada, because most provinces have legislation similar in structure to the Ontario Securities Act.

For the Canadian insurance market, the Court of Appeal's decision will be good news because it means that forecasts made by directors and officers will be less likely to lead to claims, according to Eric Dolden, an insurance attorney with Vancouver-based Dolden Wallace Folick. "I think it was a big win for directors and officers and their insurers, because the courts indicated there should be a reluctance on the part of judges to second-guess the judgment of directors and officers," Mr. Dolden said.

David Griffiths, national practice director for the financial services group and senior vp of Aon Reed Stenhouse Inc. in Toronto, noted that the trial court's ruling had caused little impact on the D&O market in Canada in terms of pricing and terms and conditions, because the market had been waiting to see what the result of the appeals process would be.

While Mr. Griffiths acknowledged that underwriters had often attempted to cite the case to justify higher premiums or retentions, not one of the hundreds of renewals he handled was negatively affected by the original Danier decision, he said.

"We really didn't see it have much of an impact on the Canadian marketplace," Mr. Griffiths said. "It was very, very bad law, and we didn't expect it to stand."

A bigger issue for the D&O market is the implementation of Bill 198, which opens the door to new lawsuits by amending the Ontario Securities Act to impose civil liability for inaccurate or incomplete corporate disclosure in the secondary market (BI, Nov. 14, 2005). Secondary-market investors may sue for misrepresentations in documents and public oral statements and failures to make timely disclosures of material changes.

"Most of the discussion with clients has been focused on the implications of Bill 198," Mr. Griffiths said.

The Danier decision has major implications for Bill 198, which is expected to give rise to an increase in D&O claims, because the Court of Appeal said material facts need to be disclosed only if they amount to a material change.

Bill 198 specifically calls for disclosure only for material changes, not material facts.

"The scope for complaints is narrower, and, therefore, it's less likely that directors and officers are going to be accused of failure to disclose," said Larry P. Lowenstein, Toronto-based chair of the national litigation department at Osler, Hoskin & Harcourt L.L.P.

As for the Danier case itself, the unsuccessful party can file for leave to appeal to the Supreme Court of Canada, which the plaintiffs have already indicated they will do.

"I don't know if the Supreme Court would grant leave, but if it does, this matter can be thrown into some uncertainty again," Mr. Dolden noted.