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1 insurance specialists The need to establish reliance in a shareholder claim for misleading and deceptive conduct April 2012 Wotton + Kearney Insurance Lawyers Sydney Written by: Patrick Boardman, Partner and Lisa Feltz, Solicitor Level 5, Aurora Place, 88 Phillip Street, Sydney Telephone Melbourne Level Bourke Street, Melbourne Telephone

2 Introduction One of the most important outstanding issues in shareholder class actions is the extent to which the shareholder has to prove reliance on the alleged wrongful conduct. In De Bortoli Wines Pty Ltd v HIH Insurance Ltd (in liquidation) [2012] FCAFC 28 the Full Federal Court considered this issue in the context of a claim for misleading and deceptive conduct (in contravention of section 52 of the Trade Practices Act 1984 (Cth) (TPA) which is now section 18 of the Australian Consumer Law). The Full Court held that the fair inference of reliance relied on by De Bortoli Wines Pty Limited (DBW) must be weighed in light of all the evidence, and it did not relieve DBW from the need to establish its reliance on the impugned conduct/information. Accordingly, where the evidence rebutted that inference of reliance, DBW failed to establish that its loss was caused by the alleged conduct of HIH. Background In 2000 DBW acquired more than 19 million HIH shares in 66 separate transactions in a 5 month period, at a total cost of $7,140, HIH was eventually liquidated and those shares became worthless. DBW s claim On 9 February 2009 DBW submitted a proof of debt to HIH s liquidators (the liquidators) for an amount equal to the cost of the shares, on the basis that the shares were acquired in reliance on misleading and deceptive information provided directly, or indirectly, by HIH (in breach of section 52 of the TPA), which were contained in: + financial statements and reports released by HIH, as well as HIH media releases published by the Australian Securities and Investments Commission (ASIC) and the Australian Securities Exchange (ASX); + advice given by third-party analysts (such as stockbrokers) which was based on the information provided by HIH to the public and the ASX; and + representations made separately by an officer and a director of HIH at the time. Liquidators decision While the liquidators admitted that some of the alleged representations were misleading and deceptive, they rejected DBW s claim on the basis that there was insufficient evidence to establish HIH s liability. In particular, the liquidators considered that DBW could not establish that its loss was caused by reliance on HIH s alleged misleading and deceptive conduct. The Federal Court proceedings On 17 February 2010 DBW sought orders pursuant to section 1321 of the Corporations Act 2001 (Cth) to set aside the liquidators decision and have its debt admitted. The remedy for a breach of section 52 of the TPA is damages pursuant to section 82 which requires DBW to establish that its loss was occasioned by conduct of [HIH]. Accordingly, the pertinent issue was whether HIH caused the claimed loss to DBW. Following a detailed review of relevant authorities, including the decisions in Digi-Tech (Australia) Ltd v Brand [2004] NSWCA 58 and Ingot Capital Investments Pty Ltd v Macquarie Equity Capital Markets Ltd (2008) 73 NSWLR 653, Stone J held that for DBW

3 to succeed in its claim, it must establish that it was induced to enter each transaction by the impugned conduct of HIH. Her Honour held that... here reliance is critical to [DBW s] claim; DBW must show that it relied on the misleading information and that that information emanated from HIH... DBW placed great emphasis on inferred reliance by reason of the fact that HIH engaged in misleading or deceptive conduct and the fact that DBW purchased HIH shares. This inferred reliance arose from the long recognised principle of Lord Blackburn 1 that...if it is proved that the defendants with a view to induce the plaintiff to enter into a contract made a statement to the plaintiff of such nature as would be likely to induce a person to enter into a contract, and it is proven that the plaintiff did enter into the contract, it is a fair inference of fact that he was induced to do so by the statement.... The inference of reliance is rebuttable and Stone J held that any inferred reliance must be weighed in light of all the evidence and, in this case, the weight of that evidence rebutted any such inference. In regard to the evidence, her Honour noted that: + on cross examination, Mr De Bortoli (the managing director of BDW who purchased the shares) could not recall when he read the relevant documents. Moreover, he confirmed that the yellow highlighting on the documents was not made by him when he read the documents but rather had been made by his lawyers in 2009 after they had read the report of the Royal Commission into the collapse of HIH. Stone J concluded that in the absence of any contemporaneous notes or markings on the documents, his assertions that he paid particular attention to statements highlighted by his legal advisors almost nine years later cannot be regarded as reliable evidence... ; and + when questioned about why he continued to buy HIH shares as the price plunged, Mr De Bortoli confirmed that he thought he knew better than the market and that he was backing his own judgment. Stone J found that those assertions were inconsistent with Mr De Bortoli s claim that he relied on HIH s representations. DBW, while expressly disclaiming any reliance on the fraud on the market theory (as that theory has not been accepted in Australia), also submitted that the HIH shares only had some market value and were able to be traded at all on the share market as a result of the representations by HIH, which were admitted to be false. In other words, DBW contended that had the true position been known, the shares could not have been traded at all. Stone J rejected this argument for two reasons: firstly, because there was no evidence to support the proposition, and secondly because it was clear from the evidence that Mr De Bortoli was betting against the market rather than relying on it. Thus, while DBW was able to establish misleading and deceptive conduct by HIH, the absence of cogent evidence of reliance on that conduct and therefore the absence of any causal link between the impugned conduct and the loss was fatal to DBW s claim. Full Federal Court s decision The essential issue in the appeal was whether her Honour erred in her findings about the absence of causation. DBW contended that she failed to accord proper weight to the fair inference principle and that she applied an unrealistic test in determining whether to accept Mr De Bortoli s evidence of reliance. 1 Smith v Chadwick (1884) 9 App Cas 187 at 196

4 The Full Court held that it was unnecessary for it to determine whether the proper approach was for it to proceed on the basis of a rebuttable fair inference principle (as neither party contended that the principle did not arise). Instead, the crux of the appeal was whether the judge erred in finding that that inference was rebutted by evidence that DBW did not rely on the impugned information. The Full Court identified the following five reasons which allowed her Honour to find an absence of reliance: Conclusion + the evidence did not support a finding that DBW read the statements of HIH s profits and net assets prior to purchasing the shares, or in the event that it did, that evidence was overshadowed by the weight DBW gave to Mr Adler s purchase of shares; + in purchasing shares from September onwards, when the market was falling, DBW knew better than the market ; + it was open to her Honour to find that due to the considerable negative media attention given to HIH from September onwards, Mr De Bortoli s creditability was undermined by his claim that he was unaware of the media reports; + DBW s evidence of reliance was given at a very high level of generality. There was no evidence of how the statements in the accounts were understood or how they related to DBW s assessment of the value of HIH shares; and + the statements attributed to an employee and a director of HIH to the effect that it was a profitable company were general statements to which little weight could be attached. The Full Court held that in order to establish that a shareholder s loss is caused by any misleading and deceptive conduct, it is necessary for the shareholder to establish reliance on the impugned information/conduct. While the Full Court did not have to make a finding of whether the fair inference of reliance arose 2, it is notable that it did not reject that inference, but rather held that it was clearly rebutted by the evidence in this instance. The effect of the judgment is that a shareholder will have to adduce evidence of its particular reliance on the impugned conduct, and cannot merely rely on the fair inference of fact, otherwise it runs the risk of the company adducing its own reliance evidence in rebuttable. This could result in the shareholder being unable to establish the necessary reliance to prove its case. However, if the Courts accept the fair inference principle, the onus of proof is arguably reversed, so that reliance is accepted unless cogent rebuttal evidence is established. This in turn raises a number of further issues still to be addressed by the Courts, namely: + the extent of required reliance for a breach of continuous disclosure obligations; + the extent to which shareholders have to provide individual discovery sufficient to allow proper consideration of a rebuttal defence; and + the extent to which indirect causation could be relied on although that has been expressly rejected by the NSW Court of Appeal 3. The Full Court decision will be relevant to the current trial of the Centro class actions regarding the mis-classification of debt (as non-current rather than current) in Centro s 30 June 2007 financial accounts. Centro s shareholders claims are based on allegations of 2 as it was accepted by both parties 3 Ingot Capital Investments Pty Ltd v Macquarie Equity Capital Markets Ltd [2008] NSWCA 206

5 misleading and deceptive conduct and breaches of continuous disclosure obligations. While it cannot seriously be disputed that Centro s debt was incorrectly classified, the issue of causation of the shareholders loss is in dispute. A decision in that matter will likely address some more of the outstanding issues in shareholder class actions. Please call Patrick Boardman on with any questions. Patrick Boardman, Partner Tel (02) patrick.boardman@wottonkearney.com.au Lisa Feltz, Solicitor Tel (02) lisa.feltz@wottonkearney.com.au