Motions to strike miss the mark in dismissing class action claims involving contractual interpretation

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Mar 29, 2019

Determining whether to bring a motion to strike is often a critical strategic decision at the early stage of a class action. The recent Ontario Court of Appeal decision McDowell v. Fortress Real Capital Inc. highlights the challenges of striking claims involving the interpretation and disclosure of significant contractual provisions. The Court allowed an appeal from an order dismissing such claims, holding that relevant evidence should be lead to prove or disprove the underlying allegations.

Background

Private investors in four syndicated mortgages commenced class actions against, among others, the mortgagors who granted the mortgages, and the trustees who held the investors’ investments in trust. The investors alleged that the defendants failed to properly disclose or misled investors about a standstill provision in the mortgage documents. In effect, the provision precluded the investors from enforcing the syndicated mortgages in the event of a default until: (i) all prior-ranking lenders were repaid; or (ii) all prior-ranking lenders approved the enforcement in writing. Notably, the trustees, and not the investors, were parties to the mortgage documents.

Motions judge dismisses two claims without leave to amend

The proposed defendants brought motions to strike the investors’ claims under Rule 21 of the Rules of Civil Procedure. The motions judge ordered (in part) that the claims against two of the mortgagors be dismissed without leave to amend. He reasoned that the investors’ rights to enforce the syndicated mortgages in equity would be no better than the trustees’ – the actual parties to the mortgage documents. After finding the trustees were barred from enforcing the syndicated mortgages, the motions judge concluded the investors were likewise barred as a matter of law regardless of the evidence that could be adduced.

Appeal allowed: the contractual interpretation issues must be decided on the basis of evidence

Justice Feldman writing for the Ontario Court of Appeal held that in dismissing the claims against the two mortgagors, the motions judge had made three findings, all of which required an evidentiary basis: 

  1. the standstill provision, when properly interpreted, barred the investors from enforcement;
  2. the standstill provision was adequately disclosed to all parties to the mortgage documents, including the trustees; and
  3. the standstill provision was adequately disclosed to the investors.

With respect to the first finding, the Court relied on the principle in Sattva Capital Corp. v. Creston Moly Corp. that the interpretation of a contract is a question of mixed fact and law. Accordingly, the Court held that the investors were entitled to lead evidence of the circumstances surrounding the formation of the mortgage documents to aid in the interpretation of the standstill provision.

With respect to the second two findings, the Court held that these were clearly factual. Although the motion judge relied on the documentary record before him in making the findings, the Court emphasized that the investors were “entitled to lead evidence both to aid in the interpretation of those documents and to prove what was disclosed and when”. The Court also commented that the effect of the standstill provision was, on its face, to render the investors’ security essentially  unenforceable. It was therefore open to argue the standstill provision was not reasonable in the circumstances, or the actual effect of the standstill provision was not properly disclosed to the investors.

Accordingly, given the finding that the plaintiffs were entitled to adduce evidence, the Court of Appeal set aside the lower court’s ruling granting the defendants’ motions to strike and allowed the action to proceed.

Take-aways

McDowell reinforces that motions to strike on the basis of contractual interpretation may fail if the proper interpretation cannot be decided without evidence. McDowell also raises the possibility that courts will consider knowledge of the effect of a contractual provision in determining whether adequate disclosure of the provision has been made – this again, would require a review of the relevant evidence. These are important considerations for defendants in determining whether to bring a motion to strike class action claims raising the same or similar issues.