Misrepresentations in a Private Placement Offering Memoranda in Canada

By Brian Koscak and Alixe Cormick

An offering memorandum (OM) must contain all information material to the investment opportunity to enable an investor to make an informed investment decision. What information is material depends on the specific business and investment opportunity of an issuer. Under Canadian securities laws, an issuer must ensure there is no misrepresentation in an OM at the time of sale. A misrepresentation is (a) an untrue statement of material fact or (b) an omission to state a material fact required to be stated or that is necessary to make a statement not misleading in the light of the circumstances in which it was made.

Failure to ensure an OM does not contain a misrepresentation has serious consequences. Investors have rights of action, statutory and common law, against an issuer and others to sue for rescission or damages if an OM contains a misrepresentation. Investors have a statutory right of action against the issuer and others if the issuer prepared the OM in reliance on the offering memorandum exemption under s. 2.9 of National Instrument 45-106 – Prospectus and Registration Exemptions (the OM exemption). Investors with a statutory right of action are not required to prove several elements required in a common law action for negligent misrepresentation or breach of contract: For example, under a statutory right of action, an investor is not required to prove that: (a) the issuer was negligent or intentional in making the misrepresentation; (b) the investor relied on the misrepresentation to his or her detriment; or (c) that the investor’s reliance on the misrepresentation was reasonable, which are all required under the common law. A statutory right of action also has the benefit of providing a cause of action for an omission. An omission is not actionable as a misrepresentation under the common law.

Notwithstanding these statutory and common law rights of action, Canadian securities regulatory authorities can also take regulatory action against the issuer for a misrepresentation under applicable securities law in Canada.

When must an issuer amend its OM?

If an issuer discovers a misrepresentation in its OM during an offering it must amend its OM before closing the offering.

An issuer offering securities on a continuous basis in reliance on the OM exemption needs to continuously review its OM to determine if it must be updated (e.g., amended and restated) to ensure there is no misrepresentation. Some issuers incorrectly assume they only need to update their OM once annually, when in fact it must be continuously reviewed to ensure there is no misrepresentation in the OM when provided to an investor and at the time of sale of the securities.

What if there is a misrepresentation in the OM?

(a) Amending and restating an OM 

If an issuer determines its OM must be updated in the ordinary course of a continuous offering, an issuer must make the necessary changes before it provides it to new investors or closes any sales of securities to investors in receipt of an OM containing a misrepresentation.

When an OM is amended and restated, an issuer must update and sign a new certificate page if the amended and restated OM is provided to investors in reliance on the OM exemption. An amended and restated OM must be filed with the applicable securities regulatory authorities in Canada within ten days after any securities are distributed to investors who received the amended and restated OM. Failure to file an amended and restated OM violates securities law.

(b) Amending and restating an OM if there is a misrepresentation discovered after an offering is completed

An issuer that discovers a misrepresentation in an OM after an offering is completed has potential investor liability and may face regulatory sanctions. Upon discovery of a misrepresentation in such circumstances, an issuer needs to immediately discuss it with legal counsel.

To limit an issuer’s liability to investors for a misrepresentation in an OM, an issuer may consider providing investors with an amended and restated OM and offer to refund their money (i.e., rescission rights).

If an issuer does nothing, then the existence of a misrepresentation gives investors a right to sue the issuer and others, subject to applicable law, if an investor subsequently discovers the misrepresentation when the issuer had knowledge, yet failed to take corrective action.

Offering rescission rights does not preclude Canadian securities regulatory authorities from taking regulatory action against an issuer and others for a misrepresentation in its OM, subject to applicable laws. From a regulatory perspective, an issuer cannot fix a misrepresentation in an OM that was provided to investors who made an investment and accordingly, issuers and others may face possible regulatory consequences, unlike an investor claim that arguably can be fixed by offering rescission rights.

(c) Amending and restating an OM if there is a misrepresentation discovered during an offering

An issuer should follow the same steps in (b) above to limit its liability to investors who made an investment based on an OM that has a misrepresentation, if discovered during an offering. However, the issuer still faces the same potential regulatory liability regardless of offering investors rescission rights.

Best practices

Issuers and their directors, officers and any signatories to the certificate page of the OM and any experts referenced in the OM must conduct or cause to conduct a due diligence review as to the accuracy and completeness of the information in the OM prior to its release to potential investors. At a minimum this review should include director and officer questionnaires, all material contracts, corporate business plans, financial statements, indentures, loan agreements and credit facilities, corporate record book, intellectual property, and independent legal and other searches.  Every statement and section in an OM must be checked for accuracy and inclusion of all material facts. A checklist can help guide the due diligence process.  Creating a due diligence file can also make future reviews and updates easier.  Conducting a thorough due diligence review will reduce the probability of a misrepresentation in an OM and provide evidence reasonable care was taken to avoid a misrepresentation.

If an issuer is amending, or amending and restating, an OM, issuers are advised to provide investors with a summary of the changes and a black-line so the changes are visible. There is no legal requirement to provide investors with a summary of the changes or a black-line. Issuers are not even required to file a black-line with the amended and restated OM they file with securities regulatory authorities after a distribution.

Issuers conducting an offering over several months using an OM may want to consider setting up a key date calendar as to when financial statements in the OM must be replaced or updated.  Other key dates may include when certain material agreements renew or expire, key milestones are projected to be reached, loan termination/renewal dates or a once a month reminder to check if the OM reflects all material changes that occurred since the OM was last reviewed. Issuers are reminded to constantly be vigilant and continuously review and consider whether its OM must be amended and restated during an offering.

Issuers should ask themselves before accepting a subscription agreement by an investor whether the OM that investor is relying on is accurate and does not contain a misrepresentation.

Directors, officers and other signatories to an OM certificate of an OM provided to investors in reliance on the OM exemption, are advised to withdraw their consent and give notice of withdrawal to investors on becoming aware of any misrepresentation in an OM.