Disclosure Obligations: Courts Adopt a Balanced Approach
November 22, 2011
Sharbern Holding Inc. v. Vancouver Airport Centre Ltd.
On May 11, 2011, the Supreme Court of Canada released its decision in Sharbern Holding Inc. v. Vancouver Airport Centre Ltd., 2011 SCC 23. In Sharbern, the Supreme Court considered, for the first time, the common law test for "materiality" and clarified important aspects of the test, all in the context of the disclosure obligations of real estate developers under the (now repealed) Real Estate Act (British Columbia) (REA). The issue of materiality is, of course, extremely important for developers and, against a recent tide of B.C. Court decisions that have tended to favour purchasers, Sharbern brings a common sense approach to bear on the issue that will be welcomed by developers and diminish the ability of purchasers to escape pre-sale contracts on merely technical grounds.
In Sharbern, a developer marketed strata lots within two interconnected hotels (one a Marriott, the other a Hilton) near the Richmond airport that were to be managed by the developer as rental pools under long term hotel management agreements, but with differing financial schemes. Purchasers of Marriott strata lots were guaranteed a gross annual return of 12% of the purchase price, with the developer receiving management fees equal to the aggregate of a monthly fee of 5% of gross rental revenue, and an incentive fee equal to 25% of the amount by which the owners’ net annual return on investment exceeded 8%. Purchasers of Hilton strata lots, however, received no guaranteed return and the management fee payable to the developer was limited to a monthly fee of 3% of gross rental revenue.
Purchasers of Hilton strata lots suffered losses, when the Richmond hotel market proved less profitable than anticipated, and alleged that the differing financial arrangements between the two hotels gave rise to a conflict of interest by incentivizing the developer to favour the Marriott over the Hilton in its operation and management of the two hotels. They also claimed that the developer’s disclosure materials, which did not expressly identify the details of the differing financial arrangements, contained "material false statements" and that the developer was liable to the purchasers under the liability provisions of the REA.
The REA contained no statutory definition of "material" so the Supreme Court was called upon to consider the common law test for "materiality." The key conclusions were as follows:
- Materiality is to be determined objectively, from the perspective of a reasonable investor.
- A fact omitted from a disclosure statement is material if there is a substantial likelihood that it would have (not just might have) been considered important by a reasonable investor or, put another way, that disclosure of the omitted fact would have been viewed by a reasonable investor as significantly altering the "total mix" of information made available to investors by the developer.
- Proof is not required that an omitted fact would have changed the reasonable investor’s investment decision, only that there was a substantial likelihood that the fact would have assumed actual significance in the reasonable investor’s deliberations.
- The determination of materiality involves a fact-specific inquiry into all the relevant considerations and circumstances forming the "total mix" of information made available to investors.
- The purchaser, not the developer, bears the burden of proving that a fact, statement or omission is material, except only where materiality may be inferred as a matter of common sense.
- In assessing materiality, a court should review the information disclosed to investors and assess it against what was omitted. The court may take into account both "behaviour evidence" of developers and purchasers in the same or similar situations, and "contextual evidence" that helps place the omitted information in a broader factual setting.
Applying these principles, the Supreme Court held that the trial judge made three legal errors in finding that the alleged conflict of interest was material. First, she treated the existence of a potential or actual conflict of interest as inherently material such that it had to be disclosed, without having determined that the conflict was, in fact, material. The Supreme Court took issue with this approach on the basis that it would result in excessive disclosure, regardless of materiality, and overwhelm investors and impair (not enhance) their ability to make decisions. Second, the trial judge reversed the onus of proof, requiring the developer to show that the conflict of interest was not material rather than requiring the plaintiffs to show that it was. Third, she failed to consider all the evidence available to her on the issue of materiality (such as the economic environment at the time the strata lots were marketed).
In the result, the Supreme Court concluded that the purchasers had failed to demonstrate a substantial likelihood that disclosure of the differing financial arrangements would have assumed actual significance in a reasonable investor’s decision.
The Sharbern decision is very important in the real estate development context, as the Supreme Court made it very clear that, although disclosure of material information is important for consumer protection, the materiality standard should not be set so low as to require excessive disclosure of unimportant facts, and thereby subject a developer to liability for trivial omissions.
Although the Supreme Court’s decision involved an analysis of the common law test for "materiality," it was reasonable to expect that B.C. courts would follow the Sharbern approach in the context of the Real Estate Development Marketing Act (British Columbia) (REDMA), even though the REDMA contains a statutory definition of "material fact." A recent decision of the B.C. Supreme Court has done just that heralding what may be a new era in the judicial approach to pre-sale contract disputes in British Columbia.
299 Burrard Residential Limited Partnership v. Essalat
In 299 Burrard Residential Limited Partnership v. Essalat, 2011 BCSC 996 (released July 26, 2011), the developer sought an order that it was entitled to retain a $1,136,000 deposit after a purchaser refused to close on a strata lot. The purchaser alleged that the developer’s failure to disclose a two-month delay in the estimated completion date, set out in the developer’s disclosure statement, constituted a misrepresentation of a "material fact" and that, because the developer failed to correct the misrepresentation by filing an amendment to the disclosure statement, the purchase contract was unenforceable pursuant to Section 23 of the REDMA. In essence, the purchaser’s argument was that any failure to disclose a completion date delay that is not "trivial" will result in a misrepresentation and render a purchase contract unenforceable.
The Court began its analysis by stating that, although the REDMA, unlike the REA, contained a definition of what constituted a "material fact," it had to be read together with the REDMA definition of a "misrepresentation," being a "false or misleading statement of a material fact" or an "omission to state a material fact."
The Court then went on to apply the Sharbern framework to determine whether there was a "substantial likelihood" that the undisclosed delay in the completion date would have assumed "actual significance" to a reasonable purchaser when deciding whether to purchase. In doing so, the Court considered recent B.C. decisions where a failure to disclose a delay in an estimated completion date was found to constitute a misrepresentation (see Chameleon Talent Inc. v. Sandcastle Holdings Ltd. 2010 BCCA 300, discussed in Volume 2, Issue 1 of Real Estate MATTERS, and Maguire v. Revelstoke Mountain Resort Limited Partnership, 2010 BCSC 1618), but distinguished them on the basis that, in those cases, the delays were significantly longer and arose from events that purchasers would not reasonably have anticipated. Although the Court acknowledged that a developer cannot avoid the obligation to disclose material delays simply by saying that the originally stated date was nothing more than an "estimate," the delay in Essalat was due to "normal" construction delays that any purchaser would reasonably expect to occur in the course of a significant construction project and, further, the total delay was less than 10% of the originally anticipated construction duration of 38 months. In the result, the court found that the purchaser had failed to discharge its burden of proving that the delay would have assumed actual significance to a reasonable purchaser.
As in Sharbern, the Court also took into account the surrounding circumstances forming the "total mix" of information and behaviour evidence of purchasers in the same situation. In particular, it noted that the purchaser’s agent had been informed before the purchase agreement was executed that a two-month delay was likely. Moreover, when the developer sent a newsletter to all purchasers containing the updated completion date, no complaints were received.
In the result, the purchase agreement was found to be enforceable and the deposit was forfeited to the developer (although an appeal has been filed by the purchaser and a stay was granted pending the outcome of the appeal).
Overall, by applying the Sharbern principles to the interpretation of the REDMA, the court in Essalat has introduced a nuanced approach to the issue of materiality and the disclosure obligations of developers. It found that even consumer protection legislation requires a balance between too much and too little disclosure and that facts and circumstances beyond the strict wording of the legislation and the language of the purchase contract, including the knowledge of the purchaser, may be taken into account. As a result, future purchasers who wish to avoid their obligations under pre-sale contracts may find the road to success somewhat more difficult to navigate.
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