In Labourers’ Pension Fund of Central and Eastern Canada v. Sino-Forest Corporation[1], the Ontario court[2] approved Ernst & Young LLP’s (“Ernst & Young”) $117 million settlement relating to class action lawsuits commenced by jilted investors following the downfall of Sino-Forest Corporation (“SFC”), once the most valuable forestry company on the Toronto Stock Exchange. The $9.2 Billion class action (which is ongoing against certain defendants) contains significant allegations of fraud that call into question SFC's reported asset values and revenues, as well as the practices of SFC's auditors, underwriters and consultants.
In addition to garnering attention as the largest auditor settlement to date in a Canadian securities class action, this landmark decision is noteworthy for the Court's approval of a comprehensive third-party release and a 'no opt-out' settlement feature granted in favour of Ernst & Young; which some critics consider controversial and extraordinary relief, particularly given the allegations of fraud underlying the SFC class actions.
The settlement, which was approved in the context of the SFC insolvency proceedings arising under the Companies' Creditor and Arrangement Act ("CCAA")[3], has expanded the use of third party releases within CCAA proceedings, even in cases involving clear and extensive allegations of fraud, and will impact the interplay of insolvency proceedings and class actions going forward.
Background
Between June 30, 2006 and March 31, 2011, SFC's share price surged from $5.75 to $25.30 CDN, an increase of 340%. On June 2, 2011, SFC's share price plummeted after a private analyst made public allegations of fraud against SFC. On the same day, the Board of Directors of SFC established an Independent Committee (the “IC”) to independently examine and review the allegations contained in the analyst’s report. After an 8 month long investigation into issues of tree ownership and existence, and professional fees in excess of $35 million, the IC released a final report on January 31, 2012 concluding that there was uncertainty surrounding SFC’s claims to a significant proportion of its reported timber assets. In addition, the IC noted significant obstacles to verifying the actual existence of the reported timber assets, including an inability to identify the precise location of the trees which had purportedly been purchased by SFC.
During this time, SFC became embroiled in regulatory and criminal investigations and was the target of multiple class action proceedings in Canada and the U.S.. Current and former holders of SFC securities alleged that SFC, and others, misstated its financial results, misrepresented its timber rights, overstated the value of its assets and concealed material information about its business operations from investors, causing the collapse of an inflated share price and resulting in damages in excess of $9.2 billion.
In addition to SFC, the class action plaintiffs sought recovery from SFC’s directors and officers, auditors, underwriters and a forestry consultant/valuator that provided services to SFC.
On March 30, 2012, SFC obtained an initial order under the CCAA, following which a stay of proceedings was granted in respect of SFC, certain of its subsidiaries and the class action defendants, in effect freezing the progress of the class action litigation pending the outcome of the CCAA process.
The Ernst & Young Settlement and Release
As the auditor for SFC, Ernst & Young was required to audit the SFC financial statements in accordance with Canadian generally accepted audited standards ("GAAS") and to prepare an auditors’ report to accompany the financial statements.[4] After the private analyst report was released and the allegations of fraud were made against SFC, several parties to the various disputes also alleged that Ernst & Young, was among other things, negligent in the scrutiny of SFC's books.
The Ernst & Young settlement was announced to the public on December 3, 2012. The proposed settlement provided for the payment by Ernst & Young of $117 million as a settlement fund, being the full monetary contribution by Ernst & Young to settle all SFC-related claims against Ernst & Young and involved, among other features, an accompanying third-party release, which precluded any right to contribution or indemnity from Ernst & Young. The proposed settlement also denied class members the ability to opt-out of the settlement, a required feature of typical class action settlements. Ernst & Young did not admit liability as part of the settlement.
On December 3, 2012, a revision to the SFC Plan of Compromise and Reorganization (the "Plan") was released reflecting the proposed Ernst & Young settlement and release, as well as a framework that would allow other third-party defendants to avail themselves of the expansive third-party release in the event that similar settlements were reached in the future (early versions of the Plan did not reference the Ernst & Young settlement and such broad third party releases).
A large majority of creditors approved the Plan on December 3, 2012 and the Plan was sanctioned by Order of Justice Morawetz on December 10, 2012. The sanctioning of the Plan did not amount to an approval of the proposed Ernst & Young settlement and release, as the settlement would not be consummated unless and until several conditions, including court-approval, had been satisfied in the future. The CCAA Court directed that the full settlement-approval hearing would take place on February 4, 2013 under both the CCAA and the Ontario Class Proceedings Act, 1992 (“CPA”).
The Objectors
A group of objectors comprising six investment funds (the "Objectors") opposed the proposed Ernst & Young settlement from the outset, and sought to appeal the CCAA Court's decision. The Ontario Court of Appeal, however, found no basis to interfere with the lower court decision and analysis.[5] In particular, the Objectors opposed the ‘no opt-out’ and broad third-party release features of the proposed settlement. They argued that the broad release was not integral or necessary to the success of SFC’s restructuring Plan and, therefore, the usual standards for granting third-party releases in the CCAA are not satisfied. Further, they argued that the proposed $117 million settlement payment was not essential or sufficiently connected to the restructuring, in the context of such an extensive, alleged fraud.
The Objectors also took the position that approval of the proposed settlement would render illusory their opt-out rights as granted by section 9 of the CPA, vitiating the Objectors' ability to opt-out of the proposed settlement to pursue Ernst & Young (and others) separately. The Objectors argued, inter alia, that the proposed settlement ought to be approved solely under the CPA (as was an earlier court-approved settlement reached between the class action plaintiffs and Pöyry (Beijing) Consulting Company Ltd., which included traditional opt-out rights) and not through what they framed as a misuse of third-party release procedures under the CCAA.
The Decision
In detailed reasons delivered on March 20, 2013, Justice Morawetz for the Ontario Superior Court of Justice approved the Ernst & Young settlement and release. In declaring the proposed settlement “fair and reasonable”, Justice Morawetz noted that the proposed settlement was part of a CCAA restructuring plan process where claims are routinely compromised and settled, and that “Such compromises fully and finally dispose of such claims, and it follows that there are no continuing procedural or other rights in such proceedings. Simply put, there are no ‘opt–outs’ in the CCAA.”
In determining the suitability of the proposed broad release, Justice Morawetz considered whether there is “a reasonable connection between the third party claim being compromised in the plan and the restructuring achieved by the plan to warrant inclusion of the third party release in the plan.” Justice Morawetz found that third-party releases are not an uncommon feature of complex restructurings under the CCAA.[6] Justice Morawetz concluded that the Ernst & Young settlement, including the release, was a necessary part of the restructuring Plan and ought to be approved. In making this determination, he found that a significant aspect of the Plan is a distribution to SFC’s creditors and that the only monetary contribution that could be immediately identified was the $117 million from the Ernst & Young settlement.
The Court held that the claims to be released against Ernst & Young are rationally related to the purpose of the Plan and, in fact, necessary for it, noting that the claims of the Objectors against Ernst & Young are intertwined and related to the claims against SFC and the purpose of the Plan.
Justice Morawetz concluded that the Ernst & Young settlement, including the release, was fair and reasonable, provided substantial benefits to relevant stakeholders, and was consistent with the purpose and spirit of the CCAA. In addition, he determined that the Ernst & Young release was not overly broad or offensive to public policy, as alleged, given the alternatives of lengthy and uncertain litigation.
Implications
This decision has expanded the use of third party releases within CCAA proceedings, even in cases involving clear and extensive allegations of fraud. As a result, distressed defendants facing class actions may look to the CCAA as a form of class action management tool. As the Ontario Court of Appeal found no basis to interfere with the lower court's decision, it can be expected that parties settling a class action within the context of ongoing CCAA proceedings, will seek the same protections as those afforded to Ernst & Young (and potentially other future settling parties) in the Sino-Forest case, including comprehensive releases and the certainty provided by ‘no opt-out’ provisions. This will undoubtedly lead to further debate as to the interplay of the CCAA and the CPA in cases involving the potential application of both statutes.
Similarly, in cases where the primary alleged wrongdoer files for CCAA protection, the focus of class action plaintiffs on ‘experts’, including auditors, underwriters and consultants, will intensify, as the willingness of such parties to settle may be enhanced due to the robust protections and certainty that can result from such settlements. In particular, the ‘no opt-out’ feature will be attractive to settling defendants and will give rise to arguments as to why proposed settlements ought to evaluated within CCAA proceedings (i.e. outside of the exclusive scope of the CPA).
More generally, the Sino-Forest decision provides a thorough analysis of CCAA case law that could be read to permit a debtor to reach agreements and settle other significant issues within a CCAA proceeding under the paramount authority of the CCAA (in this case, Justice Morawetz effectively found that the CCAA trumped the provincial CPA authority), as the Court stated that the CCAA is a "flexible statute" and that the court has "jurisdiction to approve major transactions, including settlement agreements, during the stay period defined in the Initial Order".
[1] 2013 ONSC 1078; case available at http://www.canlii.org/en/on/onsc/doc/2013/2013onsc1078/2013onsc1078.html
[2] The Ontario Superior Court of Justice [Commercial List]
[3] Companies’ Creditors Arrangement Act (R.S.C., 1985, c. C-36); available at http://laws-lois.justice.gc.ca/eng/acts/C-36/
[4] Section 3 of National Instrument 52-107 – Acceptable Accounting Principles and Auditing Standards, and by sections 78(2) and 78(3) of the Securities Act
[5] 2013 ONCA 456; case available at http://www.canlii.org/en/on/onca/doc/2013/2013onca456/2013onca456.html. The Objectors have since indicated that they intend to seek leave to appeal the matter to the Supreme Court of Canada.
[6] See ATB Financial v Metcalf and Mansfield Alternative Investments II Corp., 2008 ONCA 587 (applied the “nexus test” to determine that third party releases in CCAA proceedings must be necessary to the restructuring)