The Supreme Court of Canada Speaks to What Constitutes a Material Change

In 2017, a rockslide occurred at a Chilean copper mine. No one was hurt and no equipment was damaged, but the debris restricted access to the mine. As a result, the mine’s owner, TSX-listed Lundin Mining Corp., shut down parts of the mine, revised its production schedule downward by 20%for the following year, and decided to rely to some extent on lower-grade stockpiles of ore instead.

Lundin did not immediately disclose the rockslide and consequential operational changes. Instead, investors were informed in a periodic update roughly a month later. The following trading day, Lundin’s share price dropped by about 16%, erasing over $1 billion in value. Lundin’s then-CEO called it a “black eye” for the company, and apologized to investors for not communicating well enough about the event.

Those developments formed the backdrop for a legal battle that worked its way up to the Supreme Court of Canada, focused on “perhaps the most difficult area of securities law”: the distinction between a material fact and a material change.

• A “material change” is defined as a change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price or value of the issuer’s securities. Under Canadian securities laws, reporting issuers must report material changes “forthwith” by news release, followed by a material change report which must be filed as soon as practicable and in any event within 10 days from the day the change occurs.

• By contrast, a “material fact” is a fact that would reasonably be expected to have a significant effect on the market price or value of the securities. Material facts must be disclosed at regular intervals, such as in an issuer’s financial statements, annual information forms, and information circulars, but unlike material changes, material facts need not be disclosed forthwith.

Whether the rockslide and its consequences represented a material fact or a material change would dictate whether Lundin was offside its timely disclosure obligations by not disclosing these developments immediately. Where an issuer has not complied with its timely disclosure requirements, investors have a right of action for damages against the issuer together with each of its directors, officers, and certain others pursuant to the Securities Act (Ontario). This right of action can be powerful, because unlike other remedial options, investors do not need to prove that they relied upon the issuer’s omission or misrepresentation. To guard against frivolous litigation, the Act requires that a party obtain leave of the court before proceeding with a claim.

In its 2007 decision in Kerr v. Danier Leather Inc., the Supreme Court considered whether a change in a company’s operating results amounted to a material change requiring immediate disclosure. Lunding Mining Corp. v. Markowich builds on the principles set out in Kerrby refusing to reduce the elements of the term “material change” to restrictive definitions, and confirming the legal test an investor must meet in order to be granted leave to sue a company for failure to make timely disclosure.

Here are the key highlights of the Supreme Court’s decision, and what it means for the disclosure obligations of publicly listed issuers in Canada.

Highlights

• ‍A change is a change: None of the words “change”, “business”, “operations”, or “capital” are defined in the Act, and the Court definitively rejected the opportunity to define them in this decision, determining instead that the legislature intended these to retain their ordinary commercial meanings to allow for flexibility across industrial, factual, and financial contexts. The Court also pointed to interpretive guidance provided by courts and regulators which helps to illustrate what constitutes a material change (we explore this further below).

• ‍The test for a material change continues to have two components: first, there must be a change in the business, operations, or capital of the issuer. Second, the change must be material, in that it must be expected to significantly affect the market price or value of the company’s securities. Upholding principles set out in Kerr, the Court distinguished between internal and external developments in determining what constitutes a material change.

• The test for leave: good faith and a reasonable possibility of success. The test for leave of the court to sue a company for breach of its timely disclosure obligations requires that a plaintiff demonstrate only: (i) that the action is being brought in good faith, and (ii) there is a reasonable possibility of success at trial, based on a plausible statutory analysis applying the legislation to the facts, together with some credible supporting evidence. It is not a determination of the merits of the plaintiff’s case.

Material Changes vs Material Facts

Distinguishing between a material fact and a material change is a contextual exercise that can give rise to considerable uncertainty, as the Court acknowledged.

Over time, case law and commentary have yielded certain guiding principles:

• A material fact is “static” and provides a moment-in-time snapshot of an issuer’s affairs. A material change is“dynamic” and requires a comparison of an issuer’s affairs at two different points in time.

• A material fact can be a fact about anything, including an internal fact about the issuer or an external development such as political, economic and social developments. A material change must be a change that is internal to the issuer, and must be a change in the business, operations or capital of the issuer.

As the Supreme Court has previously confirmed, such as in Kerr, the distinction between a “material fact” and a “material change” is deliberate and policy-based: it is meant to relieve reporting issuers of the obligation to continually interpret external developments as they affect the affairs of the issuer, unless the external change would result in a change in the business, operations or capital of the issuer.

In Lundin, the Court observed that the distinction between a material fact and a material change helps to remedy informational asymmetry between issuers and investors: while information about external events is often in the public domain, the impact of those external developments on an issuer, together with internal changes in the issuer’s business, operations, or capital may be much less available to investors. Requiring immediate disclosure of such changes, where they are material, helps to “level the informational playing field.”

Case law and regulatory guidance can be illustrative of what does, and does not, constitute a material change:

• In Kerr, the company’s poor sales results for leather coats and apparel were the result of unseasonably warm weather, a fact external to the issuer, and did not represent a material change. In that decision, the Supreme Court determined that in the absence of any change to the company’s business or operations, the weather simply affected the results of operations of the business, but there was no change in the operations themselves, since sales often fluctuate in response to external factors.

• Assay and drilling results for a company’s mine could amount to a material change, since new information or a change in drilling results relating to an asset such as a mining property bears significantly on the question of that property’s value, as the Supreme Court determined in Pezim v. British Columbia (Superintendent of Brokers). In the same decision, the Court also found that the emergence of a significant contractual dispute could also represent a material change which required immediate disclosure.

• In the context of a deal that remains speculative, contingent, or surrounded by uncertainties, a single party’s willingness to proceed is not enough to constitute a material change, per the Ontario Securities Commission in AiT Advanced Information Technologies Corporation. There must be real, mutual commitment amounting to a decision to implement the transaction in order for a material change to have occurred. In AiT, a proposed merger, even if strategically significant, was not a material change because there was no substantial likelihood that the transaction would actually be completed. The regulator noted the importance of preventing disclosure of information to investors that is potentially unreliable or misleading, and confirmed that announcements of an intention to proceed with a transaction or activity should not be made unless the issuer has the ability to carry out the intent (although proceeding may be subject to contingencies) and a decision has been made to proceed with the transaction or activity by the issuer’s board of directors, or by senior management with the expectation of concurrence from the board of directors.

• Routine regulatory correspondence is not a material change if it is not a departure from the normal regulatory process, as the Supreme Court pronounced in Theratechnologies Inc. v. 121851 Canada Inc.

• A telephone call from federal prosecutors advising a company that it would not be invited to negotiate a remediation agreement to resolve a pending criminal prosecution is not a material change, as the company faced the same risk of prosecution both before and after the call and had already disclosed the risk of prosecution on many occasions, per the Ontario Court of Appeal in Peters v. SNC-Lavalin GroupInc.

• An external event that is not itself a material change internal to the issuer can nevertheless give rise to a material change. In Coventree Inc., the Ontario Securities Commission ruled that a credit rating agency’s press release advising that it would no longer provide credit ratings for certain credit arbitrage transactions gave rise to a material change requiring immediate disclosure by an investment bank specializing in structured products. This was because such transactions formed an important part of the bank’s business and investors would likely not otherwise be able to fully understand the impact of the policy change on the bank.

• As the Court noted in Lundin, just because a development is internal to the company does not make it a material change. Examples of material facts internal to an issuer could include an issuer’s board of directors negotiating a material acquisition or engaging financial advisers.

In their policies, some stock exchanges give examples of developments that might qualify as a change in an issuer’s business, operations, or capital. For example, the TSX in its guide to timely disclosure requirements states that updates which are likely to require disclosure include:

• changes in corporate structure, capital structure, or share ownership, and major acquisitions and dispositions;
• take-over bids and issuer bids;
• borrowing of a significant amount of funds;
• changes in capital investment plans or corporate objectives, and significant changes in management;
• the development of new products;
• developments affecting the company’s resources, technology, products or market;
• entering into or loss of significant contracts;
• significant discoveries by resource companies;
• significant litigation, labour disputes, and disputes with major contractors or suppliers;
• events of default under financing or other agreements; and
• firm evidence of significant increases or decreases in near-term earnings prospects.

Has a “material change” occurred?

A court will apply the following two-part analysis in considering whether a “material change” has occurred:

• ‍Change: whether there has been a change in the business, operations or capital of the issuer; and

• ‍Materiality: whether the change was material in the sense that it would be expected to have a significant impact on the value of the issuer’s shares.

Whether a material change has occurred will depend on the issuer and its business context; there is no bright-line test for making this determination. Issuers must apply their industry knowledge, their familiarity with their own business, operations, and capital, and simple common sense in order to assess whether a change has occurred and whether it is material.

As noted in Peters v. SNC-Lavalin Group Inc., a material change can also include the risk of a change in the business, operations or capital of an issuer.

Step 1: Has there been a Change?

The Act relies on the ordinary commercial meaning of “business”, “operations”, and “capital” and does not provide definitions of these terms. Issuers should apply a holistic standard for assessing corporate developments that could amount to a change.

Changes in a company’s business, operations, or capital do not include external events or performance results on their own, even if they are likely to significantly affect the company’s stock price or might otherwise qualify as a material fact. The material change reporting obligation is not an obligation to provide a running commentary on internal or external events that may impact a company’s performance.

While external events could prompt changes to an issuer’s operations, and financial results can be a reflection of changes that have been made, the disclosure requirement is triggered by the change in the issuer’s business, operations, or capital itself.

Negotiations and internal deliberations, without more, typically would not amount to a change in the business, operations, or capital of the issuer, even if they are material.

A development need not be important or substantial in order to constitute a “change”. The magnitude of the change is only considered in the second step of the test.

Step 2: Is it Material?

Having found a change to have occurred, the next step is to determine if it is material, which means that it would reasonably be expected to have a significant effect on the market price or value of the issuer’s securities.

Materiality is determined from the perspective of the reasonable investor, and is a strictly economic analysis. The impact on price or value must reasonably be expected to be significant in order to meet the threshold.

Err on the side of disclosure

The Ontario Securities Commission has advised that in borderline cases, issuers should err on the side of disclosure, and resist getting caught up in technical interpretations of securities laws.

Steps if a material change has occurred

If a material change has occurred, a reporting issuer must immediately issue a press release and file it on SEDAR+. It must also produce a material change report, including information such as a more fulsome description of the material change together with the identity and contact information of an executive officer who is knowledgeable about the change. Issuers with mineral projects or oil and gas activities must comply with certain additional disclosure requirements.

A material change report must be filed on SEDAR+ within 10 days of the change.

Insider trading

Securities laws prohibit trading by a person in a “special relationship with an issuer” where that person has knowledge of a material fact or material change that has not been generally disclosed. Issuers may also have blackout policies governing when insiders may not buy or sell securities.

The test for leave to commence an action

In assessing whether the threshold for leave has been met, courts must “undertake a reasoned consideration of the evidence to ensure that the action has some merit”. The Supreme Court affirmed the following principles:

• There must be a “reasonable or realistic chance that the action will succeed”. The plaintiff does not need to prove on the balance of probabilities that the action will be successful.

• The plaintiff’s evidence on a leave motion must not only be “credible”, but must also demonstrate a realistic or reasonable chance that the action will succeed at trial.

• A court must engage in a limited weighing of the evidence of both parties, and the credibility and competing strength of that evidence. However, a court must remember that the plaintiff has not yet had the benefit of documentary production or oral discovery to flush out a more fulsome body of evidence.

The results in Lundin

Motions judge

Initially, the motion judge dismissed Mr. Markowich’s motion for leave, on the basis that there was no reasonable possibility that the rockslide constituted a material change in Lundin’s operations, since pit wall failure was a known risk of open pit mining, and the events did not affect Lundin’s commercial viability. Importantly, the motion judge relied on a dictionary definition of “change”, and on case law interpretations of“business,” “operations” and “capital”, rather than interpreting these words in context and with recognition that the legislature intentionally left the words undefined in the Act in order for them to acquire meaning by being applied in specific factual circumstances.

However, the motion judge also stated that if he had found a change in Lundin’s business, operations or capital, there was a reasonable possibility that any such change was material, based on expert evidence Mr. Markowich had presented and on the concern exhibited by investors on the conference call after Lundin’s disclosure was ultimately made.

Ontario Court of Appeal

The Court of Appeal overturned the motion judge’s ruling and granted Mr. Markowich leave to proceed with his statutory cause of action. That court found that the motions judge had interpreted the definition of “material change” too narrowly, especially at the early stage of a motion for leave of the court.

Supreme Court of Canada

The Supreme Court dismissed Lundin’s appeal and took the opportunity to expressly reject the motion judge’s interpretation of the words “change”, “business”, “operations”, and “capital”. The Court emphasized that the legislature had intentionally declined to define these key terms in the Act, and that allowing them to retain their ordinary meaning allows for their application in a wide variety of factual scenarios, maximizing the extent to which the “informational playing field” between companies and investors is levelled.

As to the test for leave of the court, there was no dispute that Mr. Markowich’s action against Lundin was brought in good faith. As to the second step of the test, the Court noted that the motions judge had accepted that the rockslide resulted in a change in Lundin’s operations which could possibly be shown to be material at trial.

The Court concluded that based on a plausible statutory analysis, there was a reasonable possibility that Mr. Markowich could succeed at trial in showing that material changes had developed which Lundin should have disclosed forthwith. Therefore, Mr. Markowich should have been granted leave to bring an action for the alleged breach of Lundin’s timely disclosure obligations.

Key Take-Aways

• Good disclosure practices can include establishing a corporate disclosure policy, establishing a committee of company personnel to oversee disclosure, and adopting a disclosure model for planned disclosure of material corporate information.

• Ensure any developments within the organization are appropriately considered in a timely manner for their potential impact on the company’s business, operations (including production and scheduling), or capital and for any resulting disclosure needs. Maintaining open communication with key stakeholders in your organization will be helpful.

• ‍Lundin stands for the maintenance of a broad interpretation of what can constitute a material change, and the rejection of technical or restrictive definitions, whether from case law, dictionaries, or otherwise. Issuers must apply the words“change”, “business”, “operations”, and “capital” in their own factual circumstances based on their ordinary meanings, as well as on industry knowledge and common sense. While the determination of material changes is not an exact science, disclosure decisions should not be subordinated to business judgment.

• Know what your stock exchange considers to be developments which may be worthy of disclosure.

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