FEDERAL COURT OF AUSTRALIA Cadence Asset Management Pty Ltd v Concept Sports Limited [2005] FCA 1280 CORPORATIONS LAW – prospectus – disclosure – misleading statements – claim by member against the company under s 729 of the Corporations Act 2001 (Cth) – whether maintainable Corporations Act 2001 (Cth) ss 710, 728, 729, 737 Directors Liability Act 1890 (UK) s 3 Abrath v The North Eastern Railway Company (1886) 11 App Cas 247 cited Adam v Newbigging (1888) 13 App Cas 308 cited Addlestone Linoleum Company, Re (1887) 37 Ch D 191 cited Cohen v Peko-Wallsend Ltd (1986) 61 ALJR 57 followed Derry v Peek (1889) 14 App Cas 337 cited Directors of the Reese River Silver Mining Company, Limited v Smith (1869) LR 4 HL 64 cited Houldsworth v City of Glasgow Bank (1880) 5 App Cas 317 applied New South Wales v Commonwealth(1990) 169 CLR 482 cited Oakes v Turquand (1867) LR 2 HL 325 cited Peek v Gurney (1873) LR 6 HL 337 cited Reese River Silver Mining Company, In re(1867) 2 LR Ch 604 cited Scottish Petroleum Company, In re (1882) 23 Ch D 413 cited Soden v British & Commonwealth Holdings plc [1998] AC 298 cited State of Victoria v Hodgson[1992] 2 VR 613 followed Twycross v Grant (1877) 2 CPD 469 cited Webb Distributors (Aust) Pty Ltd v State of Victoria(1993) 179 CLR 15 cited Lindley, A Treatise on the Law of Companies (5th ed, 1889) CADENCE ASSET MANAGEMENT PTY LTD v CONCEPT SPORTS LIMITED, GARY MARCH, LEON DAPHNE, JEFFREY TAYLOR, STEVEN ROLTON, DAVID CARTER and JOHN MOORE VID 1605 of 2004 FINKELSTEIN J 14 SEPTEMBER 2005 MELBOURNE IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY VID 1605 of 2004 BETWEEN: CADENCE ASSET MANAGEMENT PTY LTD Plaintiff AND: CONCEPT SPORTS LIMITED, GARY MARCH, LEON DAPHNE, JEFFREY TAYLOR, STEVEN ROLTON, DAVID CARTER and JOHN MOORE Defendants JUDGE: FINKELSTEIN J DATE: 14 SEPTEMBER 2005 PLACE: MELBOURNE REASONS FOR JUDGMENT 1 Vast sums of money are invested in shares. Shares, however, have no intrinsic value themselves. Their value depends upon the prospects of the corporation that has issued the shares. Their price depends upon how much people are willing to pay based on their evaluation of those prospects. When shares are created and offered to the public, those invited to subscribe must have some idea what the shares will be worth. They have no practical opportunity of making any independent inquiry. The prospectus serves this function. It is the means by which the promoters (and others) are required to disclose to the public everything which could influence the mind of the investor. The Joint Stock Companies Act 1844, 7 & 8 Vict c 110, introduced the principle of compulsory disclosure through the medium of a prospectus and this has been a feature of English and Australian company law ever since. The Australian disclosure provisions are currently to be found in s 710 and s 711 of the Corporations Act 2001 (Cth). 2 The first defendant, Concept Sports Limited, wanted to raise $12 million. It issued a prospectus offering 24 million ordinary shares at an issue price of $0.50 each. The prospectus contained financial information about the company, including forecast sales revenue and forecast earnings before interest and tax. The prospectus also contained statements about Concept Sports' activities, the strength of its business and the future prospects for that business. In addition, there may have been several implicit representations in the prospectus, such as that all material information had been disclosed and that all reasonable investigations had been undertaken to ensure that the information in the prospectus was accurate. 3 This action, which is a group proceeding brought under Pt IVA of the Federal Court of Australia Act 1976 (Cth), is about the prospectus. The plaintiff, through a trustee, subscribed for shares in Concept Sports allegedly on the strength of the prospectus. It now alleges that: (1) the prospectus did not contain information which by s 710 of the Corporations Act it is was required to contain; (2) the forecasts for sales revenue and earnings and the statements about the company's outlook were misleading and deceptive; and (3) the implied representations were false. It seeks to recover damages under s 729 of the Corporations Act. The Corporations Act provides that if a prospectus omits information that is required by s 710, or contains misleading or deceptive statements which are materially adverse from the point of view of an investor, the person making the offer will have committed an offence under s 728. By s 729 any person who suffers loss or damage as a result may, subject to certain defences, recover that loss or damage from a number of persons, including the company making the offer. 4 The action is in its early stages. An important point has arisen that is best resolved immediately for it will affect the manner in which the case will be prepared for trial. The point is one of law and has been thrown up by the pleadings. Concept Sports says that the plaintiff cannot maintain one of its causes of action. Each side wishes to have this point finally disposed of, so that they know where they stand. As well, each side wishes to have the right to appeal my ruling on the point. Various procedures have been suggested to give effect to the parties' wishes, ranging from the determination of a preliminary point under O 29 of the Federal Court Rules to an application to strike out the allegedly offending parts of the plaintiff's statement of claim. The difficulty with all of the suggested procedures is that, on the current state of the authorities, it will result in an interlocutory order from which there may be an appeal only by leave. Notwithstanding the procedural difficulties, this is how I propose to proceed. First, I will make a final determination on the legal issue, albeit a determination on an interlocutory application. The authorities say that I can do this in an appropriate case: see eg Cohen v Peko-Wallsend Ltd (1986) 61 ALJR 57. Then, after I have handed down my ruling, I will hear the parties on what orders should be made. 5 The point comes about in the following way. There is a rule, known as the rule in Houldsworth'scase (Houldsworth v City of Glasgow Bank (1880) 5 App Cas 317), that a shareholder cannot sue for damages for a fraud or misrepresentation inducing his (or her) subscription for shares unless he first renounces the contract pursuant to which he acquired those shares. The principal basis for the rule is that to allow a claim for damages by a member against his company would be inconsistent with the implied term of the statutory contract between a member and his company and the other members (as to which see s 140 of the Corporations Act) that the capital which the member has subscribed should be applied only in payment of the debts and liabilities of the company: Houldsworth v City of Glasgow Bank (1880) 5 App Cas 317, 325 per Earl Cairns LC; Re Addlestone Linoleum Company (1887) 37 Ch D 191, 205-206 per Lindley LJ. 6 The winding up of the company before the contract has been repudiated creates a permanent bar to relief because after winding up rescission is impossible: Oakes v Turquand (1867) LR 2 HL 325. The reasons given in some of the older cases (reasons which may now be stated in somewhat different terms) are that when the company goes into liquidation: (1) the status and relative position of the contracting parties is altered as the shareholder ceases to exist, being converted into a contributory, and the company ceases to exist, being converted into a body of such contributories; (2) the subject matter of the contract is altered there being no longer any shares but only forced contributions of the contributories; and (3) the rights of creditors have intervened and those creditors are entitled to be paid in priority to all other claimants on the assets of the company, including the capital subscribed by the shareholders: see eg In re Hull and Country Bank (1880) 15 Ch D 507. In any event, when a company is in liquidation, s 563A will prevent a member from proving for damages for fraud or misrepresentation inducing his subscription in competition with other creditors. 7 Here the plaintiff and members of the group which it represents acquired shares in Concept Sport by subscription. It is common ground the plaintiff did not rescind the contract and seek restitution of the subscription price. Nor did many of the group members. Rather than rescind the contract, the plaintiff (or, more accurately, its trustee) sold the shares, thereby making rescission impossible. The loss that the plaintiff seeks to recover is the difference between the subscription price and the proceeds of sale. Other group members may also be seeking damages on a similar basis. 8 The rule in Houldsworth'scase would bar the claim if the action were for deceit or misrepresentation. The rule would not, however, bar all the claims made in the action. As well as acquiring shares by subscription, the plaintiff and some group members acquired shares in Concept Sports on market allegedly in reliance on the prospectus. The rule in Houldsworth'scase would not prevent claims being brought in relation to those shares: Soden v British & Commonwealth Holdings plc [1998] AC 298. 9 The question that requires resolution is whether Houldsworth's case is a bar to the claim under s 729 for a contravention of s 728. The plaintiff says that Houldsworth'scase only applies to common law claims for damages and not to statutory causes of action, and in particular not to a claim under s 729. (In fact the plaintiff's precise submission is that Houldsworth'scase applies only to common law claims for damages against a company in liquidation, but that submission is plainly incorrect.) Whether or not s 729 has removed "an antiquated rule which is a source of injustice and inconvenience" (the description given to the rule by McHugh J in Webb Distributors (Aust) Pty Ltd v State of Victoria (1993) 179 CLR 15, 40) is a difficult question to which I now turn. 10 The best place to begin is with the history of s 729. The section can be traced back to s 3 of the Directors Liability Act 1890, 53 & 54 Vict c 64. The Directors Liability Act was enacted in the following circumstances. According to the common law as then understood the only remedy available to a person who relied upon representations contained in a prospectus issued by or on behalf of a company was an action for deceit. The most essential element of this action was fraud. The plaintiff had to show that the defendant had falsely and fraudulently represented to him something on the faith of which he had acted. In Derry v Peek (1889) 14 App Cas 337 the House of Lords laid down that in an action for deceit it was necessary to prove mens rea and in order to prove it the plaintiff had to show that either (1) the defendant knew or believed the statement in question to be false; or (2) he did not believe it to be true; or (3) he made it in reckless ignorance of whether it was true or false. The falsity that needed to be proved had to be in the nature of a direct and positive untruth, not a mere omission, unless the fact omitted rendered that which was said to be false: Oakes v Turquand (1867) LR 2 HL 325; Peek v Gurney (1873) LR 6 HL 337. Section 38 of the Companies Act 1867, 30 & 31 Vict c 131, amended the common law by giving to a subscriber for shares a statutory right of action akin to deceit if the prospectus did not disclose the dates and names of parties to certain contracts the existence of which may have been material to the subscriber notwithstanding that the omission did not make false any statements made in the prospectus: Twycross v Grant (1877) 2 CPD 469. 11 It is also important to note that in the late 19th century it was still doubtful whether a company could be made liable in damages for the fraudulent misrepresentation of its directors or promoters. One view was that a company could not be liable under any circumstances for fraud which, being of a personal and moral quality, could only apply to a natural person. Lord Bramwell was a leading proponent of this view, as he made clear in his speech in Abrath v The North Eastern Railway Company (1886) 11 App Cas 247, 250-251. On the other hand, other judges, including Lord Justice Lindley, a leading company lawyer, were of the view that a company could be made vicariously liable in deceit: Lindley, A Treatise on the Law of Companies (5th ed, 1889) 74, 216-219. 12 Although it was necessary to prove fraud to succeed in an action for deceit, that was not a requirement if the action were for rescission of the contract and restitution of what had been paid. All the plaintiff had to establish was that there had been a misrepresentation of fact which induced him to make the contract to subscribe for shares. He was not required to prove that there had been fraud or any moral or mental state whatsoever on the part of anyone. Nor did it matter that the plaintiff might not be able to prove that those who made the false statement on the company's behalf knew it not to be true: Adam v Newbigging (1888) 13 App Cas 308, 313-314. The plaintiff could recover judgment for rescission of the contract and restitution, provided the contract had not been affirmed. 13 Instead of claiming rescission in an action, in an appropriate case a shareholder could apply in a summary way under s 35 of the Companies Act 1862, 25 & 26 Vict c 89, (which permitted rectification of the share register and is the forerunner of s 175 of the Corporations Act) for an order removing his name from the register. The section did not refer to prospectuses or misrepresentations, or to the voidability of a contract to take shares. But it was obvious that any shareholder who was in a position to rescind his contract was entitled to apply for an order to have the register rectified. Of course, as with rescission at law, restitution for misrepresentation could not occur following liquidation: In re Scottish Petroleum Company (1882) 23 Ch D 413, 433; In re Reese River Silver Mining Company (1867) 2 LR Ch 604; LR 4 HL 64. 14 This state of the law, at least as regards actions for deceit, was quite unsatisfactory. There was a strong view, expressed by Lord Herschell in Derry v Peek, that if a prospectus contained statements that were false, especially if there was want of reasonable care in making the statements, that should be actionable. The Directors Liability Act was enacted to achieve this object. The Act did so by s 3 which provided that, subject to certain exceptions, every director, promoter and other person who authorised the issue of a prospectus should be liable to pay damages that a subscriber has suffered "by reason of any untrue statement in the prospectus". 15 Thus the section established a statutory cause of action that did not have the restrictions surrounding an action for deceit. In particular it was not necessary to establish a fraudulent intention. Nevertheless, the section did not create a cause of action against the company on whose behalf the prospectus had been issued. The only persons that could be made liable for false statements were the directors, promoters and persons who authorised the issue of the prospectus. 16 The position regarding the persons who might be liable for false statements in a prospectus has undergone change. In England there is now no doubt that the company issuing the prospectus can be made liable in damages for false statements. In part this is a reflection of advances made in the common law. First, the doubt about a company's liability for the fraud of its agents has been resolved. Second, by the middle of the 20th century the action for negligent misstatement had been developed. So it was no longer necessary to rely upon a cause of action that required proof of mens rea. More importantly, however, the rule in Houldsworth'scase has been abolished. Section 111A of the Companies Act 1985 (UK), which was inserted by the Companies Act 1989 (UK), provides that: "A person is not debarred from obtaining damages or other compensation from a company by reason only of his holding or having held shares in the company or any right to apply or subscribe for shares or to be included in the company's register in respect of shares." 17 There have been no similar changes to the companies legislation in Australia. Nevertheless the plaintiff says that there have been amendments which have produced a similar result, at least as regards a cause of action under s 729. Prior to 1991 the position in relation to prospectuses was covered by s 107 of the Companies Codes of the States. In all relevant respects s 107 was to the same effect as s 3 of the Directors Liability Act upon which it was based. In 1989 there was an unsuccessful attempt to expand the range of persons who could be held liable in damages for false statements in a prospectus. In that year the Commonwealth enacted a statute entitled the Corporations Act 1989 (Cth). By s 1006 of that Act, the persons who could be held accountable for false statements in a prospectus included not only, as in the past, the directors, promoters and those who had authorised the prospectus, but also those named in the prospectus as stockbrokers, sharebrokers or underwriters, auditors, bankers or solicitors, as well as the corporation itself. According to the Explanatory Memorandum to the Bill, the new provision "aim[ed] to make all persons involved in the preparation of a prospectus responsible for the prospectus" (at [2996]). However, many provisions in the Corporations Act were struck down for constitutional reasons: see New South Wales v Commonwealth (1990) 169 CLR 482. In due course the Act was replaced by the Corporations Law which came into operation on 1 January 1991. Section 1006 of the Corporations Law reproduced s 1006 of the Corporations Act. Section 729 of the current legislation is in similar terms. 18 The question then comes down to this. Did the introduction of the company that issued the prospectus as a possible defendant to a claim for damages under s 729 overturn the rule in Houldsworth'scase? 19 There are factors pointing both ways. Those that point in favour of overturning Houldsworth'scase are these. First, the cause of action conferred by s 729 against the company is remedial in nature and should therefore be given broad effect. Second, s 729 is in terms unrestricted, and to impose a limitation (that is the limitation set by Houldsworth's case) would be inconsistent with the terms. Third, if the section has not overturned Houldsworth'scase, it would have little scope. That is to say, if rescission is a necessary precondition to an action, the plaintiff could only recover consequential or indirect damages in an action under s 729. 20 The factors that point the other way are these. First, Parliament could have but did not in terms overturn Houldsworth'scase. That is, Parliament could have but did not enact a provision similar to s 111A of the English Companies Act. Second, it is apparent that Parliament is aware of Houldsworth's case and its consequence and when it wishes to do so it will overturn its effect and do so in clear language. Here I have in mind s 737 of the Corporations Act which was introduced into the Corporations Law by the Corporate Law Economic Reform Program Act 1999 (Cth). The purpose of the new section was to provide additional remedies for a contravention of s 724 (the predecessor to s 728). One additional remedy was "the right to return the securities and have their application money repaid". According to s 737(1) the right is available "even if the company that issued the securities is being wound up". The only purpose for including these words is to reverse the combined effect of Houldsworth's case and Oakes v Turquand namely that there can be no rescission after a winding up. Third, a similar argument made in relation to the operation of s 52 of the Trade Practices Act 1974 (Cth), a "fundamental piece of remedial and protectionist legislation" (so described by McHugh J in Webb Distributors (Aust) Pty Ltd v State of Victoria (1993) 179 CLR 15, 41) was rejected by the Full Court of the Supreme Court of Victoria in State of Victoria v Hodgson [1992] 2 VR 613. Justice Tadgell who delivered the leading judgment stated (at 631) that: "To hold otherwise would be to regard the Trade Practices Act as intending to overturn by implication a cardinal tenet of limited liability which has prevailed for 130 years. It would be surprising indeed if the Trade Practices Act had that intention or effect". Fourth, if the submission were accepted it would produce an anomalous situation. I mentioned earlier that the rule in Houldsworth'scase has been given statutory effect when a company is in liquidation. If s 729 has overturned Houldsworth'scase, it could only have done so for an action against a company that is not in liquidation. Section 563A, which would preclude proof of claims when the company is being wound up, remains in place: Webb Distributors (Aust) Pty Ltd v State of Victoria (1993) 179 CLR 15. It would require a good reason indeed to impute to Parliament an intention to overturn Houldsworth'scase when the company is a going concern but not when it is being wound up. 21 It seems to me that the reasons for denying the plaintiff the relief that it seeks are to be preferred. Moreover, to hold otherwise would conflict with State of Victoria v Hodgson, a decision of an appellate court which I am required to follow. In any event, State of Victoria v Hodgson is correct, in my opinion. 22 I will hear the parties on the orders that should be made. Presently I incline to the view that I should simply dismiss the plaintiff's action in so far as it claims relief under s 729 in respect of the shares acquired by subscription. I certify that the preceding twenty-two (22) numbered paragraphs are a true copy of the Judgment herein of the Honourable Justice Finkelstein. Associate: Dated: 14 September 2005 Counsel for the Plaintiff: Dr K Hanscombe SC Mr A Watson Solicitor for the Plaintiff: Maurice Blackburn Cashman Counsel for the 1st Defendant: Mr G P Harris Solicitor for the 1st Defendant: Lander & Rogers Counsel for the 2nd 4th & 5th Defendants: Mr A McNab Solicitor for the 2nd 4th & 5th Defendants: Lewis & Weir Counsel for the 3rd, 6th & 7th Defendants: Mr J L Evans Solicitor for the 3rd, 6th & 7th Defendants: Madgwicks Date of Hearing: 8 June 2005 Date of Judgment: 14 September 2005