The High Court delivered its decision in the Sons of Gwalia case (Sons of Gwalia Ltd v Margaretic; ING Investment Management LLC v Margaretic) on 31 January 2007.
In practical terms, the decision means that shareholders’ claims for damages for misrepresentation, misleading or deceptive conduct and/or breach of the statutory obligation of continuous disclosure, rank equally with claims of other unsecured creditors.
The decision has been commented upon widely, with observations that it has the potential to substantially complicate the process of external administration and increase the cost (and potentially availability) of unsecured debt finance.
Anecdotally, it seems that disclosure is the legal topic of greatest concern to listed company boards at present. And with good reason: the planets seem to be aligning in favour of shareholder litigants, as evidenced by the Sons of Gwalia case and several other decisions upholding the validity of litigation funding arrangements. Like it or not, shareholder litigation has well and truly arrived in Australia.
One aspect of this phenomenon which may have been overlooked to date, is the due diligence issue it creates in listed company M&A.
While event-specific share price weakness is often viewed by a bidder as creating a bid opportunity, it also brings additional risk.
A bidder for a distressed target, whose share price may have come under pressure following a ‘surprise’ announcement of a contract loss or earnings downgrade, will need to be aware that it may ‘inherit’ a significant liability to shareholder litigants if a class action were to emerge alleging breach of the continuous disclosure rules or other wrongful conduct. This is a liability of the target corporation, and while there may be rights against the directors (and their insurers) these can be costly and uncertain to pursue. Further, the Sons of Gwalia case suggests that it may not be possible to control the exposure to damages claims through structural means, such as a liquidation of the target.
It may be that a broader legislative response to these issues is required, addressing not only the ranking of claims in insolvency but also the proof and quantification of shareholder claims for breach of continuous disclosure or similar provisions. Interestingly, in Canada, both Ontario and most recently Alberta have introduced specific civil liability regimes for secondary market disclosure, with British Columbia considering following suit.
In the meantime, acquirers may need to employ some innovative thinking, including the use of contingent consideration and more sophisticated scheme of arrangement structures, in order to ‘quarantine’ potential exposures.
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This part will cover the legal position in relation to promotional materials and misleading and deceptive conduct.
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