Some important issues arising out of the Full Federal Court's judgment, discussed in this note, are:
- the importance of carefully distinguishing between statements of fact and statements of opinion in market announcements, and carefully identifying the grounds for opinions
- the "duty to correct" false market information, under the continuous disclosure regime. Compliance programs should now make provision for regular review of information in the market, to make sure no material correction needs to be made
- some limitations on the "due diligence" defence for those involved in breach of the continuous disclosure obligation, and on the "business judgment" defence to the statutory duty of care and diligence(especially when invoked in the context of breach of the continuous disclosure obligation).
In a nutshell
Fortescue Metals Group (FMG) made three announcements to the ASX in August and November 2004, regarding some agreements it had made with three Chinese companies for the construction of the company's mine in the Pilbara, a railway from the Pilbara to Port Hedland, and a port at Port Hedland. The announcements stated that FMG had binding "build and transfer" contracts with the Chinese companies. In March 2005 a newspaper article claimed that the agreements were not binding "build and transfer" agreements.
ASIC took proceedings against FMG and its chief executive, Andrew Forrest, alleging that the ASX announcements were misleading or deceptive contrary to the Corporations Act, that FMG had failed to discharge its continuous disclosure obligations under the Act, that Mr Forrest was involved in those contraventions, and that he breached his statutory duty of care as a director and officer of FMG.
ASIC failed before Gilmour J, who held that the announcements were not misleading or deceptive because they were statements of opinion by FMG and Mr Forrest as to the binding nature of the agreements that had been entered into with the Chinese companies, and Mr Forrest and the company honestly and reasonably believed that the agreements were binding.
The Full Federal Court has overturned Gilmour J's judgment, holding that:
- the statements in the ASX announcements concerning the binding effect of the agreements were statements of fact rather than mere expressions of opinion
- they conveyed to a reasonable investor the message that FMG had made binding "build and transfer" contracts with the Chinese companies
- the statements were misleading because the agreements were merely agreements for further negotiations that did not immediately bind the Chinese companies to "build and transfer" the construction works to which they referred
- FMG therefore engaged in misleading conduct contrary to the Corporations Act
- Mr Forrest knew all relevant facts and was actively involved in that contravention
- by failing to correct the misleading information in the announcements, FMG breached its continuous disclosure obligation under the Corporations Act
- Mr Forrest was knowingly involved in that contravention
- by failing to prevent FMG from contravening the Corporations Act, Mr Forrest breached his statutory duty of care under the Corporations Act.
The Full Court has ordered that the matter be remitted to a Judge of the Federal Court. The Judge will deal with the penalties to be imposed in consequence of the Full Court's determinations. These could include pecuniary penalties and, in the case of Mr Forrest, an order disqualifying him from managing corporations for a stated period.
FMG is a public company listed on the ASX. Andrew Forrest is chief executive officer of FMG and is a substantial shareholder.
It was well known during 2004 that FMG was endeavouring to develop a very large iron ore project in the Pilbara, for which it needed major financing support. An analyst's report in July 2004 said the project involved a $450 million mine, a $930 million railway and a $470 million port, and aimed to be producing by the 2007 financial year.
On 5 April 2004 a market analyst stated that the conditions necessary for financial close of the project were "the completion of a feasibility study, proof of financially robust project economics, completion of environmental, aboriginal and heritage permitting and approval issues, and equity and debt fundraising commitments". In July 2004 FMG appointed a manager for the preparation of a Definitive Feasibility Study (DFS) for the project. That appointment was noted in media reports. On 9 August 2004 FMG announced that the DFS would cost $34 million, and it emerged from subsequent reports that FMG would need to obtain funds to carry the DFS through to completion. The market was aware of the critical importance of the DFS to the project's prospects. Without a viable DFS, no bank would lend to the project.
According to the trial judge, general market opinion of FMG in August 2004 reflected an air of scepticism. Nevertheless, by November 2004 FMG had defined substantial iron ore reserves and had entered into some firm sales contracts.
In early 2004, FMG and Mr Forrest entered into negotiations with three Chinese companies for the construction of a railway, port and mine in relation to the Pilbara project. The negotiations led to the execution of the three agreements summarised below, notwithstanding the absence of a completed DFS. There was evidence that the Chinese companies were keen to enhance market perception of their own capacity by doing business in a first world country such as Australia. The signing ceremonies for the contracts were high-level and solemn occasions, widely reported in China as well as Australia.
The first agreement, signed on 6 August 2004, was with China Railway Engineering Corporation (CREC), relating to the construction of a railway line from the Pilbara to Port Hedland. The second, signed on 1 October 2004, was with China Harbour Engineering Company (CHEC), relating to the construction of a port for the Pilbara project. The third, signed on 20 October 2004, was with China Metallurgical Construction Corporation (CMCC), relating to the construction of the mine and process plant for the Pilbara project.
The agreements are each described in the body of the document as a "framework agreement". They are in similar terms, except for the description of the work to be undertaken in each case. Each agreement recited that:
- the Chinese company, having closely examined all proposed documents, has submitted an offer to execute the works and FMG has accepted the offer, and the parties now wish to evidence that agreement, and
- the Chinese company will confer with the Chinese government to determine whether it will be authorised to carry out the works for the Project.
There was evidence that the financing and building of the projects by the Chinese companies would require approval from an agency of the Chinese government known as the National Development and Reform Commission (NDRC), and that a condition of approval would be that a Chinese investor take an interest in the project equity.
Broadly, the agreements provide, among other things, that the parties will jointly develop and agree in good faith on several matters, including General Conditions of Contract suitable for a Build and Transfer type contract, the Scope of the Work to be included in the Contract, Definitive engineering design, and the Value of the Works. The Value of the Works is not identified and no mechanism is given for calculating it. However, FMG agrees to provide security and the parties agree to terms of payment.
Each agreement was expressed to become binding upon the approval of the boards of directors of the relevant Chinese company and FMG, and also stated that:
'This document represents an agreement in itself, and it is recognised a fuller and more detailed agreement not different in intent from this agreement will be developed later.'
The announcements to ASX, and their effect on the FMG share price
FMG made three announcements to the ASX about the agreements.
On 23 August 2004 FMG sent a letter to the ASX, which referred to a media release of the same date on the company's website, relating to the CREC agreement. In the 23 August letter, FMG announced that it had entered into "a binding contract" with CREC "to build and finance the railway component of the Pilbara Iron Ore and Infrastructure Project". The letter said that the "Build and Transfer" contract covered the railway from the Company's iron ore tenements to the export hub at Port Hedland.
The letter referred to a media release, a longer document which again referred to the execution of a "binding agreement to build and finance the railway component" of the Pilbara iron ore project, described in the release as a "Build and Transfer" contract. In the media release, Mr Forrest was quoted as saying that "Build and Transfer" contracts are common in the international engineering and construction industry, and that under such a contract, the provider designs to customer specification, builds, commissions and then transfers the facility to the customer. The release said that "under the terms of the contract, CREC will take full risk under a fixed price agreement on the rail project ...". CREC approved the terms of this media release.
On 5 November 2004 FMG sent a letter to the ASX, which referred to a media release of the same date on the company's website, relating to the CHEC agreement and the CMCC agreement. Again the letter announced that FMG had executed "binding contracts" with CHEC and CMCC, "pursuant to a design, build and finance arrangement for the respective component parts of FMG's Port Hedland ship loading and stockyard facility and FMG's Mine Processing Plant". The media release said that "binding contracts" announced and signed that afternoon in Beijing "commit Chinese financing and construction support for the A$1.85 billion iron ore and infrastructure project". It said that "the three agreements now form a total project construction and finance solution", and specified that the three Chinese companies were committed to provide financing, design and construction of their respective components of the project. Gilmour J found that CHEC and CMCC approved, or at least did not disavow, the terms of this media release.
FMG's letter to the ASX of 8 November 2004 responded to a request that FMG provide the ASX with the material terms of the framework agreements. The letter did not do so, except for a summary of the arrangements for payment by instalments. Instead the letter emphasised "further developments" including the signing of separate agreements by CHEC and CMCC with Australian engineering and contracting companies, while referring incidentally to the "three separate agreements" that covered "the three important component parts" of FMG's Pilbara Iron Ore Infrastructure Project (namely rail, port and processing plant).
The basic claim in these letters and media releases, namely that FMG had executed binding agreements with each of CREC, CHEC and CMCC to build, finance and transfer the railway, port and mine for the Pilbara project, was repeated in a number of subsequent publications by FMG. These included an announcement at a press conference held after publication of the 23 August 2004 releases, when Mr Forrest said that the price of the railway line was "confidential but we are pleased to say it is competitive".
FMG's share price rose from 59 cents at the close of trading on 23 August 2004 to $1.93 at the close of trading on 9 November 2004, and then to the closing price of $5.05 on 23 March 2005.
Gilmour J found that, notwithstanding FMG's announcements to the market in August and November 2004, the market was aware that significant aspects of the framework agreements still had to be agreed upon through the DFS process, and that each of the framework agreements was ultimately dependent on a bankable DFS.
The newspaper article
In March 2005 an article was published in the Australian Financial Review which asserted that the framework agreements did not impose any legally binding obligation on the Chinese companies to build, finance and transfer the railway, port and mine. The share price fell after publication of the article, but subsequently improved over the closing price of $5.05 on 23 March 2005.
Gilmour J found that the AFR article was engineered by Mr He of the NDRC as a blunt commercial tactic in an attempt to wrest majority control of the project from FMG. He said the article did not reflect the actual views of the Chinese contractors, who regarded themselves as bound by the framework agreement to build the infrastructure.
FMG provided copies of the framework agreements to the ASX on 29 and 30 March 2005.
ASIC initiated the present proceeding in March 2006, after investigations. It sought a declaration that FMG had engaged in misleading and deceptive conduct under s1041H of the Corporations Act, by falsely representing to the investing public that the framework agreements were enforceable agreements to build, finance and transfer the railway, port and mine. Since s 1041H is not a civil penalty provision, the declaration of contravention of that provision was essentially a stepping stone towards the conclusion that FMG contravened its continuous disclosure obligation in s 674(2).
ASIC claimed that FMG contravened s 674(2) by:
- failing to disclose the terms or true meaning of the framework agreements, or
- making inaccurate disclosure of the framework agreements, or
- failing to correct its misstatements as to the terms of the framework agreements.
It claimed declarations of contravention and pecuniary penalties against FMG.
ASIC alleged that Mr Forrest was involved in FMG's contraventions of s 1041H and s 674(2) because he authorised or approved the letters and media releases sent to the ASX. ASIC also alleged that Mr Forrest contravened the statutory duty of care and diligence in s 180(1) of Corporations Act, because his involvement in the contravening conduct exposed FMG to pecuniary penalties.
In contrast with the James Hardie case, ASIC did not claim that the rest of the FMG board were involved in the contravention and in breach of their duty.
The judgment at the trial
Gilmour J comprehensively rejected ASIC's case. He held that:
- FMG had not engaged in misleading and deceptive conduct because:
- its statements about the binding nature of the framework agreements were necessarily statements of opinion as to their legal effect;
- FMG's directors, including Mr Forrest, honestly and reasonably held the opinion they expressed;
- FMG honestly and reasonably believed that the NDRC had approved the making of the framework agreements, and that agreement upon the issue of equity to a Chinese entity would be a mere formality;
- likewise, FMG did not fail to comply with its continuous disclosure obligation because:
- FMG, by its directors and officers (including Mr Forrest), honestly and reasonably believed that the framework agreements bound the parties to build, finance and transfer the railway, port and mine;
- therefore FMG did not become aware of the information alleged by ASIC (namely that the agreements were not binding), and there was nothing for it to disclose;
- since FMG had not engaged in misleading conduct and had not failed to meet its continuous disclosure obligation, Mr Forrest could not have been involved in any such contravention by FMG, and therefore the case against Mr Forrest also failed.
Gilmour J considered whether, in the event that (contrary to his conclusion) the making of the framework agreements should have been disclosed under s 674, their non-disclosure would be regarded as having a material effect on the price or value of FMG shares (that is, whether the information in the framework agreements would be likely to influence persons who commonly invest in securities in deciding whether to acquire or dispose of FMG shares: s 677). There was conflicting expert evidence on this question. Gilmour J concluded that the 23 August announcement did not have any statistically significant effect on the FMG share price, but the November announcements did.
Although his Honour's conclusions on other issues made it unnecessary for him to consider the scope of the continuous disclosure obligation, he nevertheless expressed the view that s 674 and Listing Rule 3.1 only require the disclosure of omitted material, and do not require the disclosing entity to correct information already provided to the ASX.
ASIC's allegation of dishonesty
At the trial ASIC attacked the claim by FMG and Mr Forrest that they had an honest and reasonable belief that the framework agreements were binding build and transfer agreements. ASIC accused FMG, its board and in particular Mr Forrest, of deliberate dishonesty in making those claims while knowing that they were false. It said there was no evidence that FMG obtained any legal advice concerning the agreements, and that if it had obtained competent legal advice, it would have been aware that the framework agreements did not bind the Chinese contractors to build and transfer the infrastructure.
Gilmour J said that in fact FMG did have the benefit of competent professional legal advice in relation to the framework agreements. He referred to the minutes of the FMG board meeting on 22 January 2005 and an e-mail of 30 March 2005, which record the advice of Mr Huston, a solicitor employed by FMG, that the CMCC framework agreement was binding. The judge said Mr Huston was a very experienced and competent commercial solicitor. Moreover, he trenchantly criticised ASIC for not referring to these documents at the trial, saying he only became aware of their existence during the closing address by Mr Forrest's senior counsel. He said the documents demonstrated there was no basis for ASIC to assert dishonesty on the part of FMG, its board and, in particular, Mr Forrest. He said that allegations of dishonesty should be made only where there is a reasonable evidentiary basis for them.
On appeal, Keane CJ noted that the board minutes of 22 January 2005 were the subject of a claim of privilege by FMG until after ASIC had made its final address at the trial; and more importantly, the evidence did not support any inference that Mr Huston gave FMG legal advice supporting the reasonableness of FMG's public statements at any time before the statements were made.
The Full Court's findings
The Full Court (Keane CJ, Emmett J and Finkelstein J) disagreed with Gilmour J's finding that a statement about the legal effect of an agreement is necessarily a statement of opinion. The question whether a statement is misleading or deceptive is to be assessed by considering how the statement would have been regarded by an ordinary and reasonable investor.
The Full Court held that FMG's market announcements were not statements of opinion, but were unequivocal assertions that the Chinese contractors had assumed a legally enforceable obligation to build the infrastructure for the project on terms that included deferred payment by FMG. The Court held that ordinary and reasonable investors would have taken the 23 August announcement to mean that the uncertainty that had previously attended the financing of construction of the railway for the project, in the absence of a completed DFS, had been resolved.
The Full Court found, after closely analysing the framework agreements, that they could not be accurately described as binding agreements to build, finance and transfer the infrastructure for the project.
Consequently, FMG's market announcements were misleading and deceptive, contrary to s 1041H of the Corporations Act.
As to continuous disclosure, the Full Court decided that since misleading statements had been made to the market by FMG, and the information that the statements were misleading would be expected by a reasonable person to have a material effect on the price or value of FMG shares, s 674 required that the statements be corrected.
The Full Court held that Mr Forrest knowingly participated in the events leading to FMG's misleading or deceptive conduct, as he was chief executive officer and was intimately and directly involved in negotiations with the Chinese and the execution of the framework agreements. He knew of the terms of the framework agreements and the disparity between those terms and FMG's representations about them. Therefore he was involved in FMG's misleading or deceptive conduct, and he was also involved in FMG's failure to comply with its continuous disclosure obligation. He contravened his statutory duty of care and diligence by allowing FMG to fail to meet its continuous disclosure obligation, thereby exposing it to pecuniary penalties. Mr Forrest failed to establish the "due diligence" defence to liability for involvement in a continuous disclosure contravention (s 674(2B)), and the business judgment defence to the statutory duty of care (s 180(2)).
Statements of opinion and statements of fact
The Full Court has provided some important guidance as to the distinction between statements of opinion and statements of fact in market announcements.
First, the Full Court emphasises that for the purpose of applying the "misleading and deceptive conduct" provisions, the Court's task is to identify the representations that were conveyed to ordinary and reasonable investors by the market announcement, and to determine whether those representations were untrue when made. The making of statements may be misleading or deceptive conduct even if the person who makes the statements had no intention to mislead or deceive and did not know or even suspect that the statements were untrue. A person's conduct may be misleading or deceptive even though the person has acted honestly and reasonably.
Secondly, a statement about the legal effect of an agreement may be a statement of fact or a statement of opinion, depending on the meaning conveyed to the ordinary reasonable recipient, a matter which in turn depends on the language used and the context in which the statement is made. As Keane CJ said:
"If I tell an audience that I sold my car for $1000 I would not ordinarily or reasonably be taken by my audience to be saying no more than that it is my belief that the terms of a document I have signed could arguably be interpreted by a court to mean that I have sold my car for $1000. My statement would ordinarily and reasonably be understood as an account of what has actually occurred by way of the making of an agreement and of the terms which are contained in it."
Thirdly, a statement of opinion may amount to misleading or deceptive conduct, because the statutory provision is not confined to statements of fact. But a statement that is recognisable as a statement of opinion will not be misleading or deceptive even if the opinion is wrong, provided the opinion is genuinely and reasonably held by the person who puts it forward.
It is therefore important to distinguish between statements of fact and statements of opinion. A statement of opinion in a market announcement conveys the idea to ordinary and reasonable investors that the statement expresses a view on which a different opinion might also be entertained, in contrast with a matter of fact about which no doubt can be entertained.
The lesson for the drafter of a market announcement is to consider whether statements that are proposed are in the nature of opinions or statements of fact, and then to make sure that the drafting indicates which category is selected.
The Full Court does not expressly require that, in order to avoid being misleading or deceptive, a statement of opinion should include the basis for the opinion. But if the basis for the opinion is not included, there is a risk that the statement will be construed as a statement of fact not allowing for alternative views, or that it will not be regarded as an opinion genuinely and reasonably held. Keane CJ said that the obvious solution for FMG would have been to disclose the full terms of the framework agreements.
The true effect of the agreements: "agreements to agree" and agreements to negotiate
All three judges deal at some length with the question whether the framework agreements were legally binding agreements for the building of the infrastructure of the project. The issues they address relate to the construction of commercial contracts, rather than company law, and so this part of the judgments will not be analysed in detail here.
However, every lawyer who drafts a commercial agreement will benefit from the summary of the law, especially in the judgment of Keane CJ, on such matters as "agreements to agree" and the "Masters v Cameron" issue, the general approach of the courts to the construction of commercial agreements, the significance of the recitals to an agreement, judicial techniques for assessing the intention of the parties, and the significance of providing for a third-party to decide on the terms of the final agreement.
The duty to correct a misleading market announcement
The continuous disclosure obligation imposed by s 674 and Listing Rule 3.1 does not necessarily require a disclosing entity to correct information already provided to the ASX. But according to the Full Court, a corrective announcement is needed if the correction is information that is material to the price or value of the disclosing entity's securities: that is, if the corrective information would be likely to influence investors in deciding whether to acquire or dispose of the securities of the entity.
The Full Court's clarification of the "duty to correct" is important for listed entities and their directors. Compliance programs should now make provision for regular review of information in the market, to make sure no material correction needs to be made. In principle, the "duty to correct" applies not only where the misleading information came from the company itself, but also if misleading information has been put into the market by someone else.
In the James Hardie case in the Court of Appeal of New South Wales, the principal question was whether the directors had approved the draft media announcement claiming that the new foundation was fully funded. There was no issue before the Court of Appeal as to whether the directors should have made a corrective market announcement. Now the Fortescue case tells us that if the corrective information is material, an announcement is required.
Mr Forrest's "due diligence" and "business judgment" defences
Section 674(2), read in conjunction with Listing Rule 3.1, establishes the continuous disclosure obligation for a listed disclosing entity. Section 674(2A) creates liability for a person who is involved in a listed disclosing entity's contravention of s 674(2). Section 674(2B) says that a person does not contravene s 674(2A) if they prove that they took all steps (if any) that were reasonable in the circumstances to ensure the listed entity's compliance, and after doing so, believed on reasonable grounds that the listed entity was complying.
Mr Forrest submitted that he was protected by s 674(2B) because there were "reasonable grounds" upon which he had formed the belief that the framework agreements were binding. The Full Court disagreed, for two reasons. First, a person invoking the defence must prove that they took all steps that were reasonable to ensure compliance with the entity's disclosure obligations. Mr Forrest was not able to point to any steps he took to ensure that the framework agreements were, in law, binding agreements to the effect represented by FMG. Secondly, there was evidence that at the end of October 2004 Mr Forrest knew that further steps were necessary to reach agreement on the scope, financing, subject matter and price of the project.
Thus, where the listed entity's contravention is a failure to discharge the "duty to correct", a person invoking s 674(2B) needs to show that they took reasonable steps either to make the market information correct or to cause the entity to issue a correcting announcement.
The Full Court held that protection under the business judgment rule in s 180(2) was not available to Mr Forrest, for two reasons. First, a decision not to make accurate disclosure to the market of the terms of a major contract is not a decision relating to the "business operations" of the company and is therefore not a business judgment.
Secondly, according to Keane CJ, the business judgment rule cannot be construed as affording a ground of exculpation for a breach of the statutory duty of care and diligence, where the director's want of diligence results in a contravention of another provision of the Act, and the other provision contains specific exculpatory provisions enacted for the benefit of the director. This proposition is stated without elaboration or reference to authority. It will significantly limit the business judgment rule when it is invoked in the context of breach of the continuous disclosure obligation.
Was ASIC justified in prosecuting this case?
Keane CJ noted that it was a "curiosity" of the case that there was no evidence that any member of the investing public was misled by, or suffered losses as a result of FMG's contraventions of the Act. He said this was presumably because those who invested in FMG have profited handsomely from the investment, and "this circumstance may be said to raise a question as to whether the prosecution of this case by ASIC was a game worth the candle". He noted, however, that it was not for the Court to call into question the exercise of ASIC's discretion to determine which cases it should pursue. Emmett J expressed a similar view.
Finkelstein J, who generally concurred with the reasons of the Chief Justice, expressed a very different view on this point. He said one of the most important objectives of Chapter 6CA of the Corporations Act (which includes s 674) is to ensure that there is a fully informed and therefore efficient market for listed securities. Those trading in FMG shares during the period from 23 August 2004 to the end of March 2005 had been seriously misinformed about the affairs of the company. While there was no evidence of a complaint having been made that share traders had suffered loss, the only open inference from the evidence was that traders did lose money, possibly significant sums, if they sold before the price recovered. But he said that even if no one had made any significant loss, if the market was materially misled, it could hardly be right that a prosecution not commence because "by reason of serendipity" shareholders made a gain: "if that were the approach, the continuous disclosure obligations could be sidestepped by any successful corporation whose share price continued to climb after investors discovered that the corporation misled the market". He said it was not only proper for ASIC to have commenced the proceeding, but it would have been subject to just criticism had it failed to do so.
Where to from here?
The Full Court has declared that FMG and Mr Forrest contravened specified provisions of the Corporations Act, and has ordered that the matter be remitted to a Judge of the Federal Court. The Judge will have to consider appropriate penalties. The continuous disclosure provision is a civil penalty provision, and so FMG and Mr Forrest may be subject to pecuniary penalties, and Mr Forrest may be subject to a disqualification order.
The matters that have been held to be relevant to a "penalty hearing" include whether the case can be classified as serious misconduct, whether the respondent was aware of the impropriety of the actions at the time, whether the respondent has shown remorse and contrition, whether the respondent acted on the advice of professionals, and whether the respondent was of previously unblemished character. Obviously the findings and observations of the Full Court will be relevant, and additionally there may well be further evidence from both respondents going to the relevant matters. The "penalty hearing" is likely to be substantial.
Mr Forrest has announced an intention to appeal, though at this stage the grounds of appeal are not known. Parties wishing to appeal will have to seek special leave from the High Court.