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Focus: The Timbercorp class action cut down

29 September 2011

In brief: In a landmark decision, the Victorian Supreme Court recently dismissed a class action by Timbercorp investors following the collapse of the Timbercorp Group in April 2009. Partner Irene Trethowan and Lawyers Kate Austin and Brenton Pollard look at the decision, which further clarifies the disclosure obligations of companies when issuing product disclosure statements for financial products and is likely to have implications for investors involved in other managed investment scheme class actions.

How does it affect you?

  • Section 1013C of the Corporations Act 2001 requires an issuer of a product disclosure statement (PDS) to disclose 'significant risks' associated with a financial product to potential investors. In the context of the Timbercorp managed investment schemes, Justice Judd found that one such significant risk (which he ultimately found had been adequately disclosed) was the performance risk, being the risk that the responsible entity may be unable to perform its contractual obligations relating to the schemes in the future.
  • In the case of other types of risks requiring disclosure, Justice Judd found that the ability of a company to properly manage a particular risk is relevant to whether it can be said to be a 'significant' risk within the meaning of s1013C.
  • Where information relevant to the issuer of the PDS is otherwise publicly available to potential investors, for example because it is contained in the annual reports of the listed holding company, it will not be required to be separately disclosed in a PDS.
  • Investors in managed investment schemes are likely to have difficulties in pursuing claims based on allegations of PDS non-disclosure where the evidence establishes that their investment decision was largely tax driven and they did not rely on information contained in the PDS.

Background

Following the collapse of the Timbercorp Group in April 2009, the plaintiff, Mr Woodcroft-Brown, commenced a group proceeding under Part 4A of the Supreme Court Act 1986 (Vic) on his own behalf and on behalf of investors who at any time between 6 February 2007 and 23 April 2009 held an interest in a managed investment scheme of which Timbercorp Securities Limited (Timbercorp Securities) was the responsible entity. In commencing the proceeding, the plaintiff and group members sought damages for the loss of their investments and sought to avoid repayment of loans entered into with Timbercorp Finance Limited to finance their investment in the relevant schemes.1

The plaintiff's case was that Timbercorp Securities failed to disclose information about 'significant risks' associated with the schemes, contrary to its statutory obligations under s1013C of the Corporations Act. Additionally, the plaintiff alleged that Timbercorp Securities had engaged in misleading and deceptive conduct.2 The plaintiff alleged that the following significant risks should have been disclosed:

  • 'Structural risks' associated with the Timbercorp Group's ability to maintain sufficient cash flows, including risks that scheme members may default on payments, that the Timbercorp Group may not be able to renew its funding arrangements and that cash flow from the securitisation of loans may not continue to be available.
  • 'Adverse matters', including a taxation announcement by the Australian Government in 2007 that upfront deductions of application fees for non-forestry schemes would no longer be allowed and the general tightening of the global credit markets as a result of the global financial crisis.3

Justice Judd was highly critical of the plaintiff's case. His Honour commented that:

In [the plaintiff's] attempt to cover every possible combination or permutation of fact and law, attributing principal liability to Timbercorp Securities and accessorial liability to Timbercorp Finance and the directors, the plaintiff constructed an elaborate and sometimes illusive web of allegations. The complexity was compounded by the failure of the statement of claim to record a coherent narrative.

In particular, his Honour was highly critical of the way in which the case advanced by the plaintiff at trial materially differed from the case pleaded in his statement of claim. Because the plaintiff made no application to amend his statement of claim at trial (an application which his Honour commented he would have been likely to refuse), his Honour held that the plaintiff should be confined to his pleaded case as set out above.

The decision

Events that affect the 'performance risk'

The plaintiff was unsuccessful in his claim that Timbercorp Securities failed to disclose certain 'significant risks' related to the financial position of the Timbercorp Group in PDSs issued to investors in Timbercorp schemes, as required by section 1013C of the Corporations Act.

The risks that the plaintiff alleged Timbercorp Securities failed to disclose did not constitute 'stand-alone risks' requiring disclosure. Such risks, which included the risk that the Timbercorp Group could not secure ongoing bank funding, were incapable of isolation from what Justice Judd termed the performance risk associated with all companies (the risk of a company being unable to carry out its contractual obligations), which management are required to address on a day-to-day basis.

Justice Judd found that the performance risk was disclosed to Timbercorp investors in the PDSs and that the specific risks alleged by the plaintiff would only need to be disclosed if they materially impacted on the performance risk by posing a real threat to the ability of the responsible entity to carry out the schemes. In the case of the risk of securing ongoing bank funding, there was no real threat to the ability of the responsible entity to carry out its obligations because, on the evidence, the banks were willing to support the Timbercorp Group all the way up until early 2009, well after the issue of the last Timbercorp PDS.4

Only 'significant' risks require disclosure

According to Justice Judd, whether a risk is 'significant' will depend on the potential consequences arising from materialisation of the risk and the probability of its occurrence. In his Honour's view, the ability of an entity to manage the risk is important both to its likelihood of occurrence and its potential consequences. For example, the tax announcement in 2007, which the plaintiff alleged threatened the viability of Timbercorp Securities, was not a significant risk unless it had a real potential to bring about the failure of the responsible entity. The evidence disclosed that, at most, the tax announcement would lead to a short-term decline in profits and, as long as the Timbercorp Group could manage the impact of this event, it did not pose a threat to the responsible entity.5

The continuous disclosure regime and PDS disclosure obligations

Under the Corporations Act, information is not required to be included in a PDS if it would not be reasonable for a person, considering as a retail client whether to acquire a financial product, to expect to find in the PDS.6 Whether a product is an ED Security and the impact of the requirements in Chapter 2M and ss 674 and 675 of the Act are relevant to whether it would be 'reasonable' for a retail client to expect to find certain information in a PDS.7 As interests in Timbercorp schemes were ED Securities, the defendants submitted that, if information was 'generally available' (within the meaning of s675 of the Act), it was not required to be disclosed in Timbercorp PDSs.

The defendants argued that, since information concerning the global financial crisis and the taxation announcement was generally available, these matters did not require disclosure. His Honour agreed with this approach and also found that the information disclosed in the Timbercorp Group's consolidated annual reports disclosed much of the information relating to the performance risk. As such, it was not reasonable to expect this information also to be included in the PDS. His Honour's findings on this point are significant, considering there is no other reported case concerning the operation of s1013F of the Act in the context of ED Securities.

Reliance on representations in a tax-driven scheme

A key feature of Justice Judd's decision was his approach to the question of reliance. He was also highly critical of the form and content of the plaintiff's evidence in this area and repeated the concerns of Chief Justice Spigelman in Gardner v Agricultural and Rural Finance8 regarding 'ex post facto protestations of reliance on financial representations with an investment in a tax driven scheme.' In this regard, in finding that the plaintiff had not relied on the PDS in making his investment decision, Justice Judd placed emphasis on the following factors:

  • that the PDSs were provided to the plaintiff at a two-hour meeting with a financial adviser, over a glass of wine, after which the plaintiff signed the application to enter into the scheme;
  • the end of the financial year was near and the plaintiff had a significant tax liability; and
  • the plaintiff's request to his financial adviser for tax-effective investments.

Conclusion

The decision is likely to have implications for current or contemplated class actions arising out of the collapse of managed investment scheme operators following the global financial crisis. Justice Judd has adopted a commercial approach to questions of reliance and the scope of PDS disclosure obligations that may pose considerable difficulties for aggrieved investors. In this regard, it is understood that the solicitors for the Timbercorp investors, Macpherson and Kelley, are likely to recommend mounting an appeal. In the meantime, a hearing on costs, which are likely to be substantial, is scheduled for 6 October, after which final orders will be made.

Footnotes
  1. Woodcroft-Brown v Timbercorp Securities Limited (in liquidation) [2011] VSC 427.
  2. The plaintiff's misrepresentation case did not feature prominently in his Honour's judgment but related to claims that Timbercorp represented that it was 'sufficiently' strong and that certain relevant matters were omitted from the PDSs. His Honour found that the alleged misrepresentations were not misleading or deceptive.
  3. Other adverse matters in the plaintiff's statement of claim included that Timbercorp was near insolvency, that Timbercorp had breached loan covenants and that there were doubts as to whether Timbercorp could continue as a going concern. However, these did not feature prominently at trial because the factors either arose after the issue of the final PDS or were too vague to be classified as risks.
  4. Timbercorp Securities did not issue any further PDSs after 30 June 2008.
  5. at [183].
  6. Section 1013F(1).
  7. Section 1013F(2).
  8. [2007] NSWCA 235 per Chief Justice Spigelman.

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