Update on Sundial Growers, Inc. Securities Litigation

Sundial Growers, Inc. (“Sundial”) is a Canadian-based company that operates a number of facilities in Canada and in the United Kingdom. As we previously noted in our comprehensive Update on Securities Litigation Against Cannabis Companies, investors filed parallel state and federal actions against Sundial, certain individual defendants and the company’s underwriters in September 2019, alleging violations of Sections 11, 12(a) and 15 of the U.S. Securities Act. On May 15, 2020, the Honorable Barry R. Ostrager of the Supreme Court of the State of New York, New York County, issued a written order dismissing all of the plaintiff’s claims and, in doing so, made some findings that are of particular interest to companies operating in the cannabis industry.

Background

On August 1, 2019, Sundial completed an IPO, selling 11 million shares of common stock at $13 per share. In its Registration Statement, the company stated that it produces high quality, premium cannabis in its indoor grow rooms located in Alberta, Canada. The Registration Statement further touted the company’s high quality cannabis, which the company stated gave it a competitive market advantage and allowed it to charge higher prices. On August 16, 2019, MarketWatch published an article alleging the existence of severe quality control deficiencies in Sundial’s products that would likely impact 10% of the company’s sales for the quarter ended June 30, 2019. The article also claimed that prior to the IPO, one of the company’s corporate buyers, Zenabis, returned a half ton of the company’s product on the purported basis that it contained visible mold, parts of rubber gloves and other non-cannabis material. Relatedly, in its disclosure of its financial results for the quarter ended June 30, 2019, Zenabis stated that “certain third-party producers failed to supply saleable cannabis in line with contractual obligations” and that they had to return a total of 554 kg of cannabis to the supplier. Zenabis did not name any of the third-party suppliers.

In the parallel state and federal securities class actions against Sundial, plaintiffs allege that the Registration Statement contained materially false and misleading statements because it failed to disclose that a number of its cannabis batches were of low-quality and not fit for sale to its customers, which precipitated the large return of product by Zenabis. Plaintiffs further allege that the company’s deficient manufacturing and quality control processes resulted in the production of low-quality cannabis products, adding that the facilities were kept in dilapidated conditions which generated mold spores and caused crop infections. The defendants moved to dismiss the complaints in both of the proceedings.

Motion to Dismiss Granted in State Court Proceeding

In the New York Supreme Court action, the defendants’ motion to dismiss was set to be heard on April 10, 2020. Due to the COVID-19 pandemic, the motion to dismiss hearing was taken off the court’s calendar and the judge decided the motion on the papers, issuing a written order on May 15, 2020 dismissing the case.

Key Takeaways for Publicly Traded Cannabis Companies

1. Foreign Defendants Subject to the Court's Jurisdiction

The Court’s ruling concerning personal jurisdiction will be interesting to non-U.S. based cannabis companies trading on U.S. exchanges. Although Sundial is headquartered in Canada and operates in Canada and the U.K., it trades on NASDAQ. The Company, the individual defendants and the foreign underwriter defendants moved to dismiss the complaint on grounds that the Court lacked personal jurisdiction over them. The Court held that plaintiff’s complaint adequately demonstrated that facts “may exist” to exercise personal jurisdiction over the foreign defendants, including the following:

• Sundial has an agent for service of process based in New York
• The underwriter defendants worked with their New York affiliates and drafted the Registration Statement in New York, NY, disseminated the statements alleged to be materially false and misleading in New York, NY, and affirmatively solicited Sundial investors through the Registration Statement in New York, NY
• The individual defendants reviewed the Offering Documents at the IPO closing in New York, NY.

These facts were deemed sufficient to establish jurisdiction in the U.S. courts over a Canadian-based company at the motion to dismiss phase.

2. Statements About Product Quality Not Actionable

Pursuant to Section 11 of the Securities Act of 1993, a shareholder may seek relief if “any part of the registration statement, when such part became effective, contained an untrue statement of material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading.” 15 U.S.C. § 77k. Here, plaintiff alleged that various statements concerning the quality of Sundial’s cannabis brands and products were false and misleading. The challenged statements touted the “high quality” and “premium” nature of Sundial’s brands and products, and included the following examples:

• Our purpose-built indoor modular grow rooms enable us to produce large volumes of high-quality cannabis in small batches.
• We also believe that our premium, high quality brands and products will deliver superior consumer experiences, resulting in strong consumer loyalty and advocacy.
• We believe that the combination of this craft-at-scale cultivation model, our diverse genetic library and our experienced cannabis cultivation team will result in the highest quality cannabis on the market.
• We are developing high-quality, premium cannabis brands for the adult-use market.
• We intend to capture a leading position in this market by offering differentiated brands underpinned by premium products that deliver consistent and superior user experiences.
• Our purpose-built indoor modular grow rooms enable us to produce large volumes of high-quality cannabis in small batches . . . We believe that the combination of this craft-at-scale cultivation model, our diverse genetic library and our experienced cannabis cultivation team will result in the highest quality cannabis on the market. . .
• We also believe that our premium, high quality brands and products will deliver superior consumer experiences, resulting in strong consumer loyalty and advocacy. Our tailored supply chains are intended to optimally balance high quality products and low-cost production, which we believe will further contribute to our superior margins and maximize stakeholder returns over time.

The Court held that each of the challenged statements “was either (1) corporate puffery, too vague to be actionable, (2) a sincere statement of corporate optimism, or (3) sufficiently offset by robust risk disclosures.” Specifically, the Court held that “the terms ‘high quality’ and ‘premium’ are clear examples of puffery because they are general and not subject to verification. At most, ‘high quality’ and ‘premium’ are statements of opinion, which are also not actionable.”

In response to plaintiff’s argument that the challenged statements misrepresented current facts, the Court noted that plaintiff had ignored the fact that when viewed in full context the majority of the statements began with opinion-based or forward-looking language, such as “we believe” and “we intend.”

3. The Importance of Risk Disclosures

In rejecting the plaintiffs’ argument that the return of product by Zenabis evidenced Sundial’s product quality issues, the Court paid special attention to Sundial’s “robust 35-page risk disclosure section of the Offering Documents.” The Court found that Sundial had disclosed the “exact type of risk” at the crux of plaintiff’s Complaint – namely that there are risks inherent in the agricultural business and even when growing cannabis indoors, the crops are vulnerable to natural elements. Sundial also disclosed that they had to dispose of crops due to crop disease prior to the company’s IPO.

Conclusion

Ultimately, the Court found that the Registration Statement revealed that “Sundial made no guarantees with respect to the quality of its product, and instead claimed that it intended to produce ‘high quality and premium’ cannabis, while warning that (1) efforts to do so may be frustrated due to agricultural risks and (2) a market for high-quality, premium cannabis products may not materialize.”

The Court granted the defendants’ motion and dismissed the case in its entirety. The federal class action against Sundial is still pending and plaintiffs in that case filed a Second Amended Complaint on April 30, 2020.