On 19 November 2020, Shine Lawyers announced that they would appeal the judgment. In advance of the appeal, we have analysed the key takeaways of the primary judge's landmark decision, which (unless reversed on appeal) remain good law in Australia.
Lessons from Crowley v Worley
- Aggressive, stretch, or optimistic targets set in budgets and forecasts do not, in and of themselves, mean that representations to the market regarding the achievability of those optimistic targets lack a reasonable basis. Companies are more likely to succeed in defending shareholder class actions if they can establish that budgets and forecasts were set following a comprehensive, robust and detailed budgeting process.
- Errors discovered in hindsight (which contributed to the miss of those optimistic targets) do not necessarily undermine the reasonable basis of the forward-looking representations at the time they were made. A post-event review by senior management following Worley's downward revised forecast and significant share price drop contained a number of observations about a 'culture of optimism' within Worley and insufficient allowance for downside risks. The Court accepted that while those observations were a candid and genuine description of what had gone wrong with the budgeting and forecasting processes, the post-event review did not mean that the FY14 Budget, which underpinned the forecast, lacked a reasonable basis.
- Unexpectedly poor results that emerge over the course of a financial year do not automatically require a company to immediately revise its earnings guidance. The Court recognised that companies have the capacity to turn things around, engage in cost-cutting exercises, and experience negative or positive variability in earnings over the course of a year – all of which may preserve the reasonableness of the original earnings guidance.
- The Court’s analysis repeatedly had regard to the application of the onus of proof. As Worley raised credible evidence showing that the Board and the CEO had reasonable grounds for making the guidance representations (those reasonable grounds being the FY14 Budget), and demonstrating that the process by which the FY14 Budget was developed was also reasonable, the onus of proof shifted to the applicant to prove the unreasonableness of the FY14 Budget. The applicant repeatedly failed to do this and, therefore, the Court found that Worley did not engage in misleading or deceptive conduct by making, repeating and maintaining its guidance representations.
- Though materiality needs to be assessed on a case by case basis, a variance of 5% to guidance may be sufficiently material to require a corrective disclosure to the market.
- It is unclear whether directors or senior management should have regard to market views (particularly if those views are sufficiently divergent) as to the expected performance of their company, and be required to make a corrective disclosure if they became aware of information that was materially different to those market views. On the facts of this case, views held by Credit Suisse, Deutsche Bank, Morgan Stanley, Macquarie and Citibank analysts did not give rise to a consensus market expectation that Worley would deliver FY14 NPAT of $354-$368m, by reference to which Worley was required to disclose any material information.
- Companies should nevertheless remain vigilant as, although in this case Worley demonstrated that the process by which its budgets were developed was reasonable, there remains some uncertainty about how doubts held by senior management about a budget, even if not held by or capable of being known by the board, might ultimately undermine a contention that the budget, and thus guidance, was reasonable.
Summary of key facts
Worley is an ASX-listed company. On 14 August 2013, Worley represented to the market that it anticipated Net Profit After Tax (NPAT) of $322m in the 2014 financial year (FY14 Guidance). Worley advised that its expectation rested on a 'solid foundation'. That foundation was an internal FY14 budget approved by Worley's board of directors in August 2013 (FY14 Budget).
On 9 October 2013, Worley announced that its first-half result in FY14 would be lower than the previous year. Despite this, Worley reaffirmed its FY14 Guidance. Worley's FY14 Guidance was also repeated on 10 and 15 October 2013.
However, on 20 November 2013, Worley downgraded its FY14 Guidance to between $260-$300m. Following the announcement, Worley's share price fell by $5.59 per share (an approximately 26% decline).
On 27 October 2015, Larry Crowley commenced a shareholder class action on behalf of shareholders who purchased shares in Worley in the period between 14 August and 20 November 2013 (the Relevant Period). Mr Crowley alleged that he and other shareholders had suffered loss by reason of Worley's alleged misconduct in the Relevant Period, namely that:
- Worley failed to comply with its continuous disclosure obligations under s 674 of the Corporations Act 2001 (Cth) (Corporations Act); and
- Worley engaged in misleading or deceptive conduct in contravention of s 1041H of the Corporations Act, s 12DA of the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act) and/or s 18 of the Australian Consumer Law (ACL).
Mr Crowley advanced three arguments in respect of Worley's alleged misconduct. These were:
- the FY14 Budget, which underpinned the FY14 Guidance, lacked reasonable grounds when it was approved by the Board;
- Worley lacked reasonable grounds for maintaining its FY14 Guidance between 21 September and 15 October 2013, at which stage it should have been clear that assumptions in the FY14 Budget were failing; and/or
- Worley was aware of a market consensus expectation that it would deliver FY14 NPAT of $354-368m (which was above its FY14 Guidance) and Worley ought to have corrected the market consensus expectation when it became aware that its earnings would fall materially short of it.
Mr Crowley sought to rely upon the market-based causation theory and a share price inflation to allege his loss. Put another way, Mr Crowley asked the Court to determine whether Worley's FY14 Guidance substantially inflated Worley's share price over its true value.
When does guidance or a budget lack reasonable grounds?
Mr Crowley's argument that Worley's FY14 Guidance lacked a reasonable basis on 14 August 2013 rested on several critiques of Worley's budgeting process. In particular, Mr Crowley critiqued the following aspects of Worley's FY14 Budget:
- Worley 'required' its locations to adopt Worley's overall FY14 growth strategy, as determined by senior management of the company without regard to regional market conditions;
- senior management 'demanded' adjustments to operational Earnings Before Interest and Tax (EBIT) in the amount of $88.6m;
it was inappropriate for Worley to include a stretch target of $12m EBIT in the FY14 Budget;
- Worley's performance in its major markets was deteriorating;
- the FY14 Budget did not include a contingency against underperformance;
- Worley's blue sky revenue figures, which referred to estimated revenue from projects not identified at the time of forecasting, were insufficiently scrutinised;
- the FY14 Budget projected an unreasonable amount of blue sky revenue; and
- Worley had a historical track record of underperforming against its internal budget.
Criticisms made by Mr Crowley in respect of Worley's requirements or demands of its locations ((a) and (b) above) were, in large part, drawn from a post-event review into Worley's budgeting processes by Worley's then CFO, Simon Holt (Holt Memorandum). The Holt Memorandum recounted Worley's culture of growth expectation, that blue sky targets might have been premised on the hope of materialisation rather than on a sound basis, and that management assumed that regional markets were 'sandbagging' their budget estimates. Mr Crowley described the Holt Memorandum as a 'damning assessment' of Worley's 'high pressure budgeting culture'.
At a general level, the Court observed that Worley's FY14 Budget, with the benefit of hindsight, may have been 'overly optimistic'. However, the Court did not find that Worley's FY14 budgeting processes and its FY14 Guidance lacked reasonable grounds at the time they were approved and made. Key to the Court’s decision was evidence from Worley’s management showing a rigorous process of building up the budget by soliciting input from regions/locations. The fact that senior management imposed stretch targets on the regions, and/or that there was debate about the budget, including commentary about it being 'aggressive', did not necessarily mean that senior management did not believe that the budget was achievable and reasonable. The Court considered that there was an adequate review of the budget’s inputs when the budget was prepared, and the fact that FY14 Budget was revised down three months later did not mean it lacked a reasonable basis at the time it was formulated and approved.
In respect of the Holt Memorandum, while the Court accepted that Mr Holt's criticisms represented a candid and genuine assessment of the errors in Worley's budgeting methodology, it did not mean that the FY14 Budget lacked a reasonable basis at the time it was approved. Rather, the Holt Memorandum represented a retrospective analysis of Worley's errors leading up to the FY14 Budget that was made with the benefit of hindsight. Relevantly, Gleeson J found that Mr Crowley's attempted portrayal of the Holt Report as a 'damning assessment', was an 'exaggeration'.
Unexpected results do not necessarily undermine the reasonable basis for guidance
Mr Crowley argued that even if Worley's FY14 Budget was reasonable on 14 August 2013, the unreasonableness of Worley's FY14 Guidance became increasingly apparent to the Board and senior management between 14 August 2013 and 20 November 2013, when Worley's performance fell below the expectations set out in the FY14 Budget. To that end, Mr Crowley noted that despite recording declines in its first-quarter results, Worley reaffirmed its FY14 Guidance on 9, 10 and 15 October 2013.
Mr Crowley also pointed to Board packs which, among other things, downgraded the yearly estimated FY14 NPAT range and noted that all financial contingencies had been deployed two months into the financial year. Likewise, Mr Crowley drew attention to Worley's commencement of an 'EBIT improvement program' in September 2013, which was accompanied by emails referring to a 'major reset'. In light of these facts, amongst others, Mr Crowley argued that Worley had 'relinquished' elements forming the grounds of its FY14 Budget, and therefore ought to have reasonably recognised it was likely to fall short of its FY14 Guidance.
Her Honour dismissed Mr Crowley's arguments as unpersuasive, noting that the applicant failed to demonstrate or set out any evidence that would meaningfully call into question the reasonableness of Worley's FY14 Guidance up to the point that it downgraded guidance on 20 November 2013. While the Court accepted that there were concerns about Worley performance against the FY14 Budget, it did not accept that a 'cost reduction program' could not have turned things around and that Worley should not, therefore, be taken as knowing that the FY14 Budget was unreasonable or unachievable. Similarly, analysis undertaken prior to Worley's October AGM indicating that Worley would be more dependent on the second half of the financial year than it had historically been, did not, by itself, amount to knowledge or awareness about the lack of a reasonable basis for the FY14 Budget and FY14 Guidance.
Onus of proof
In respect of Mr Crowley's misleading or deceptive conduct case, the Court rejected Worley's argument that its FY14 Guidance constituted a present expectation of its views, rather than a representation with respect to a future matter. Her Honour held that Worley's use of the words 'expect' with the qualification 'uncertainties in world markets' did not sufficiently render the FY14 Guidance as not being made with regard to the future.
The onus of proof, therefore, fell on Worley to establish in evidence a reasonable basis for its FY14 Guidance by operation of s 12BB(2) of the ASIC Act and s 4(2) of the ACL, as a person is taken not to have had reasonable grounds for making the representation unless evidence is adduced to the contrary.
Gleeson J held that the reasonableness of Worley's FY14 Guidance was to be assessed by asking whether its Board and its CEO (the only executive director) had reasonable grounds for the FY14 Guidance based on their knowledge/state of mind at the time the FY14 Guidance was given. Her Honour assessed this by considering the state of mind of the Board collectively and the state of mind of the CEO individually. Her Honour found that the Board and the CEO individually held reasonable grounds for giving, repeating and maintaining its FY14 Guidance at all relevant times as:
- 'the evidence does not show that particular integers or portions of the FY14 Budget were overstated or understated so as to be unreasonable or unjustifiable'; and
- 'nor does the evidence demonstrate that a more sceptical approach would probably have led the Board to conclude that the FY14 Budget should not be approved'.
Once Worley adduced evidence accordingly, the applicant was required to demonstrate the FY14 Budget's unreasonableness. As noted in sections 2 and 3 above, Mr Crowley repeatedly failed to do so. The Court observed that the evidence put forward by Mr Crowley fell 'well short of proving on the balance of probabilities that the FY14 Budget did not provide reasonable grounds for the August 2013 earnings guidance statement'.
Information and materiality
Pursuant to s 674(2) of the Corporations Act, Worley was obliged to notify the market of information that a reasonable person would expect to have a material effect on the price or value of Worley's shares if the information were generally available in the Relevant Period. A similar obligation exists in r 3.1 of the ASX Listing Rules. The relevant questions for the Court to answer were: (i) what standard of materiality was to be applied; and (ii) when did Worley become aware of information that was sufficiently material?
Mr Crowley submitted that a market consensus view existed that Worley would deliver FY14 NPAT in the range of $354-$368m (which Worley was aware of) and Worley was obliged to correct once it Worley became aware of information suggesting that it would fall materially short of the market consensus view. To establish that a market consensus view existed, Mr Crowley relied upon a variety of analyst projections issued after Worley's FY14 Guidance expressing optimism regarding Worley's FY14 NPAT, including those published by Credit Suisse, Deutsche Bank, Morgan Stanley, Macquarie, Citibank and UBS.
In relation to the materiality threshold, Mr Crowley submitted that a material change was likely to connote a change of between 5% and 10%. The Court accepted this argument, explicitly adopting Beach J's approach in Myer, in which his Honour concluded that 'materially lower' meant at least 5% lower.
On the facts of this case, her Honour did not consider that there was a market consensus view that Worley would deliver FY14 NPAT of $354-$368m (as was pleaded by Mr Crowley). Accordingly, it could not be said that a single consensus expectation of professional analysts existed in the Relevant Period, against which Worley was required to assess its performance and disclose any material effects pursuant to s 674(2) of the Corporations Act. While not stated expressly, her Honour appears to have rejected Mr Crowley's argument that various separate analyst views as to Worley's expected financial performance could be aggregated together to form a single consensus view in respect of which Worley was required to disclose material information. Gleeson J reached this conclusion despite evidence from Worley's board packs indicating that the Board assessed its performance by reference to an aggregated range of analyst figures.
Even if a consensus expectation did exist, her Honour did not consider that it was likely that Worley's FY14 results would have fallen materially short of the (assumed) consensus expectation during the Relevant Period. In concluding so, her Honour adopted Beach J's threshold of materiality in Myer and applied a 5% reduction to this (assumed) consensus expectation on each of the pleaded dates, for the purpose of evaluating Mr Crowley's case. As a result, there was no continuous disclosure obligation on Worley to communicate any information to the market to correct the (assumed) consensus expectation.
Since the Court did not consider that Worley's conduct gave rise to any contraventions, it was not necessary to make findings in relation to causation and loss. As a result, Beach J's decision in Myer remains the only authority in support of market based causation. The key takeaways from Myer are addressed in our article on that decision.
Companies should nevertheless remain diligent
Gleeson J's judgment in Crowley v Worley turned largely on the individual facts of the case, although it should give comfort to companies who engage in rigorous budget preparation processes. Several questions remain unanswered from the judgment that are relevant for listed companies issuing market guidance:
- It is unclear, but it appears that Gleeson J considered that the Board and senior executives need to be 'aligned in their expectation' in order for the company to have reasonable grounds for the guidance. This suggests that the Board (as a collective) and the CEO (as an individual), based on the information available to them, must all have had reasonable grounds for approving and giving the guidance, and that if one or other of them did not, then the company may not.
- It is also unclear whether a company will have reasonable grounds for its guidance given in circumstances where its Board approves guidance based on a budget submitted to it by senior executives, but unbeknown to the Board (and the CEO), the budget in fact included some unreasonable elements or assumptions, or contained material errors of which the CFO and/or senior executives were aware or should have been aware. There is a risk that a court may find that if the budget is unreasonable or contained material errors, then the company may not have reasonable grounds for any guidance based on that budget.
Crowley v Worley will be the first shareholder class action to go before an appeals court, and may provide the first appellate level judgment in this type of proceeding.
Since her Honour's judgment was heavily focused on factual evaluations of Worley's conduct, Mr Crowley's grounds of appeal are more likely to be focused on factual and evidentiary criticisms of the judgment, such as whether the primary judge erred in failing to find that Worley did not have reasonable grounds for its FY14 Guidance. This means that it is unlikely that the Full Court will provide further guidance on specific questions such as the calculation of loss in shareholder class actions.
However, it is likely that any obiter comments made by the Full Court of a more generic, broader reaching nature may be influential in assessing the future prospects of shareholder class actions in Australia. No doubt this appeal will be watched with great interest by class action participants, listed corporates and insurers.