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Sino-Forest’s ‘gatekeepers’ handed a loss

Ontario Appeal Court upholds decision on Sino-Forest auditors, underwriters

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The former auditors and underwriters of scandal-plagued Sino-Forest Corp. have lost a bid to try to have what's left of the company cover any damages that result from legal claims against them from burned investors.

In a ruling released Friday, the Ontario Court of Appeal dismissed an appeal launched by auditors Ernst & Young LLP and BDO Ltd. and a long list of Bay Street underwriters.

The challenge was closely watched by bankruptcy lawyers on Bay Street, as it tested recent changes to Canada's insolvency law and was expected to serve as a precedent for other auditors and underwriters involved with companies that collapse.

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When Sino-Forest collapsed after a short-seller alleged it was a "Ponzi scheme," lawyers for investors in a potential $9-billion class action against the company also targeted its auditors and underwriters, alleging negligence.

The defendants deny the allegations, which have not been proven in court. The lawsuit has not been certified as a class action on behalf of investors.

Sino-Forest's auditors and underwriters all had indemnity clauses in their contracts with the firm that were meant to force Sino-Forest to pay any legal costs or damages they might face as a result of dealings with it.

Sino-Forest, facing probes by the Ontario Securities Commission and the RCMP, sought protection under the Companies' Creditors Arrangements Act earlier this year. It had planned to sell its assets, held by its subsidiaries, to a third party. But a suitable buyer could not be found, and the firm now plans to transfer its remaining assets to its debt holders, who must first vote on the deal. A vote is scheduled for Nov. 29.

In a CCAA, equity interests, or shareholders, are ranked after secured and unsecured creditors, often leaving them with nothing when a company is sold off. And as part of Sino-Forest's restructuring deal, the judge overseeing the process, Mr. Justice Geoffrey Morawetz, ruled that the indemnity claims of Sino-Forest's auditors and underwriters for any damages, but not their legal fees, would be considered equity claims.

That prompted lawyers for auditors and underwriters to go before the appeal court, arguing that recent amendments to the CCAA had been misinterpreted. They argued that their claims were debt, since they were third-party contractors, not shareholders.

But the three-judge appeal panel unanimously ruled that Judge Morawetz was correct, and that under the CCAA, the auditors' and underwriters' claims for any damages they are ordered to pay should be considered equity claims, since they ultimately related to litigation launched by shareholders.

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"We see no basis to interfere with the supervising judge's decision to consider whether the appellants' claims were equity claims before the completion of the claims procedure," Friday's decision reads.

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About the Author
Toronto City Hall Reporter

Jeff Gray is The Globe and Mail’s Toronto City Hall reporter. He has worked at The Globe since 1998. He spent six years as the law reporter in The Globe’s Report on Business, covering Bay Street law firms and writing about fraud, insider trading and corporate tax avoidance. More

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