MODIFIED PROPORTIONATE LIABILITY
Report of the Standing Senate Committee on Banking, Trade and Commerce
September 1998
Chairman : The Honourable Michael Kirby
Deputy Chairman : The Honourable David Tkachuk
MEMBERSHIP
The Honourable Michael Kirby, Chairman
The Honourable David Tkachuk, Deputy Chairman
and
The Honourable Senators:
| Angus, W. David | Kenny, Colin |
| Austin, Jack, P.C. | Kolber, E. Leo |
| Callbeck, Catherine S. | *Lynch-Staunton, John (or Kinsella, N., acting) |
| *Graham, Alasdair B., P.C. (or Carstairs, Sharon) | Meighen, Michael Arthur |
| Hervieux-Payette, Céline, P.C. | Oliver, Donald H. |
| Kelleher, James F., P.C. | Stewart, John B. |
*Ex Officio Members
Staff from the Parliamentary Research Branch, Library of Parliament:
Ms. Margaret Smith, Research Officer, Law and Government Division.
Staff from the Committees and Private Legislation Directorate:
Ms. Lise Bouchard, Administrative Assistant.
Gary Levy
Clerk of the Committee
ORDER OF REFERENCE
Extract from the Journals of the Senate, Wednesday, October 22, 1997:
"The Honourable Senator Carstairs for the Honourable Senator Kirby moved, seconded by the Honourable Senator Callbeck:
THAT, the Standing Senate Committee on Banking, Trade and Commerce be authorized to examine and report upon the present state of the financial system in Canada;
THAT the Committee have the power to permit coverage by electronic media of its public proceedings with the least possible disruption of its hearings; and
THAT the Committee submit its final report no later than December 10, 1998.
The question being put on the motion, it was adopted."
Paul Bélisle
Clerk of the Senate
CONCLUSIONS AND RECOMMENDATIONS
1. Fraud or Dishonesty
2. Provision of Financial Information
3. Net Worth Test
4. Allocating the Risk of a Defendant’s Insolvency
5. Residual Judicial Discretion
APPENDIX A - WITNESSES
APPENDIX B - JOINT AND SEVERAL LIABILITY AND PROFESSIONAL DEFENDANTS (MARCH 1998)
The Committee’s study of the issue of joint and several liability and professional defendants has been a unique undertaking. It began in August 1995 when the Honourable John Manley, Minister of Industry, asked the Standing Senate Committee on Banking, Trade and Commence (the "Committee") to hold hearings on a number of policy issues related to the modernization of the Canada Business Corporations Act (the "CBCA"). Among the matters that the Minister asked the Committee to examine was the issue of auditors’ liability.
Subsequent to the Minister’s request, representatives of the Canadian Institute of Chartered Accountants (CICA) appeared before the Committee in early 1996 to outline their liability concerns. Maintaining that auditors are facing a liability crisis brought on for the most part by the application of the rule of joint and several liability, the CICA proposed that the CBCA and federal legislation governing financial institutions be amended to implement a system of proportionate liability in relation to claims for financial loss arising from the issuance of financial information.
In its August 1996 report, Corporate Governance, the Committee expressed the view that the issue of joint and several liability as it affects all professionals, not just auditors, warranted further investigation and agreed to hold hearings on the subject.(1) Those hearings were held in October and November 1996. In December 1996, the Committee issued an Interim Report, Joint and Several Liability and Professional Defendants.(2) The Interim Report stated that an options discussion paper would be prepared outlining the range of options which could be considered for replacing joint and several liability if a decision were made that a legislative change was warranted.
The Committee asked the Canadian Bar Association (CBA) and the CICA to review the draft options discussion paper to ensure that it outlined all of the most widely used and discussed approaches for dealing with the liability concerns raised in connection with joint and several liability.
After the release of the Options Discussion Paper in October 1997, the Committee held further hearings to focus on which option, if any, ought to be recommended to the federal government for adoption. A subsequent report in March 1998 recommended joint and several liability be replaced by a modified form of proportionate liability, but the report left two issues unresolved. Once again, the Minister of Industry asked the Committee to hold hearings and recommend how the two unresolved issues should be settled. This report deals with those outstanding issues.
In order for readers to follow the details of the policy development process outlined above, the March 1998 report and the Options Discussion Paper are attached as Appendix B to this report.
In the course of dealing with the joint and several liability issue, the Committee has had the singular opportunity of taking an issue from its inception; with the assistance of two eminently qualified organizations, the CICA and the CBA, developing the policy options to be considered; conducting consultations with interested parties through public hearings; and developing recommendations for legislative change. This has been a very satisfactory process for the Committee and the witnesses involved.
The Committee strongly believes that a process of this kind could and should be used to develop policy in other areas. The Committee is of the view that the process leading to the recent changes to the Bankruptcy and Insolvency Act would have benefited from earlier input at the parliamentary level. In particular, the Committee believes that proposals for reform of the rules relating to personal bankruptcy should be developed in a similar manner. The Committee commends this process to the government for use in the future.
The Standing Senate Committee on Banking, Trade and Commerce issued its report, Joint and Several Liability and Professional Defendants, on March 17, 1998. The report made specific recommendations to the federal government on how the liability regime for persons involved in the preparation and issuance of financial information under the Canada Business Corporations Act and federal legislation governing financial institutions and cooperatives should be changed.
The Committee recommended that a form of modified proportionate liability be adopted in relation to financial information issued under the legislation referred to above. The elements of the modified proportionate liability regime recommended by the Committee in its March report included:
- The classification of individual plaintiffs as sophisticated or unsophisticated;
- The use of a net worth test to determine who would be sophisticated or unsophisticated;
- The continued application of joint and several liability to claims made by unsophisticated plaintiffs;
- The application of modified proportionate liability to claims made by sophisticated plaintiffs;
- The continued application of joint and several liability to claims arising out of fraudulent or dishonest conduct;
- The development of a formula for sharing the risk of an insolvent defendant amongst sophisticated plaintiffs and the remaining solvent defendants.
At hearings leading up to the March 1998 report, the Canadian Institute of Chartered Accountants suggested that an unsophisticated plaintiff be defined as an individual whose net worth is less than $100,000 excluding pension plan assets, registered retirement savings plans (RRSPs), and the value of a person’s principal residence, home furnishings and automobiles. The Financial Executives Institute Canada supported the CICA’s proposed definition but did not recommend a threshold amount. Alison Manzer of the Canadian Bar Association (CBA) suggested that the threshold amount could be $100,000, $150,000 or $200,000 but anything less than $100,000 would be inappropriate. She also suggested that assets such as RRSPs as well as a person’s home and pension should be excluded from the definition of net worth.
In the report, the Committee noted that the U.S. Private Securities Litigation Reform Act of 1995 distinguishes between "small" and other types of investors for the purpose of determining whether a plaintiff will be subject to a proportionate or joint and several liability regime. The Act uses a two-part – net worth/percentage claim – test to define a small investor. A small investor is a plaintiff whose net financial worth is less than $200,000 and whose recoverable damages are equal to more than 10% of his or her net worth. Net worth is defined as the fair market value of a plaintiff’s assets minus liabilities.
In its March report, the Committee rejected the notion of a percentage claim component and made no recommendation about the nature of the net worth test that should be used to define an unsophisticated plaintiff.
A crucial aspect of the modified proportionate liability concept is how the risk of a defendant’s insolvency is to be allocated amongst plaintiffs (excluding unsophisticated plaintiffs) and the remaining co-defendants.
The proposal put forward by the CICA, and favoured by the FEIC and the CBA provided that solvent defendants would continue to bear the full risk in relation to claims made by unsophisticated plaintiffs. Where sophisticated plaintiffs were involved, however, they would bear the entire risk of a defendant’s insolvency.
Other models attempt to strike a different balance between the goal of compensating a plaintiff and the goal of relieving solvent defendants of the total liability burden by reallocating an insolvent defendant’s uncollected share amongst the remaining co-defendants.
In its March report, the Committee did not reach a conclusion as to how the risk of a defendant’s insolvency should be allocated amongst sophisticated plaintiffs and the remaining co-defendants. The Committee expressed concerns about adopting a modified proportionate liability regime that would transfer to sophisticated plaintiffs the entire risk associated with the insolvency of one or more defendants. The Committee thought it would be appropriate to look at establishing some sort of "half-way house" between transferring the entire risk of an insolvent defendant to a sophisticated plaintiff (proportionate liability) and having solvent defendants bear the entire risk (joint and several liability).
After considering the Committee’s report, the Department of Industry asked the Committee to consult with stakeholders and to give the Department specific recommendations on the following two issues:
- how the net worth test should be framed;
- how the risk of a defendant’s insolvency should be allocated amongst sophisticated plaintiffs and the remaining solvent co-defendants.
On June 23, 1998, the Committee held hearings in Ottawa at which the following witnesses appeared:
- Mr. John Campion
- Canadian Bar Association
- Canadian Institute of Chartered Accountants
- Certified General Accountants of Canada
- Investment Dealers Association of Canada.
The Committee also received written submissions from the Financial Executives Institute Canada and the President and Chief Executive Officer of the Toronto Stock Exchange.
The Committee’s study spanned a considerable period of time and generated a number of reports. The Committee’s recommendations on the liability regime that should replace joint and several liability are summarized below.
- A form of modified proportionate liability should replace joint and several liability for claims for financial loss arising by reason of an error, omission, statement or misstatement in financial information issued under, or contained in a document issued under, the Canada Business Corporations Act, the Bank Act, the Insurance Companies Act, the Trust and Loan Companies Act, the Cooperative Credit Associations Act, the Canada Cooperative Associations Act, and the Canada Cooperatives Act.
- Joint and several liability should continue to apply to claims made against a defendant who knowingly or intentionally engaged in fraudulent or dishonest conduct.
- The modified proportionate liability regime should distinguish between sophisticated and unsophisticated plaintiffs.
- Joint and several liability should apply to claims made by unsophisticated plaintiffs; modified proportionate liability should apply to claims made by sophisticated plaintiffs.
- A net worth test should be used to distinguish between sophisticated and unsophisticated plaintiffs.
- The net worth test should be one of the following two models:
Model 1. A sophisticated plaintiff would be an individual with a net worth of $100,000 or more, excluding the value of a principal residence, registered retirement savings plans (RRSPs and RRIFs), and registered pension plans.
Model 2. A sophisticated plaintiff would be an individual with a net worth of $500,000 or more. No assets would be excluded.
- The court should have discretion to apply the rule of joint and several liability to an individual who would otherwise fall into the sophisticated plaintiff category where it was just and reasonable to do so.
- A middle ground should be adopted in relation to allocating the risk of an insolvent or unavailable defendant amongst sophisticated plaintiffs and the remaining solvent defendants. If a shortfall were created because a defendant was unable to pay its share of a judgement, the shortfall would be reallocated on a proportionate basis amongst the parties based on the court’s determination of each party’s contribution to the loss.
- The reallocation formula may be expressed in the following manner: additional payment = shortfall x allocated percentage of loss.
Example: A loss of $100,000 is allocated by the court as follows: 10% to party A, 20% to party B, 30% to party C and 40% to party D. If C were unable to pay its allocated share, there would be a shortfall of $30,000. A would pay 10% of the $30,000 shortfall ($3,000) for a total of $13,000; B would pay 20% of the shortfall ($6,000) for a total of $26,000; D would pay 40% of the shortfall ($12,000) for a total of $52,000.
WITNESSES
| ISSUE NO. |
DATE | WITNESSES |
| 24 (1st session / 36th Parliament) |
June 23, 1998 | From Fasken Campbell Godfrey: Mr. John Campion; and Mr. Robin Roddey. From the Investment Dealers Association of Canada:
From the Certified General Accountants Canada:
From the Canadian Institute of Chartered Accountants:
From the Canadian Bar Association:
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