Ontario Court of Appeal Holds that the Creator of an Exchange-Traded Fund May Owe Duty of Care to Investors

2 July 2020

By Zachary Pringle

In its recent decision Wright v. Horizons ETFS Management (Canada) Inc.1, the Court of Appeal for Ontario set aside the dismissal of the plaintiff’s motion for certification on the basis that it disclosed no reasonable cause of action pursuant to section 5(1)(a) of the Class Proceedings Act, 1992. This decision may expand the scope of recovery for claims made for pure economic loss for the negligent performance of a service.

The Law: Canadian Courts have limited the circumstances in which a plaintiff may recover in negligence for pure economic loss (loss not causally connected to physical or property harm). At present, such claims are limited to five categories of liability established by the Supreme Court of Canada:2

  1. the independent liability of statutory public authorities;
  2. negligent misrepresentation;
  3. negligent performance of a service;
  4. negligent supply of shoddy goods or structures; and
  5. relational economic loss.

If the plaintiff’s claim for economic loss falls within one of the established categories of liability, the Court must then determine whether the defendant owed the plaintiff a duty of care. In 2017, the Supreme Court of Canada in Deloitte & Touche v. Livent Inc. (Receiver of)3 reviewed the two-step approach to determine the existence and extent of a duty of care in claims for pure economic loss:

  1. Determine whether a prima facie duty of care exists by considering:

a. are the parties in a sufficiently close and direct relationship (proximity); and

b. if the harm suffered is reasonably foreseeable;

  1. If so, whether there are residual policy considerations that should insulate the defendant from liability.

In claims for pure economic loss, the proximity consideration requires the plaintiff to prove that the relationship between the parties falls within and/or is analogous to established classes of relationships where proximity has already been found to exist (such as doctor-patient or solicitor-client),4 or establish proximity through a full analysis.5

For the negligent performance of a service, a full proximity analysis requires the Court to consider the scope of the defendant’s “undertaking” to provide a service, and the plaintiff’s reasonable reliance on that undertaking, such that the risk of injury was reasonably foreseeable.6 If a prima facie duty of care is established, the Court then turns to policy considerations which may act to insulate the defendant from liability.

Background: The Defendant, Horizons ETFS Management (Canada) Inc. (“Horizons”), created and managed a complex derivates-based exchange traded fund, or ETF (the “Fund”).7

Before an ETF can begin trading on a Canadian stock exchange, its manager must file a prospectus. In this case, Horizons filed a prospectus that contained the following warnings:

…Units of [the Fund] are highly speculative and involve a high degree of risk, some not traditionally associated with mutual funds. No ETF by itself constitutes a balanced investment plan. An investor may lose a portion or even all of the money that they place in an ETF.

The risk of loss in investing through derivatives can be substantial. In considering whether to buy Units of an ETF the investor should be aware that investing through derivatives can quickly lead to large losses as well as large gains. … Market conditions may also make it difficult or impossible to liquidate a position. [emphasis added]

The Fund performed well until February 5, 2018, when it lost approximately 90% of its value overnight. Collectively, the Fund investors lost approximately $40 million. The Fund did not recover. Two months later, Horizons announced that it was terminating the Fund.

Shortly thereafter, a representative plaintiff (the “Plaintiff”) proposed a class action against Horizons for negligence. The Plaintiff alleged that Horizons had breached its duty of care and failed to meet the applicable standard by designing, marketing and managing a notionally innovative investment product that contained fundamental design flaws and that inappropriately exposed investors to risk. In particular, the Plaintiff alleged that Horizons failed to ensure that the Fund would not lose a majority of its value in a single day, or in the alternative, it failed to warn investors of that risk.

The Certification Motion: On the motion, the Plaintiff argued that his characterization of the negligence claim fit within or was analogous to previously established classes of relationships for this type of negligence. Horizons disagreed, and argued that the allegations pleaded did not give rise to a reasonable cause of action.

The motions judge considered features of the claim and whether it fell within or was analogous to established classes of relationships in the preexisting categories of liability of (i) “negligent supply of a shoddy goods”, and (ii) “negligent performance of a service”. His Honour concluded that it did not. His Honour then conducted a separate duty of care analysis, and concluded that while there was a close relationship between Horizons and the Plaintiff, the only undertaking given by Horizons in creating and managing the Fund was to place on the exchange a financial product that operated in accordance with the accompanying disclosure documents, and nothing more.

On the basis of the narrow undertaking given by Horizons, His Honour held that there was insufficient proximity between the Plaintiff and Horizons which could give rise to a duty of care. Therefore, he concluded that the Plaintiff could not have a common law negligence claim against Horizons and struck this cause of action from the statement of claim.8

The Appeal: On appeal, the Court agreed with the motions judge that the Plaintiff’s claim did not fall within and was not analogous to established classes of relationships within the category of negligent supply of shoddy goods. It differed, however, on the category of the negligent performance of a service.

The Court of Appeal specifically found that the claims made in this case were analogous to those made in Cannon v. Funds for Canada Foundation,9 in which the Court found that the creator and promoter of a tax avoidance program arguably owed a duty of care to the program’s participants. The Court of Appeal held:

There is arguably, therefore, a relationship of proximity between Horizons and the Class. Horizons undertook to create and sell a Fund that was suitable for some investors and, on the pleading as drafted, it was not. … For these reasons, [the Plaintiff] has a reasonable prospect of demonstrating that the claim falls within a recognized duty of care under the category of negligent performance of a service.

The Court of Appeal also disagreed that Horizons gave only a narrow undertaking to “place on the exchange a financial product that operated in accordance with the accompanying financial disclosure.” Rather, as the Fund manager, Horizons undertook to its investors to act honestly, in good faith, and in the best interests of the investment fund. The Court found that, assuming the allegations in the pleadings are true, Horizons created a Fund that was doomed to fail and therefore not suitable for any investors. If that is the case, then Horizons arguably failed to meet their undertaking to investors for which the risk of injury was foreseeable, which may also give rise to a novel duty of care owed to the Plaintiff by Horizons.

The Takeaway: It is important to keep in mind that this decision was made in the context of a motion for certification of a class action, and the Court of Appeal made no finding that there is a duty of care between a creator and/or manager of a securities fund and its investors. Rather, the only conclusion reached was that, on the facts pleaded, the negligence claim might succeed, and should not be struck as having no reasonable prospect of success.

However, this is a significant decision in that it may expand the scope of claims for the negligent performance of a service to include the creators and managers of securities funds.

12020 ONCA 337 (CanLII).
2Martel Building Ltd. v. Canada, 2000 SCC 60 (CanLII) at paras. 38 and 45.  
32017 SCC 63 (CanLII).
4Ibid at paras. 26-27.
5Ibid at para. 29.
6Ibid at paras. 30-31.
7An “ETF” is a kind of security which is a collection of other securities that tracks a specific market index, sector, or commodity, and are bought and sold on major stock exchanges throughout the trading day. In a sense, ETFs are similar to mutual funds, except mutual funds are not publicly traded throughout the day on an exchange.
8Wright v. Horizons ETFS Management (Canada) Inc., 2019 ONSC 3827 (CanLII) at para. 6.
92012 ONSC 399, 13 C.P.C. (7th) 250.

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