Disclosing insolvency to the market and market-based causation:

Earlier this year the Federal Court dismissed a claim bought by over 70 shareholders of the once highly successful financial services firm Babcock & Brown in the case of Grant-Taylor v Babcock & Brown Limited (In Liquidation) [2015] FCA 149.  Following solvency concerns in March 2009, and as a result of the global financial crisis, Babcock & Brown was placed in administration and subsequently into liquidation in August 2009.

The shareholders commenced proceedings against Babcock & Brown and claimed that Babcock & Brown had breached its continuous disclosure obligations by failing to disclose to the market, pursuant to section 674(2) of the Corporations Act 2001 (Cth), that:

  • final dividends had been unlawfully paid out of capital;
  • certain financial reports did not give a true and fair view of its financial position;
  • it was insolvent on 29 March 2008; and
  • a final dividend for the 2007 year had been paid out of funds borrowed on the back of an asset revaluation.

The shareholders allege that the shares were purchased at an inflated price caused by the company’s failure to disclose information to the market and claimed losses by reason of “marked-based causation” (a concept that has not yet been accepted by Australian Courts).

Disclosure of insolvency to the market

In response to claims by the shareholders that the failure to disclose that Babcock & Brown was insolvent resulted in a loss, it was submitted by Babcock & Brown and its liquidator “that insolvency was a matter of opinion and that Listing Rule 3.1 did not operate to require the directors to form opinions that they did not hold…”.[1]

The court was required to consider whether the directors were aware that Babcock & Brown was insolvent in the context of the ASX Listing Rule 19.12, which states:

… an entity becomes aware of information if a director or executive officer … has, or ought reasonably to have, come into possession of the information in the course of the performance of their duties as a director or executive officer of that entity.

Justice Perram determined that insolvency is a question of fact, notwithstanding that directors may be required to form an opinion about insolvency in the course of their duties.  He concluded that the shareholders needed to prove:

  • that the directors were actually aware of Babcock & Brown’s insolvency;
  • that Babcock & Brown’s insolvency should have been known to the directors; or
  • the directors were actually aware, or should have been aware, of an opinion that the company was insolvent.

Evidence was lead before the Court in relation to the solvency of Babcock & Brown and it was held that “the evidence shows that the directors did not have material before them on 29 November 2008 indicating that BBL was insolvent.”[2] Therefore, the shareholder’s claim against Babcock & Brown failed.

Market-based causation

The shareholders did not succeed with any of their claims and as such, the issue of market-based causation did not need to be determined.

While no Australian Court has finally determined if failure to comply with continuous disclosure obligations can be said to cause shareholder loss, interestingly, Justice Perram stated in obiter that:

Had it been necessary to reach a view, it is likely I would have agreed with the plaintiffs’ submissions… while reliance is a sufficient condition for establishing causation it is not a necessary one… For those reasons I would accept that a party who acquires shares on a stock exchange can recover compensation for price inflation arising from a failure to disclose material required by s 674 to be disclosed, so long as they are not themselves aware of the non-disclosed material.[3]

Lavan Legal comment

This decision highlights the distinction between a director’s opinion and knowledge (both actual and objective).  Although the shareholder’s application was dismissed and the concept of market-based causation did not need to be determined, Justice Perram’s comments may lead to the future acceptance of the principle in Australian Courts.

[1] Grant-Taylor v Babcock & Brown Limited (In Liquidation) [2015] FCA 149 at [154].

[2] Ibid, at [191].

[3] Ibid, at [219] – [220].

Disclaimer – the information contained in this publication does not constitute legal advice and should not be relied upon as such. You should seek legal advice in relation to any particular matter you may have before relying or acting on this information. The Lavan team are here to assist.