In what seems like an untimely coincidence, the Western Australian Supreme Court was approached by three unrelated listed companies earlier this year, each seeking declarations that defects in a multitude of cleansing notices issued by it would not invalidate the offers and sales of its shares made in reliance on those cleansing notices.
The court obliged in each case, making pertinent observations in its judgments as to when the court may – and may not – be in a position to grant relief from contraventions of and liability under the Corporations Act in exercise of its discretionary power under section 1322 of the Corporations Act.
How were the cleansing notices defective?
In Australia, securities that have not been issued under a prospectus cannot be on-sold within 12 months of their issue except in very limited circumstances. One of the exceptions heavily relied upon by listed entities to enable the on-sale of their securities is the issue of a cleansing notice that contain certain prescribed information, including relevantly, confirmation by the entity that it has complied with its obligations with respect to the appointment of auditors.
Unfortunately for Bellevue Gold Ltd, Matador Mining Ltd and New Century Resources Ltd, all three companies discovered that following the resignation of their previous auditors, they had:
- neglected to obtain shareholder approval to the appointment of their new auditor (whose appointment by the board to fill the casual vacancy was only effective until the company’s next AGM); and
- subsequently allowed offers and sales of their shares in reliance on cleansing notices that were defective because they incorrectly represented that the relevant company was in compliance with its obligations under Chapter 2M of the Corporations Act, including with respect to the appointment of an auditor.1
In submissions, counsel for Bellevue Gold Ltd posited the argument that because the Corporations Act obliged a company to rectify erroneous statements in its cleansing notice once discovered and provided a specific procedure for doing so, the cleansing notices in question were not in fact defective as the company was not aware of the errors they contained at the time they were issued. The court did not favour this argument but declined to express a conclusive view on the issue, noting that the court’s remedial powers under section 1322 did not require a positive finding that there had been a contravention of the Corporations Act.
What remedial orders did the companies seek, and why were they important?
On application by each company, the court made remedial orders under section 1322 to validate the appointment of each company’s new auditor (with retrospective effect), absolve the companies and their current and former directors and officers of civil liability for the relevant contraventions of the Corporations Act, and declare the relevant defective cleansing notices and all offers and sales of securities made in reliance on them valid.
It was critical to the court’s decision to grant these orders that the companies’ failures to properly appoint new auditors and their subsequent misrepresentations in the cleansing notices as to compliance with Chapter 2M (collectively, Contraventions), were the product of honest error and inadvertence; in particular, the companies’ officers:
- did not act in any deliberate disregard of the law;
- honestly believed that the companies were in compliance with their financial reporting and auditing obligations; and
- promptly took legal advice and further action when this was found not to be true.
Her Honour Justice Hill was not convinced that the remedial orders could be made on the alternative ground that the Contraventions were “essentially of a procedural nature”, noting in particular that “the provisions governing the appointment of an auditor have been designated by Parliament to be sufficiently serious as to constitute a criminal offence”.
Her Honour also appeared in her judgments to place great weight on the flow-on effect on the companies, its shareholders and the securities market in general if the validating orders were not made. In relation to the validation of:
- the appointments of the auditors, Justice Hill noted that the status of the companies’ financial reports would remain uncertain if the appointments were not validated which could impact the companies’ ability to issue cleansing notices for any future capital raisings as the companies would be unable to certify its compliance with Chapter 2M going forward; and
- the defective cleansing notices, Justice Hill noted the commercial uncertainty and expense for the company arising from problems caused by void or voidable offers and sales of its shares, as well as the substantial injustice to shareholders of not being able to trade their shares on an open market (due to ASX suspending the shares from trading until such time as orders are made by the court).
These recent WA decisions highlight just how important good corporate governance is to ensuring that a company is able to raise capital quickly when required by making ‘low doc’ offers (like pursuant to a cleansing notice). And because we are all human, the cases show that the courts can be quick to come to the aid of companies that act quickly and candidly in seeking to address any errors made.
If it has been a while since your company’s corporate governance processes have been reviewed or you have a specific issue in mind, we would gladly take a look to see how we can resolve any molehills before they become mountains.