By Robert Austin and Carolyn Reynolds
The High Court of Australia has unanimously allowed an appeal by Fortescue Metals Group (FMG) and Andrew Forrest from last year's decision of the Full Federal Court. The High Court found that FMG's market announcements, that it had entered binding agreements with Chinese state-owned enterprises (SOEs) to build, transfer and finance its massive Pilbara infrastructure project, did not amount to misleading conduct.
The High Court's reasoning demands careful consideration, to assess the implications for market announcements and continuous disclosure.
Facts and background
During August - December 2004 FMG made repeated announcements to the effect that it had entered into binding agreements with three Chinese SOEs to build, finance and transfer the railway, port and mining construction work for its massive Pilbara iron ore and infrastructure project.
In fact, the agreements were very slim framework agreements, which contemplated that fuller and more detailed agreements would be developed later.
In March 2005 the Australian Financial Review published an article suggesting the agreements were not binding contracts to build, finance and transfer the railway, port and mine. In response to the ASX's request for comment, FMG then provided the ASX with a copy of the framework agreement with one of the Chinese entities.
In 2006 ASIC commenced proceedings in the Federal Court alleging that the market announcements were misleading or deceptive and that FMG contravened the continuous disclosure requirements of the Corporations Act by not correcting the information. It alleged that Mr Forrest was involved in the contraventions, and was also in breach of his duty of care by allowing the company to contravene the law.
The trial judge dismissed ASIC's claims, on the grounds that the market announcements were expressions of opinion as to the legally binding force of the agreements, and FMG had a reasonable basis for its opinion.
The Full Federal Court unanimously allowed an appeal (see our alert). The Full Court found that the market announcements represented that the framework agreements were legally enforceable contracts to build, transfer and finance infrastructure, and since they were not, publication of the market announcements amounted to misleading conduct by FMG. The Full Court held that FMG breached its continuous disclosure obligation by failing to correct the misleading information, and that Mr Forrest was involved in that contravention, and was also in breach of his duty of care and diligence by failing to prevent the company from contravening.
The High Court has now reversed the Full Federal Court's decision. There were two judgments reaching the same conclusion, but for somewhat different reasons: the joint judgment of French CJ, and Gummow, Hayne and Kiefel JJ (the majority judges) and the judgment of Heydon J. All judges found that the market announcements were not misleading or deceptive, and consequently there was no breach of the continuous disclosure obligation by FMG and no breach of duty by Mr Forrest.
We shall explain the Court's reasoning under seven numbered headings, and then offer some comments.
1. Misleading or deceptive?
The central difference between the majority's joint judgment and the Full Federal Court was about the meaning of the market announcements. According to the Full Court, when FMG said it had 'entered into binding agreement[s] ... to build, transfer and finance' the railway, port and mine, it was saying something about the legally binding effect of the agreements.
The majority judges disagreed. ASIC's assertion that the market announcements were misleading and deceptive required that it prove the effect of the announcements on the intended audience, and that this effect was misleading. The majority judges identified the intended audience as investors (present and possible future investors) and perhaps, some wider section of the commercial business community (at ).
The majority judges said that when the announcements were properly read in their context, they would not convey to the audience statements about the legal effect of the agreements, under Australian law or any other law. Instead, they would be read as statements about what the parties to the agreements understood that they had done and intended would happen in the future (at ). They were summaries of what the agreements themselves said: namely that there was an agreement; to carry out a Build and Transfer of the identified Works; which would become 'binding' upon approval by the directors of the parties.
It would have been 'extreme or fanciful' for the audience of investors to have understood the market announcements as directing attention to the question of enforcement of the agreements by an Australian court if the parties later disagreed (at ).
Accordingly, it was not necessary for the majority judges to pronounce upon whether the framework agreements were legally enforceable. However, they noted that if the market announcements had been statements that the agreements were legally enforceable, the question would arise, under whose law? There was a 'real and lively possibility' that the validity of the agreements might be governed by Chinese law (at ). They also commented that the public expression of acceptance by the Chinese SOEs at signing ceremonies of what were described as binding obligations might be a much more powerful spur to performance of ... obligations than any possible legal action (at ).
2. Agreements 'to build and transfer'
The majority judges rejected ASIC's argument that it was misleading to describe the agreements as 'Build and Transfer' contracts. They did so because the agreements described themselves as agreements to 'Build and Transfer', and contemplated fuller and more detailed agreements. It does not follow from the fact that there were to be fuller agreements, that it was inaccurate to describe the framework agreements as 'Build and Transfer' contracts .
3. Fact v opinion
The trial judge and the Full Federal Court emphasised the distinction between statements of fact and statements of opinion. An incorrect statement of fact is necessarily misleading. If the statement is a statement of opinion, the question is whether there is a reasonable basis for it. The Full Court found that the statement that FMG had entered into binding contracts to build and transfer was a statement of fact (if I say I have sold my car for $1000, I am not expressing an opinion about whether a court would find I have a binding agreement, I am stating a fact).
The majority judges rejected this approach . They said it was unprofitable to attempt to classify a statement according to some 'taxonomy, no matter whether that taxonomy adopts as its relevant classes fact and opinion, fact and law, or some mixture of these classes'. Instead the court should examine closely what it is that the statements conveyed to the audience.
Heydon J took a different approach on this point. He regarded the market announcements as necessarily statements of opinion about the legal effect of the agreements, because 'the binding quality of an alleged contract is an inherently controversial matter of professional judgment' . He found it unnecessary to decide whether a statement of opinion conveys not only that the opinion is held, but also that there is a basis for it. He contemplated that judicial recognition of a duty to have reasonable grounds when expressing an opinion would widen misleading and deceptive conduct liability (at ).
In order to assess whether there was a reasonable basis for the expressions of opinion in the market announcements, it is first necessary to identify the opinion in fact conveyed. In Heydon J's view, the audience to whom the market announcements were directed would not have understood FMG as claiming agreements that would make it 'practicable to force' the SOEs to build, transfer and finance the railway, as ASIC alleged. The target audience would have understood the representations as being less high and less intense - namely representations that there was a binding agreement containing machinery capable of procuring the result that the SOEs would voluntarily build, transfer and finance the project (at , ).
Heydon J reached this conclusion after an analysis of the target audience (at ). It was an investor audience and it was not naive:
It was not an audience to whom the adjectives 'Western Australian', 'mining' and 'Chinese' would excite a sudden certainty about the imminent creation of wealth beyond the dreams of avarice.
It was a 'tough, shrewd and sceptical' audience conscious of the problems of creating infrastructure in the harsh conditions of Western Australia, and in doing so in cooperation with the Chinese. This audience would have realised that a legal agreement is unlikely to be enough to 'force' the Chinese SOE to do anything:
When Bismarck was asked during the war of 1870 how he would force the British Army to surrender if it landed on the Baltic Coast, he said he would send a police constable to arrest it. Fortescue's target audience would have known that it would be very much less easy for Fortescue to deal with the People's Republic of China.
4. Misleading conduct and fraud
ASIC alleged that either the market announcements were misleading statements of fact, or were statements of opinion for which FMG did not have 'a genuine and/or reasonable basis.' According to the majority judges, this latter allegation amounted to claiming that FMG was making either a fraudulent or negligent misrepresentation.
The allegation of fraud or negligence was out of place in misleading conduct case, where there should be only two questions: what was conveyed by the market announcements to the intended audience, and was that misleading or deceptive? (at ):
It is fundamental, and long established, that if a case of fraud is to be mounted, it should be pleaded specifically and with particularity. ... it is greatly to be doubted that it will ever be appropriate to pile, one on top of the other, as many alternative allegations as were made in this case. [Although sometimes a case may be pleaded in alternatives, this does not extend to] planting a forest of forensic contingencies and waiting until final address or perhaps even an appeal hearing to map a path through it. In this case, there were hundreds, if not thousands, of alternative and cumulative combinations of allegations. (at -)
ASIC's allegation, that the framework agreements did not state certain matters, was without foundation, and 'embarrassing to the fair trial of the proceedings'. (at )
5. Continuous disclosure
The conclusion that FMG's market announcements were not misleading was enough to dispose of ASIC's claim that FMG breached its continuous disclosure obligation by failing to correct the misleading information it had put into the market.
ASIC sought leave to advance an alternative case of contravention of the continuous disclosure obligation, by claiming that even if FMG had made no public announcements, it would have been obliged to disclose the terms of the agreements. The majority judges found that the market announcements accurately conveyed to their intended audience what the agreements provided, and so it was not to be supposed that FMG's continuous disclosure obligation would require it to publish the very text of the agreements (at ).
Heydon J said that on ASIC's case, the framework agreements were no more than unenforceable agreements to agree, and if that were true they would have been of trivial significance and not likely to influence the share price (at ). His Honour did not consider whether there would have been an obligation to disclose the agreements if they had the legal effect he attributed to them.
6. Directors' duties
As ASIC had failed to establish a breach of the misleading conduct or continuous disclosure provisions, its claim that Mr Forrest breached his duty of care by failing to prevent FMG from contravening the law must necessarily fail. The High Court therefore did not make any comment in relation to the content of the statutory duty of care and diligence or the business judgment rule.
7. The concluding remarks of the majority judges
The majority judges defended the High Court's decision against any criticism that the decision had artificially limited the protection afforded to the investing public -. They said they had not decided that, when a company makes a market announcement that it has a contract with another company, this necessarily conveys nothing more than a message about what the contract document contains. They said the message conveyed by market announcements to the intended audience can only be determined by a close and careful analysis of the facts. This suggests that the High Court's decision should be regarded as very fact specific.
The majority judges also drew attention to the protection for investors that is provided by the law in a case where a market announcement is fraudulently or dishonestly made (at ).
Some comments on the High Court's judgment
Does the judgment lower the bar for continuous disclosure? According to the majority judges, the market announcements were accurate and not misleading, even though on an objective view there were significant gaps in the disclosed arrangements regarding pricing, conditions and other matters. Does it follow that other listed entities can disclose their material contracts to the market in the same limited way?
We think not. This was a special case, in which the binding nature of the framework agreements was affected by the fact that FMG's counterparties were Chinese SOEs, and the agreements expressly stated that they were binding even though more detailed agreements were to be developed.
In more routine circumstances, listed entities will be well advised to make careful disclosure of all of the salient terms of a material contract, immediately after (and possibly even before) entering into it. They should consider whether it is appropriate to give ASX a copy of the contract. The overriding obligation is to disclose, immediately, all information concerning the contract that a reasonable person would expect to have a material effect on the price or value of the entity's securities.
The High Court did not give general guidance on the content of the continuous disclosure obligation. But, with respect, one wonders whether Heydon J was right to say that if the framework agreements had been unenforceable agreements to agree (as ASIC alleged), there would have been no disclosure obligation because they would have been trivial and unlikely to influence the share price. That, surely, is a matter of fact to be determined on the evidence, but conceivably announcements about 'agreement to agree' arrangements with Chinese SOEs, even if expressly declared to be unenforceable, might have boosted the FMG share price.
While our overall conclusion is that the continuous disclosure obligation remains firm and undiminished, there is one aspect of the judgment that is troubling. This is Heydon J's assessment, apparently without relying on any evidence, that the target audience for the market announcements was relatively sophisticated.
That is out of line with the more common perception within the corporate community and corporate advisers that market disclosure must recognise a target audience that includes retail investors for whom very little, if any, sophistication can be assumed. If Heydon J's approach on this question were to be accepted, the quality and utility of market announcements could well decline.
The High Court's decision will demand several responses from ASIC. First, ASIC and its legal advisers will have to take to heart the highly critical comments made by the majority judges about the complexity of ASIC's pleaded case. When ASIC frames future proceedings, it will be more important than ever to limit the issues for determination with surgical precision, so as to select issues that do not require extensive and expensive factual investigations, that can be presented in a clear and linear fashion, and that invite the court to adopt a principle that will provide guidance to the market.
Second, ASIC will need to decide whether the High Court's judgment should alter its enforcement strategy, for example by accelerating the tendency to deal with continuous disclosure by infringement notices and enforceable undertakings rather than by litigation (as to the use of infringement notices see our Leighton Holdings alert).
We suggest that increased use of infringement notices is undesirable because of their potential unfairness for the listed entity concerned (which may, as a practical matter, prefer to pay a fine than to go to the expense and effort of establishing its innocence), and also because the infringement notice procedure does not generate principles for guidance of the market in areas of uncertainty.
Of course, there is no guarantee that pursuing a civil case to judgment will lead to the establishment of a principle to guide listed entities about their disclosure obligation. As shown above, the High Court has decided the Fortescue Metals case on a narrow, fact-specific basis. But it is of some significance that, since the High Court limited the scope of its decision, much of what the Full Federal Court said remains 'on the table', though resting in the shadowy light of compromised precedent.
Thus, it remains open to future courts to develop the duty of listed entities to make corrective disclosure when the market is misinformed, to explain more fully the extent to which corporate contravention exposes the corporation's directors to a charge of breach of their statutory duty of care and diligence, and to give more flesh to the business judgment defence.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.