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Focus: Developers, beware advertising material that misleads and deceives

4 June 2009

In brief: A recent judgment of the Federal Court gives some very useful insights into how advertising material for the sale of residential product can be misleading and deceptive. Partner Tony Davies (view CV) and Lawyer Donna Burnett report.

How does it affect you?

  • While developers regularly use special purpose companies (SPVs) for particular projects to, among other things, quarantine liability with the relevant SPV, particular care has to be taken to make sure this is effective (at least in the face of section 52 of the Trade Practices Act 1974 (Cth) actions involving misleading and deceptive conduct).
  • When making representations about future matters, a detailed report by appropriate experts should be obtained and reviewed. It is not sufficient merely to rely, without more investigation, upon the report of an apparent expert.
  • Advertising material should accurately reflect the true position as set out in formal contract documents.

Introduction

The judgment in Ackers v Austcorp International Ltd 1 is a detailed one (of approximately 100 pages). Significantly, the court found that:

  • a parent company may not be able to rely on the 'corporate veil' of a subsidiary to protect itself from a charge of misleading and deceptive conduct; and
  • a misleading impression created by marketing material cannot be 'made good' by a subsequent contractual disclosure of the true position.

Background

Austcorp International Ltd (Austcorp), an experienced property developer, was approached in 1999 to product manage a new 145-room serviced apartment resort at The Entrance (a town on the central coast of NSW).

A development management agreement was entered into under which Austcorp Development Management Pty Ltd (Austcorp Development), a subsidiary of Austcorp, was engaged to manage The Entrance project. Austcorp Development was responsible for, among other things, the marketing and promotion of the sale of the apartments, procuring and supervising construction, and effecting the sale and settlement of the apartments.

The marketing material to promote the sale of the resort indicated a number of critical matters that were subsequently held to be misleading and deceptive, namely:

  • the security of a 10-year lease to Pacific International Hotels Ltd (an experienced hotel operator);
  • a guaranteed 7 per cent per annum net return for 10 years; and
  • the return to investors being guaranteed by Pacific International Hotels.

Misrepresentations

In fact, the true position in regard to the rental guarantee was that:

  • at the time of settlement, a $2 company independent of Pacific International Hotels, Mustara Holdings Pty Ltd, leased the apartments from the owners. Mustara had been a subsidiary of Pacific International Hotels but ownership had been transferred prior to settlement; and
  • the 'fine print' of the contract documents disclosed that Pacific International Hotels had only guaranteed the 7 per cent return for the first year of the 10-year lease to Mustara.

Mustara was unable to pay rent under the leases granted to it by apartment owners. Pacific International Hotels paid for the one-year rent payment (under its guarantee for that period) and, after that time, no further rent was payable. As a result, various apartment owners bought action for misleading and deceptive conduct against Austcorp, not against Austcorp Development.

The developer's position

In general terms, Austcorp maintained the following:

  • any misleading and deceptive conduct action should have been bought against Austcorp Development – the subsidiary of Austcorp – as it was the entity that entered into the development management agreement; and
  • even if the marketing material did not expressly refer to the limited one-year guarantee of Pacific International Hotels, the contractual documentation made it quite clear.

The court's findings

The court held the following.

  • Because Austcorp was actively engaged in the promotion of the sales (for example, its logo was used, clearly endorsing the product), it could not hide behind its subsidiary – Austcorp Development. In particular, the court said, 'After all its activity in promoting the development in the sale of apartments in the resort, it would be extraordinary if Austcorp now could hide behind its previously hidden corporate veils'.
  • The court offered the view that where a parent company was contracting on behalf of a subsidiary in regard to the development, to protect the parent all documentation should confirm the parent was acting as agent. It was not necessary that the principal the agent represented was disclosed.
  • Although Austcorp argued that the impression conveyed by the marketing material relating to a guaranteed 7 per cent return was clarified by the contract documents – namely, that there was a limited one-year guarantee and the lease granted by apartment owners was a lease to a $2 company (Mustara) – the continual use of 'guaranteed return' and 'assured success' in the advertising material could not be treated as a mere puff. The court said, 'After all, Austcorp set the misleading representations in motion. It cannot simply rely upon the overstatements in the brochure to be corrected where they were seriously made and used as powerful marketing tools in preparing the brochure with the knowledge that they had that effect'.
  • The court, when considering the argument that the disclaimer in the contractual documentation modified the marketing material, endorsed the view of previous courts that it is not permissible to make representations but then withdraw them in formal contract documentation. Notably, the court said: 'But Austcorp was asserting to other people (solicitors) or other factors (the full contractual documentation and, where relevant, disclosure statement when read and properly understood) would undo completely the very state of mind its marketing activities had induced by conveying the representations complained of so as to induce the applicants to proceed. It is not an attractive argument. Marketing messages are simple and powerful.' [Bold added.]
  • Austcorp did not have reasonable grounds for making the future representations about rental return for the property. It had not carried out any detailed analysis on the rental return from any acknowledged experts in the area. This was a fatal flaw. As the court said: 'Austcorp did not do any due diligence or analysis to see how Mustara or Pacific International Hotels could meet the guaranteed return over 10 years. Moreover, Austcorp knew of, but did not examine, the Pacific International Hotels business'.
  • Although the disclosure statement that went with the formal contract documentation did refer to the limited 12-month guarantee of rental, the court said, 'the disclosure statement was no match to disabuse anyone who had the patience to read through its dense and confused terms for the powerful simplicity of the messages in the promotional material'. (That message being that there was a guarantee rental return of 7 per cent per annum for 10 years.)

The key lessons

  • Make sure that marketing material, especially such things as rental guarantees, is consistent with the formal contract terms.
  • Consider the financial ability of a relevant party to meet any rental guarantee over the life of the guarantee. This may involve conducting detailed due diligence or procuring reports by acknowledged experts.
  • If it is proposed to use a subsidiary to carry out a development, ensure it is quite clear in all documentation that the subsidiary is responsible for all aspects of the development and that anything done by the parent is only done as agent for the subsidiary.

Conclusion

Ackers v Austcorp International Ltd highlights what a powerful tool the Trade Practices Act can be in the hands of aggrieved buyers. Developers need to have an active trade practices management program in place. The case provides a detailed insight into the traps that developers can fall into without such a program.

Footnotes
  1. [2009] FCA 432. 

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