Canada: Alleged Extension Of Time Does Not Prevent Discount Brokerage To Conduct Sell-Out In Its Discretion

A margin account permits an investor to borrow money from a broker in order to buy more securities than an investor would otherwise be able to purchase with their own capital. "Margin" requirements are established by the Investment Industry Regulatory Organization of Canada and represent the percentage the investor is required to fund for the proposed purchase of securities. For certain "eligible" securities, the investor can borrow up to 70%.

However, in the event an investor's position declines to the point where the margin loan exceeds the required percentage of the market value of the securities, the broker is entitled to sell the investor's securities in its sole discretion, at any time and without notice, to maintain the margin requirement and protect the broker's loan against the risk of a potentially unlimited downside.

This is the case, as recently determined in Susin v. TD Waterhouse Discount Brokerage,¹ even where the broker is alleged to have provided the investor with additional time to bring their account "onside" and the brokerage decides to sell the investor's securities before such time.

In general, the brokerage reserves this right under its contractual agreement with its customers.

Facts and argument in the Susin case

In the Susin case, the discount brokerage brought a summary judgment motion to dismiss an investor's action for damages allegedly suffered as a result of a credit sell-out of two "margin" accounts during the height of 2008 market downturn. These accounts only held shares in Manulife Financial Corporation.

There was no dispute that the investor (who brought the claim as the executor of his wife's estate and who also held a margin account in his own name with the discount brokerage) had read, understood and agreed to the terms of the account agreements that governed the margin accounts.

However, the investor claimed that when the discount brokerage sold securities in both his and his wife's accounts, it had no right to do so because even though the accounts became "under-margined", as a result of the percentage of debt to the market value in the accounts exceeding 70%, a phone call from a credit officer at the discount brokerage had waived the brokerage's contractual right to begin selling securities in the accounts at the time it did so.

The investor contended that the credit officer told him that the securities in the accounts would not be sold right away and that the investor was being given an extension to either sell the securities on his own or to add funds to the accounts so as to comply with the brokerage's margin requirements.

A number of issues flowed out of the phone call between the investor and the credit officer.

Whereas the brokerage denied that its credit officer had granted any kind of extension to the investor to meet the margin requirements, the investor argued that an audio recording of a phone call between the investor and the credit officer had been altered to delete the critical extension of time and that the brokerage breached its duty of care in selling securities in the accounts.

While the investor produced an expert to support his contention that the audio recording had been manipulated, the brokerage challenged the expert's qualifications and evidence. As well, aside from general allegations that the brokerage was negligent in selling securities because the accounts were not under-margined, the investor argued that even if the accounts were undermargined the brokerage breached its duty of care to the investor because it sold the stocks in the accounts at a time when they were increasing in value and that the brokerage had failed to immediately post a notice of the sell-out of securities on the investor's electronic interface which he used to trade securities.

The investor also argued that the brokerage breached its duty of care to him by failing to offset the under-margined accounts with funds from another margin account that was in the name of the investor's daughter. This account contained a margin "surplus".

Decision of the Court

The Court granted summary judgment in favour of the discount brokerage and dismissed the investor's action.

The Court first determined that at the time the brokerage's credit officer called the investor, the accounts at issue were under-margined to the extent that the percentage of debt to the market value in the accounts was 84%.

The Court then considered the discussion that took place between the credit officer and the investor and found, even accepting the investor's allegation that an extension of time had been provided (which the brokerage denied), that there had nevertheless been no waiver of the brokerage's contractual rights to sell the securities at the time it did so.

Under paragraph 3 of the Margin Agreement, the brokerage had the contractual right to conduct a credit sell-out at any time and within its sole discretion if it considered that it was advisable to do so for the brokerage's protection.

A notice or demand did not invalidate this right and any purported extension given by the credit officer could only result in a waiver if there was an indication of (i) a full knowledge of the rights and (ii) an unequivocal and conscious intention to abandon the contractual rights.

In the circumstances, notwithstanding the dispute over the alleged "manipulated" audio recording, which the court did not need to resolve, no waiver had taken place because the brokerage never acted inconsistently with its rights under the contract. Indeed, the contract expressly provided that an account holder's waiver of notice could not be "invalidate[d]" by any demands or calls that the brokerage might make to an account holder in relation to an account.

More specifically, the agreement provided:

Given that the investor had agreed by contract that the brokerage could conduct a sell-out regardless of the terms of any notice or demand, the brokerage also owed no duty of care to the investor.

The law clearly provides that parties can limit the scope of a tort duty through a contract, and in this case the investor led no evidence to establish that the brokerage had been negligent.

The Court found as well that although the brokerage had led no expert evidence in connection with its duty of care, the obligation to produce expert evidence fell on the investor.

The investor was obligated to put his best foot forward and to adduce the necessary expert evidence as to standard of care in the situation involving the investor's case.

The brokerage was also entitled to a dismissal of the investor's claim because the evidence clearly revealed that the accounts at issue were undermargined at the time the brokerage engaged in the sell-out, and that it was under no obligation whatsoever to offset the margin deficiencies in the accounts with funds from the daughter's over-margined account.

There was simply no contractual basis for the brokerage to access funds in the over-margined account. The contract only permitted the brokerage to transfer funds into an account holder's account "any credit balance in any of your accounts, including any free balances in your margin account." The daughter's account did not qualify as "your" account.

In any event, the Court found that there was insufficient credit in the daughter's account to cover the deficiencies in the under-margined accounts.

With respect to the brokerage's alleged failure to post notice of the sell-out in the investor's electronic interface in a timely fashion, the Court found that this claim was confined to tort because there was no contractual obligation on the brokerage to provide notice of a credit sellout within any particular timeframe.

The tort claim, however, did not raise any genuine for trial because, again, the investor failed to provide expert evidence to support his claim, and, in any event, the agreement between the parties provided that the investor agreed to "indemnify and hold TD Waterhouse harmless from any and all claims and causes of action, however caused, arising from your use of or inability to use or maintain a connection with the Services." "Services" was defined as including the "Active Trader Platform", or electronic interface, that the investor used for his trading.

The posting of a notice of a trade was a claim that arose out of the "use" of that service.

Lastly, the Court determined that the brokerage was entitled to conduct the sell-out (irrespective of the investor's "belief" that the Manulife share price was increasing) on the basis that a broker is not required to become a "co-speculator" with its account holder. In any event, there was no evidence that the brokerage could (or should) have forecasted the future fluctuations of market securities let alone in a period of extreme volatility. The Court also rejected the investor's argument that the brokerage was not entitled to conduct the sell-out because the accounts were not in a "negative equity" position which was ultimately inconsistent with the clear language of the account agreement requiring the investor to "maintain such margin as [the brokerage] may in [its] absolute discretion require from time to time".

Footnote

1 2020 ONSC 959

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