Australia: Corporate Update

• Continuous disclosure obligations – damages implications
• ASX's Corporate Governance Consultation Paper

• Ranking of shareholder claims upgraded... or are they? : Sons of Gwalia Ltd v Margaretic [2007] HCA 1

• Third Line Forcing Changes: Relief for Franchisors

Continuous disclosure obligations apply to listed companies and some unlisted companies.

In broad terms, the obligation is that the company discloses information which is not generally available and is such that a reasonable person would expect to have a material effect on the price of the company’s shares.

A recent decision of the Western Australia Supreme Court awarded damages to a shareholder against a company where the company failed to comply with its obligations of continuous disclosure.

Jubilee Mines ("Jubilee") was an explorer of gold with limited cash resources. Mr Riley, the Managing Director, was allotted a significant number of shares. Mr Riley resigned from his position of Managing Director in 1993, however he maintained ownership of his shares until selling them in 1995.

In the meantime, in 1994, Jubilee received a letter from Western Mining Corporation informing them that nickel had been found in land covered by one of their mining tenements. This information became a central issue in this case. It was argued that this information was market sensitive in nature. As a result, it would substantially affect Jubilee’s share price upon its release.

It was not until 1996 that Jubilee announced the results of this discovery. In 1997, there was a further announcement that Jubilee had received "spectacular results from the mining" of nickel deposits. As a result, the share price substantially increased.

Mr Riley's claim as a shareholder of Jubilee was framed as a contravention by the Directors of Jubilee in failing to release the information contained in the Western Mining Corporation letter to the ASX. As a result, Mr Riley, as a shareholder and someone who commonly invests in shares, suffered damage when he sold his shares for a price that was considerably less than it would have been had the information been released.

It was held that Jubilee negligently failed to notify the ASX of the information contained in the letter from Western Mining Corporation, which had a material effect on the price of its shares. It was further held that the information was ‘likely’ to have influenced investment and share prices and as a result, should have been disclosed.

The damages that Mr Riley sought were calculated as the difference between the price of the shares after the material announcements were made to the market, and the price of the shares when Mr Riley sold his shares.

The court held that Mr Riley suffered a foreseeable loss as a result. Damages were awarded to Mr Riley in the amount of $1.856 million.

Mr Riley’s success is likely to encourage shareholders to bring claims to similar effect under the current provisions of the Corporations Act. Companies may be liable to shareholders where they do not disclose information relevant to the price of shares. The possible implications of this case should be read in light of the recent High Court decision in Fostif, where the High Court endorsed the practice of litigation funding in jurisdictions where the torts of maintenance and champerty had been abolished.

The case is also a reminder about the obligations of publicly-listed companies under the continuous disclosure rules to release price-sensitive information promptly to the market.
By Alan Eden or Michael Owens.

In November 2006, ASX’s Corporate Governance Council released its proposed changes to the Guidelines in the shape of its Explanatory Paper and Consultation Paper on Good Corporate Governance and Best Practice Recommendations. There are several drivers for change, including legislative changes to company law triggered by CLERP 9 and practical experience suggesting changes to the Guidelines were necessary.

Particular areas that are targeted for review are as follows:

• Recasting ethical and responsible decision-making.

• Amending the concept of material business (or non-financial) risk.

• Strengthening the audit committee functions and composition.

• The role of the Corporate Governance Council concerning sustainability and corporate responsibility.

The consultation review period ended during February 2007. The revised guidelines are intended to come into operation on 1 July 2007.

For more information, contact Alan Eden or Prins Ralston.

Section 563A of the Corporations Act 2001 states a very simple priority rule when it comes to competing claims by creditors and shareholders against companies: shareholders come last. This provision does not, however, operate in a vacuum. Australian law gives people various rights to sue for misleading and deceptive conduct, including one contained under section 1041H of the Corporations Act 2001. Alongside section 563A, section 553 allows all debts payable by, and all claims against, a company subject to a winding up to be admissible to proof against the company.

In the Sons of Gwalia case, the High Court has confirmed that some claims by a shareholder are not postponed to those of unsecured creditors in the winding up of a company. In this case, a shareholder of Sons of Gwalia Ltd claimed that he suffered financial loss and damage by reason of buying shares in the company on the ASX because the company breached its continuous disclosure duties by not disclosing its true financial position and prospects to the market and this breach (by omission) was misleading and deceptive. The shareholder was not a foundation or subscriber shareholder. As a result of this failure to adhere to the continuous disclosure rules, the shareholder lost all of his money because the shares he purchased were valueless.

Six of the seven Justices of the High Court of Australia ruled that the shareholder’s claims for misleading or deceptive conduct by the company (as well as a claim based on the wrong of deceit) were independent of section 563A. Two results followed. First, the shareholder's claim was not ranked last. Secondly, the shareholder’s misleading or deceptive conduct claim and deceit claim were admissible to proof on the winding up of the company.

Sons of Gwalia Ltd v Margaretic will mean different things to different members of the commercial community. Shareholders will draw comfort from the decision as reinforcing their position in a winding up where they can establish claims for misleading and deceptive conduct against the company (and if necessary, directors and senior managers). Insolvency administrators and liquidators may consider that this decision complicates the administration of winding up. For directors and senior managers, the decision emphasises the need for prompt release of market-sensitive information in accordance with the continuous disclosure regime. For the finance industry, it is suggested that companies may experience difficulties in attracting investment or finance, especially from those overseas markets (such as US) where shareholder claims are always subordinated to those of creditors. The UK experience (where shareholders with similar claims may rank equally with creditors) does not appear to support those claims.

As a postscript, readers might be interested to know that since this decision came down, there have been calls from business and finance community for legislative intervention to introduce US- and Canada-type provisions into Australian law. In the US and Canada, specific legislation prevents shareholders from ranking equally with ordinary creditors for damages claims for losses arising in respect of the acquisition of their shares. The Parliamentary Secretary to the Treasurer has requested that the Corporations and Markets Advisory Committee (CAMAC) examine three issues raised by this case:

1. Should shareholders who acquired shares as a result of misleading conduct by a company prior to its insolvency be able to participate in an insolvency proceeding as an unsecured creditor for any debt that may arise out of that misleading conduct?
2. If so, are there any reforms to the statutory scheme that would facilitate the efficient administration of insolvency proceedings in the presence of such claims?
3. If not, are there any reforms to the statutory scheme that would better protect shareholders from the risk that they may acquire shares on the basis of misleading information?

Readers should keep watching this space for any relevant updates which Gadens Lawyers will bring you as they happen.

Readers may also be interested in our other article concerning the successful shareholder’s claim in the Jubilee case in Western Australia. Taken together, both cases have given an impetus to shareholder claims and excited the interest of litigation funders.
By Alan Eden or Michael Owens.

Franchisors have long been concerned by the impact of section 47 of the Trade Practices Act 1974, which prohibits certain forms of what is known as "exclusive dealing". Basically, exclusive dealing takes place when a supplier (whether a corporation or an individual) of goods and services supplies those things to its customers on the condition that the customer also buyers other goods and services from the same supplier (second line forcing) or an affiliate of it (in which case the exclusive dealing is third line forcing). Many franchisors use related companies to supply different products to the franchisee, which in combination are integral to the successful working of a franchise. This takes place often for reasons such as economies of scale and enhanced purchasing power.

In December 2006, section 47 of the Trade Practices Act 1974 was amended by carving out from third line forcing under sections 47(6) and 47(7) any third line forcing practised on a person by related corporations. While this amendment is not confined to franchisors, franchisors will welcome this change because it reduces the risk of exposure of liability to a pecuniary penalty of up to $10,000,000 (or even higher, depending on the circumstances) for any exclusive dealing conduct. What is a related corporation depends on the application of standard rules and the Corporations Act 2001.

Previously one way of obtaining protection from prosecution for third line forcing conduct was by notification of such conduct to the Australian Competition and Consumer Commission ("ACCC"). Notification of third line forcing by related corporations is no longer required.

Franchisors should consider the amendments in review of commercial sourcing and downstream supply arrangements (including their franchise agreements) to see how they can take advantage of the liberated third line forcing provisions in the Trade Practices Act 1974.
By Michael Owens.

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