Summary
In the matter of Touch for Health Pty Ltd as Trustee for Knight Superannuation Fund v Property Mentors Australia Pty Ltd (No 3) [2024] FCA 1381 (“PMA Case”), Neskovcin J of the Federal Court of Australia recently provided some very helpful guidance as to when an Information Memorandum (“IM”) may be considered misleading, or likely to mislead or deceive in breach of s12DA of the ASIC Act. Statements relating to the timeframe by which an investor would make a return and the quantum of the expected return on the investment were both misleading. Directors of the issuer of the IM were found to know each statement was false and found them personally liable for the losses under s12GF(1) of the ASIC Act.
Facts
In brief, a company that was in the business of providing a property “mentoring” subscription service established (via another entity acting as trustee) a managed investment scheme (the “Fund”). The Fund was not registered and so open only to persons who met the definition of “wholesale client” under the Corporations Act. The defendant issued the IM for the Fund in 2015, seeking to raise $1.25m for a property development in Western Australia. The IM contained a number of statements including:
– the “expected return on the investment of greater than 30% over the life of the project”;
– the life of the project was expected to be 12 – 15 months;
– the trustee of the Fund had entered into an “unconditional contract of sale” over land; and
– a “fixed price building contract ….. ha[d] been entered into” to develop the land for sale of separate dwellings.
The land was purchased but the Fund failed. Its promoters were unable to achieve pre-sales, obtain finance and the trustee had “secretly mortgaged” the property. The trustee was unable to pay its debts and the property succumbed to the trustee’s lenders who took possession of the land. It would appear the Fund’s life came to an end proving a worthless investment to a group of people who had provided over $1m.
Consideration
A breach of s12DA of the ASIC Act was the key claim argued for the applicants (the losing unitholders) with the litigating parties agreeing that the Fund was a “managed investment scheme” and therefore a “financial product”, the promotion of which was a “financial service” enlivening the ASIC Act. Section 12DA(1) is a plain and clear provision that states: “A person must not, in trade or commerce, engage in conduct in relation to financial services that is misleading or deceptive or is likely to mislead or deceive.”
Section 12BB(1) of the ASIC Act relevantly provides that if a person makes a representation with respect to any future matter and the person does not have reasonable grounds for making the representation, the representation is taken, for the purposes of s 12DA, to be misleading.
The Court noted at the time of the issue of the IM, the following facts existed:
1. A building contract had not been entered into; and
2. Building works were not likely to be commenced until 6 months after the settlement of the acquisition.
Once the building contract was executed, there was no term requiring the works to be completed in accordance with the timeframes suggested in the IM. These factors assisted the Court to find that statements about the timeframe of returns were misleading.
The Court also meticulously analysed the financial models underpinning the expected 30% return statement. It did so having regard to the various unit issues to ordinary investors and a related party co-investor. The Court noted:
1. Because the co-investment and arrangements set out in the trust deed and IM did not occur, on an analysis of the facts of the investment the Court found that “a distribution of profits and return of capital to unitholders in proportion to their unit holding would have meant that the “Profit % ROI” would have been negative”.
2. The suggestion of 30%+ returns when the real return would have been negative was misleading.
3. The IM omitted details in relation to the expected return on investment that even the IM issuer did not appreciate until the trial.
In a sour note for the directors of the issuer of the IM, the Court found that the Directors were “knowingly involved” in the contravention. The Directors knew the statements in the IM were false and so they became liable for the loss.
Disclaimers
While the IM had qualifications and disclaimers, the Court stated that: Disclaimers and exclusion clauses cannot be relied upon to exclude liability for contravention of the statutory provisions regarding misleading or deceptive conduct. This quote resonates: ‘The disclaimers and other similar statements relied upon by the respondents did not erase or dispel the misleading effects of the statements in the (paragraph 99).’
Observations and guidance on the production of Information Memorandums
– Statements unsupported by reality – eg the executed building contract – are clearly problematic. Appropriate due diligence should ensure that if a positive statement is being made about a fact, the fact should be provably true. There are classic examples such as where a document is agreed but not executed, it must be described in this form in an IM.
– Disclaimers and qualifiers do not act as a panacea to protect lies, mistruths or exaggerations.
– Financial modelling to support returns should be robust to assess third party scrutiny (like a Federal Court Judge!).
– Directors who are knowingly involved in falsehoods should expect to be personally responsible.
– There was no mention of any of the parties holding an Australian Financial Services Licence to provide the abovementioned financial services. While this is curious, the investors were ultimately successful applying the concepts of the ASIC Act. They have not pursued claims arising from either the lack of an AFSL or the “secret mortgage”.