Availability of indirect market based causation to shareholders
Originally Published by Andrew Sharpe and Angela Smith on Thursday, May 19, 2016 9:13:19 AM
The issue of how causation can be established has been one significant debate in Australian securities class actions involving alleged breaches of the Corporations Act by corporations. It has been unresolved whether shareholders must prove individual reliance on the contravening conduct of companies, or if the conduct affects the market price of shares purchased and/or sold by shareholders is sufficient.
The recent New South Wales Supreme Court decision of Re HIH Insurance Limited (In liquidation)[1] which delivered judgment of four sets of proceedings brought by shareholders of HIH Insurance Limited (HIH), sought to resolve some of this uncertainty by determining that shareholders may prove causation without direct reliance by establishing that the price of the shares they bought was inflated by a company’s misleading conduct.
While there have been a number of recent decisions[2] that have (in obiter) provided tacit approval of indirect market-based causation, this decision is the first to approve and apply it.
The plaintiff investors acquired shares in HIH Insurance Limited (HIH) between 26 October 1998 and 15 March 2001 (the last day that HIH traded on the ASX). The plaintiffs alleged that during 1999 and 2000, HIH engaged in misleading and deceptive conduct by overstating its operating profit and financial position, contravening section 52 of the Trade Practices Act (1974) (TPA) and sections 995 and/or 999 of the Corporations Act (2001).
As a consequence of this conduct, the plaintiffs alleged that they acquired shares in a market which was falsified by HIH’s misrepresentations of its financial results. When HIH went into liquidation, the plaintiffs lodged proofs of debt on the basis that they had sustained loss by paying more for the shares than they otherwise would have had the market price not been artificially inflated.
The liquidators and scheme administrators rejected the proofs, causing the plaintiffs to appeal to the New South Wales Supreme Court seeking that their proofs be admitted. In reaching its decision, the Court considered:
The relevant provisions of the TPA and the Corporations Act allow recovery by a plaintiff who has suffered loss ‘by’ the contravening conduct.
In order to establish causation, Australian Courts have traditionally held that where a misrepresentation has induced a transaction (including a share transaction), the plaintiff must show that it relied on that misrepresentation to enter into the transaction. In this case, the plaintiffs did not allege such direct reliance, instead arguing that they acquired shares in a market regulated by the ASX which was distorted by HIH’s misrepresentations. But for such distortion they would have been able to have acquired the shares at a lesser price and, therefore, they would have suffered a lesser loss when HIH subsequently failed.
Justice Brereton considered it sufficient for the plaintiffs to demonstrate that the contravening conduct by HIH deceived the market in which shares were traded, where the plaintiffs had reasonably assumed that the market had set a share price that had been informed of HIH’s true financial position.
His Honour accepted the plaintiffs’ position, distinguishing the previous authorities which required actual reliance to be proved by each individual class member. He determined that a sufficient causal connection was established without the plaintiffs directly relying on the contravening conduct. It was sufficient that the plaintiffs collectively showed ‘by evidence and/or inference that the contravening conduct distorted the market price so as to cause the shares to trade at an inflated price’[3].
The Court found that the measure of the plaintiffs’ damages was closely related to their causation case. Having considered expert evidence on the appropriate methods of calculation, Justice Brereton determined that the measure of damages was the difference between the price the HIH shares were trading at and the price they would have traded at if the contravening conduct had not occurred, but all other factors had remained constant.
This is the first decision to determine authoritatively that indirect causation is applicable in investor claims against listed companies. The previous requirement that each class member strictly prove their individual reliance on the impugned conduct presented a difficult evidentiary hurdle for proponents of class action litigation. Typically, such actions were resolved by settlement at sums which reflected a discount to account for such difficulties. As such, the acceptance of market causation may potentially encourage further such claims and a more robust approach to the negotiation of quantum on behalf of plaintiffs. As this approach to causation has yet to be considered at the appellate level, it is unlikely that this will be the last word on the issue in the Australian context.
The recent New South Wales Supreme Court decision of Re HIH Insurance Limited (In liquidation)[1] which delivered judgment of four sets of proceedings brought by shareholders of HIH Insurance Limited (HIH), sought to resolve some of this uncertainty by determining that shareholders may prove causation without direct reliance by establishing that the price of the shares they bought was inflated by a company’s misleading conduct.
While there have been a number of recent decisions[2] that have (in obiter) provided tacit approval of indirect market-based causation, this decision is the first to approve and apply it.
Background
The plaintiff investors acquired shares in HIH Insurance Limited (HIH) between 26 October 1998 and 15 March 2001 (the last day that HIH traded on the ASX). The plaintiffs alleged that during 1999 and 2000, HIH engaged in misleading and deceptive conduct by overstating its operating profit and financial position, contravening section 52 of the Trade Practices Act (1974) (TPA) and sections 995 and/or 999 of the Corporations Act (2001).
As a consequence of this conduct, the plaintiffs alleged that they acquired shares in a market which was falsified by HIH’s misrepresentations of its financial results. When HIH went into liquidation, the plaintiffs lodged proofs of debt on the basis that they had sustained loss by paying more for the shares than they otherwise would have had the market price not been artificially inflated.
The liquidators and scheme administrators rejected the proofs, causing the plaintiffs to appeal to the New South Wales Supreme Court seeking that their proofs be admitted. In reaching its decision, the Court considered:
- whether HIH was liable to the plaintiffs for the loss and damage caused by the contraventions;
- whether the plaintiffs were entitled to damages on the basis of indirect causation without proving direct reliance on the contravening conduct; and
- the basis for quantification of the plaintiffs’ damages.
Market-based causation
The relevant provisions of the TPA and the Corporations Act allow recovery by a plaintiff who has suffered loss ‘by’ the contravening conduct.
In order to establish causation, Australian Courts have traditionally held that where a misrepresentation has induced a transaction (including a share transaction), the plaintiff must show that it relied on that misrepresentation to enter into the transaction. In this case, the plaintiffs did not allege such direct reliance, instead arguing that they acquired shares in a market regulated by the ASX which was distorted by HIH’s misrepresentations. But for such distortion they would have been able to have acquired the shares at a lesser price and, therefore, they would have suffered a lesser loss when HIH subsequently failed.
Justice Brereton considered it sufficient for the plaintiffs to demonstrate that the contravening conduct by HIH deceived the market in which shares were traded, where the plaintiffs had reasonably assumed that the market had set a share price that had been informed of HIH’s true financial position.
His Honour accepted the plaintiffs’ position, distinguishing the previous authorities which required actual reliance to be proved by each individual class member. He determined that a sufficient causal connection was established without the plaintiffs directly relying on the contravening conduct. It was sufficient that the plaintiffs collectively showed ‘by evidence and/or inference that the contravening conduct distorted the market price so as to cause the shares to trade at an inflated price’[3].
Quantifying the loss
The Court found that the measure of the plaintiffs’ damages was closely related to their causation case. Having considered expert evidence on the appropriate methods of calculation, Justice Brereton determined that the measure of damages was the difference between the price the HIH shares were trading at and the price they would have traded at if the contravening conduct had not occurred, but all other factors had remained constant.
Implications
This is the first decision to determine authoritatively that indirect causation is applicable in investor claims against listed companies. The previous requirement that each class member strictly prove their individual reliance on the impugned conduct presented a difficult evidentiary hurdle for proponents of class action litigation. Typically, such actions were resolved by settlement at sums which reflected a discount to account for such difficulties. As such, the acceptance of market causation may potentially encourage further such claims and a more robust approach to the negotiation of quantum on behalf of plaintiffs. As this approach to causation has yet to be considered at the appellate level, it is unlikely that this will be the last word on the issue in the Australian context.
[1] [2016] NSWSC 482.
[2]Camping Warehouse Australia Pty Limited v Downer EDI Limited[2014] VSC 357 where a Company brought an unsuccessful strike-out an application against investors who argued continuous disclosure of a Company in that certain information was not made generally available by the Company, and that a reasonable person would have expected that the relevant information would have had a material effect on the price or value of the Company’s securities, if that information had been made generally available.
see also: Caason Investments Pty Ltd v Cao [2015] FCAFC 94 where it was held to be reasonably arguable that a party can rely on market- based causation when making a claim based on section 729 of the Corporations Act 2001, under which a party who suffers loss or damage can seek compensation with respect to a defective disclosure document.
[3] Ibid, [78].