On 2 October 2012, the High Court ended a long battle between ASIC and Fortescue Metals Group Ltd (“Fortescue”) and its founder and chairman Andrew Forrest. Fortescue and Forrest emerged victorious but, no doubt, bruised as a result of the seven-year stoush with ASIC.
The case goes back to 2004 and 2005 when Fortescue, which was not yet a “third force” in iron ore, triumphantly announced to the market (via the ASX) that it entered into “binding agreements” with Chinese stateowned enterprises to build the railway, port and mine for its iron ore project in Pilbara. Naturally, the announcements had an immediate positive impact on Fortescue’s share price.
The agreements were called “framework agreements”. Although they dealt with multi-billion dollar investments, they were only a few pages long and explicitly left many matters, including the scope of work, timeframe and price. Nevertheless, the agreements
stated that they were binding.
When ASIC obtained copies of these agreements, it has decided that the agreements were not binding and alleged that Fortescue engaged in misleading and deceptive conduct in contravention of the Corporations Act as well as contravening the continuous disclosure requirements of s 674 of the Corporations Act. ASIC also alleged that Mr Forrest failed in his duty to act with care
At first instance, Gilmour J of the Federal Court dismissed ASIC’s claims finding that the statements to the ASX were merely statements of opinion and that Fortescue (and Mr Forrest) honestly and reasonably held this opinion. When ASIC appealed, the full Federal Court held unanimously for ASIC (Fortescue Metals Group Ltd v Australian Securities and Investment Commission).
1 The court held that Fortescue’s statements were not statements of opinion but rather statements of historical fact. The court also held that the agreements were too incomplete to be binding.
In the words of Finkelstein J: If an arrangement is incomplete it may be impossible to find that a contract has come into existence notwithstanding the intention of the parties. For a contract to be valid the agreement must be sufficiently definite and explicit so that the parties’ intention can be ascertained with a reasonable degree of certainty. One missing element of each agreement
is the price to be paid for the works. In construction contracts the price is of fundamental importance. If it is not agreed, or there is no agreed method of ascertaining it, there can be no bargain. The reason no price was agreed is the inevitable consequence of another major omission: the scope of the works were barely described, let alone defined.
The High Court has now overturned the Federal Court’s decision (Fortescue Metals Group Ltd v Australian Securities and Investment Commission).2 The High Court’s decision is elegant in its simplicity and enlightening in its perspective (which is different from both the trial judge’s and the full Federal Court’s). In essence, the High Court said that it was not relevant whether the agreements were in fact legally binding. What was relevant according to the High Court was whether Fortescue’s statements “conveyed to their intended audience what the parties to the framework agreements had done and said they had done”. In other words, as the agreements stated they were binding (and the parties genuinely intended them to be — there was no compelling
evidence to the contrary) and Fortescue’s statements to the ASX accurately conveyed that, the statements were not misleading or deceptive.
There is a sound logic behind the High Court’s reasoning. Whether or not a contract is legally binding under Australian law is not always a simple question even for lawyers, let alone company directors who are responsible for informing the market of any material developments in their companies. Furthermore, as the High Court correctly pointed out, the whole enquiry as
to whether the agreements were legally binding in accordance with Australian law was misconceived in this case because the agreements may have not even been governed by the Australian law but rather were governed by the law of China — the agreements were with Chinese entities, were signed in China and contained no choice of law clause.
However, as compelling as the High Court’s logic is, there is some fear that the judgement may have watered down the protections for investors against misleading and deceptive conduct. Indeed, if a company does not have to understand or to enquire properly whether or not a contract is actually binding when announcing it to the market (as long as it genuinely believes so and the contract says so in some way), then what is to stop the companies from misleading the market (and inflating the share price) by misrepresenting the true legal effect of agreements? The High Court acknowledged this risk but felt that the law dealing with fraud sufficiently mitigates it. This is true, however we know that proving fraud is exceedingly difficult. Perhaps, the risk is indeed not significant because well-run and well-advised companies are diligent in ensuring that the information they provide to the market is accurate and complete. There is certainly nothing in the High Court’s decision that should change this.
The case also highlights inherent problems with so-called preliminary agreements (such as letters of intent, memoranda of understanding, framework agreements and so on). They are as ubiquitous as they are ridden with problems. All too often, such agreements, even if expressed to be binding like in this case, are so incomplete and poorly drafted that they simply cannot live up to the parties’ intent.
For inhouse lawyers, especially those who are charged with the task of advising directors on their companies’ continuous disclosure obligations, the challenge is not only to ensure that any preliminary agreements are properly drafted and sufficiently complete, but to ensure that the market is promptly and correctly informed of their content and effect. This is, by no means, a trivial task.