On January 23, 2023, the Quebec Superior Court denied leave to pursue a class action against HEXO Corp. The proposed class action raised various allegations of misrepresentation and breaches of disclosure obligations over the period of April 2018 to March 2020.1
The decision determined that the announcement of negative news followed by a decline in a public issuer’s stock price is not enough on its own to satisfy the requirements of claims for statutory misrepresentation. Arguments based on backwards reasoning with the benefit of hindsight will not meet the evidentiary burden on plaintiffs to show a reasonable possibility that the action will be resolved in their favour.
A. Factual Background
i. Supply Agreement
In April 2018, HEXO issued a press release announcing that it entered into a supply agreement with what became the Société québécoise du cannabis (the “SQDC“) to be the preferred supplier of cannabis products in Quebec for five years (the “Supply Agreement“). The press release stated that the Supply Agreement required SQDC to purchase 20,000 kilograms of product in the first year following the legalization of cannabis. It disclosed that the SQDC had the right to terminate the agreement under certain circumstances and included cautionary language regarding the reliance on forward-looking statements. The company’s Management Discussion and Analysis (“MD&A“) underscored the strategic importance of its relationship with SQDC and estimated that potential revenue under the Supply Agreement could reach $1 billion.ii. Corporate Acquisition
In March 2019, HEXO issued another press release announcing that it would acquire Newstrike, another publicly traded cannabis company. With that acquisition, HEXO estimated its net revenues from the sale of cannabis in Canada would be more than $400 million. The announcement included that the acquisition of Newstrike would add approximately 470,000 square feet of additional production space in Ontario’s Niagara Region and achieve annual synergies of approximately $10 million. The day after this announcement, in a call with analysts, the company stated that 250,000 square feet of the Niagara production space was licensed and operational.iii. Revenue Estimates
Following the announcement of the acquisition, the company made statements about estimated revenues. For example, in the company’s MD&A dated June 12, 2019, it estimated that revenues would double in Q4 2019 because of, among other things, the Supply Agreement and the Newstrike acquisition.iv. String of Bad News
Over the course of the following nine months, the company issued a series of negative announcements that caused repeated drops in the company’s stock price. These announcements included:- The company was withdrawing its revenue guidance of $400 million and was right-sizing its operations, including winding down operations at the Niagara facility acquired from Newstrike.
- “Block B” of the Niagara facility (approximately 17 per cent of the facility) was discovered as not being adequately licensed. Cultivation and production activities in the unlicensed space were immediately stopped. The company subsequently announced it would sell the Niagara facility.
- HEXO’s Q4 2019 financial results were approximately 40 per cent lower than forecasted.
- HEXO recorded three separate impairments on inventory in the range of $265 – $280 million. The company identified material weaknesses in its internal controls of its financial reporting in various areas including its year-end inventory count.
- SQDC failed to purchase its 20,000-kilogram commitment under the Supply Agreement in the first year and HEXO was not going to enforce this commitment because of its overall business relationship with the SQDC and its position in the Quebec market.
B. Alleged Misrepresentations
Owing to the decline in the company’s stock price, the plaintiff sought authorization to institute a secondary market claim against HEXO, filed under the Quebec Securities Act, and further sought leave to pursue a class action against the company for damages arising from statutory and civil misrepresentations. The plaintiff alleged HEXO misrepresented that: 1. The Supply Agreement guaranteed revenues associated with the sale of 20,000 kilograms of cannabis in the first year; 2. The acquisition of Newstrike:
a. included fully licensed and operational facilities;
b. would generate more than $10 million in annual synergies;
c. along with the Supply Agreement, would result in the doubling of HEXO’s net revenue between Q2 and Q4 in 2019;
3. HEXO would achieve revenue of greater than $400 million for the 2020 fiscal year;
4. HEXO’s inventories were accurate and its internal controls were effective.