Tutorial 11 revision PDF

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Tutorial 11 Guide - Corporate Finance - Fundraising (Required readings Chapters 18, 19, 20, 21 in the prescribed textbook and to the lecture PowerPoints of Fundraising) Students should read the case law discussed in the prescribed textbook. The following is only a guide to answering the following tutorial questions and not to be taken as a complete and comprehensive answer to the questions. All reference to sections in this answer guide relate to provisions under the Corporations Act 2001 (Cth) (‘CA”). 1. What are securities for purposes of the fundraising disclosure provisions? Section 700 Corporations Act 2001 (Cth) (“CA”) defined securities as shares, debentures, a legal or equitable interest in shares or debentures, options to acquire shares or debentures. 2. What is the difference between a prospectus and a profile statement? Ch 6D Corporations Act provides for the type of disclosure documents. Under s 709, the types of disclosure documents that may be used for offering securities to prospective purchasers are:    

a prospectus; a short form prospectus; an offer information statement; and a profile statement. A prospectus is the most common form of disclosure document and must generally be prepared for an offer of securities under Ch 6D (s 709(1)), unless it is a small capital raising of under $10 million or falls within the exceptions in s 708. A short form prospectus - refers to material already lodged with ASIC, such as the financial reports of the company. The aim is to present a shortened and simplified form of information to retail investors, while still enabling technical details to be revealed to advisers and others. Investors may obtain a copy of the full documentation on request: s 712(5). Ch 6D, s 710 – a prospectus must contain all information that investors and their professional advisors would reasonably require to make an informed assessment of matters set out in s 710 (2) , s 709(1) CA, see chapter 9 [19-500] – [19-520] An offer information statement may be used instead of a prospectus for an offer of securities of $10 million or less: s 709(4). This document has fewer disclosure requirements than a prospectus. A profile statement is a brief summary statement prepared in addition to a prospectus. The company is still required to prepare and lodge a prospectus with ASIC but s 721 allows for a profile statement, rather than the prospectus to be sent out to 1

investors with offers, provided ASIC has approved. Investors are entitled to a copy of the prospectus, at no cost, upon request: s 721(3). 3. Under what circumstances are companies exempt from preparing a disclosure document? Disclosure must be provided to investors in connection with offers of shares (other than Crowd-sourced funding (CSF offers) as provided under Ch 6D of the Corporations Act 2001 (Cth) unless the offers are small scale personal offers, offers to sophisticated investors, offers to professional investors, offers to persons associated with the company, offers under dividend reinvestment plans and bonus share plans and other forms of offers as provided by s 708 or s 708AA Corporations Act 2001 (Cth). 4. How does the Corporations Act define a ‘small –scale offer’ and a ‘sophisticated investor’ Section 708 states that disclosure is not required if the offer is part of a small-scale, private offering that does not result in more than 20 new members subscribing for share or subscriptions totalling $2 million, in a 12 month period. Section 708 (8) permits offers to be made to sophisticated investors without disclosure documents. The exception applies to investors in one of the following, “(a) the minimum amount payable for the securities on acceptance of the offer by the person to whom the offer is made is at least $500,000; or (b) the amount payable for the securities on acceptance by the person to whom the offer is made and the amounts previously paid by the person for the body's securities of the same class that are held by the person add up to at least $500,000; or (c) it appears from a certificate given by a qualified accountant no more than 6 months before the offer is made that the person to whom the offer is made: (i) has net assets of at least the amount specified in regulations made for the purposes of this subparagraph; or (ii) has a gross income for each of the last 2 financial years of at least the amount specified in regulations made for the purposes of this subparagraph a year; or (d) the offer is made to a company or trust controlled by a person who meets the requirements of subparagraph (c)(i) or (ii).”

5. When will a debenture issue require a disclosure document to be issued? Debentures are essentially debt securities. Disclosure document is required for all security issues. Section 283BH (1) states that debentures can only be described in a prospectus or any other document inviting loans as either a: mortgage debenture (when secured by a first

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registered mortgage over real property); debenture (any other type of security arrangement); an unsecured note; or an unsecured deposit note. 6. How do you determine what ‘material’ information must be included in a disclosure document? General disclosure test: Section 710 requires that the prospectus provides all the information that investors and their professional advisers would reasonably require to make an informed decision in relation to the rights and liabilities attaching to the securities offered, the assets and liabilities of the body, the financial position and performance of the company and the prospects of the body; and Specific disclosure test: Section 711 imposes additional disclosure requirements. It requires disclosure of ‘interests and fees of certain people involved in forming the company or preparing the float’. The prospectus must also set out the terms and conditions of the offer. GIO Australia Holdings Ltd v AMP Insurance Investment Holdings Pty Ltd (1998) 30 ACSR 102 – when a profit forecast is provided, ASIC had cautioned against its incorrect use. 7. What purposes do supplementary and replacement disclosure document serve? when a person making the offer becomes aware that the disclosure document contains misleading or deceptive statements, has omitted key information or new circumstances have arisen since lodgement that are materially adverse from the point of view of an investor, they may lodge a supplementary or replacement document with ASIC: s 719 CA. These provisions exist to ensure that disclosure documents remain current and reliable and do not breach s 728 and present an opportunity to cure defects. 8. Who may be potentially liable for defective disclosure during a capital raising? Directors and Board of Directors – directors must act in accordance with their duties owed to the company. The impact of duties to act in good faith in the interest of the company and to exercise powers for proper purpose extends in the context of share issues. Case Law - Re Spargos Mining NL (19900 8 ACLC 1,218; 3 ACSR 1. (See chapter 16 pp 345 -346 prescribed textbook, Hanrahan et al, Commercial Application of Company Law (2020).) Part 6D.3 Prohibition and liabilities, s 728 (1) CA If ASIC is satisfied that a disclosure document is misleading or deceptive, ASIC may issue an interim stop order. Such an order prevents the offer, sale, issue or transfer of securities under the disclosure document, while the order is in force. If the company lodges a supplementary or replacement disclosure document, then ASIC may revoke the stop order, if its concerns

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have been satisfied, otherwise it will hold a meeting to determine whether a final stop order should be made. 9. How could due diligence be proved if the directors are sued for a defective prospectus document? s180, liability for misleading and deceptive statements/representation, s189 defence, Refer to Chapter 21 [21-160] – [21-180], see page 646 in textbook.

Problem question 1. Flywell Ltd is the owner of an Australian domestic airline. The management of Flywell Ltd intends to expand its Australian domestic operations and the board of directors of Flywell Ltd decides to revamp its fleet of aircraft and to purchase extra planes. However, the company does not have the capital. To raise the capital for its expansion Flywell Ltd wishes to induce each investor to invest $10,000 with the company in exchange for shares in the company. The company aims to raise between $9 million and $11 million to new funds. (a) Advise Flywell Ltd of its fundraising obligations under the Corporations Act paying particular attention to the specified facts. Assume that Flywell has issued shared and has lodged a prospectus with ASIC. The prospectus contains totally unrealistic profit forecast made by the directors and supported by a quote from an independent industry expert. Flywell’s expansion was a disaster because market demand for domestic travel slumped unexpectedly soon after the prospectus timeframe closed due to the Covid-19 pandemic. Issue: What are Flywell Ltd fundraising obligations under the Corporations Act 2001 (Cth) (‘CA’)? Laws: Prospectus sections 709 – 713, small scale or personal offers disclosure document required, see s 708 (2). Section 710 provides the requirement for the information that should be in the disclosure document. Section 728 prohibits offering securities under a disclosure document that is materially deficient. Section 729 deals with liability for breaches of s 728. Sections 731, 732 and 733 set out the defences that may be raised.

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GIO Australia Holdings Ltd v AMP Insurance Investment Holdings Pty Ltd (1998) 30 ACSR 102 – when a profit forecast is provided, ASIC had cautioned against its incorrect use. Application: (In the application part of the answer to the problem questions students should apply sections noted in the law part to the facts given in part (a) of the question.) Firstly, provide an overview of procedure for disclosure document for securities issue under s 710 Corporations Act 2001 (Cth). Note that all applications for securities issue must be lodged with ASIC before distribution – s 718. The purpose of disclosure documents is to promote disclosure of information that investors reasonably require to make informed decisions and to protect investors from exploitation. Discuss if Flywell has lodged a prospectus with ASIC and complied with s 710. Explain what information should be included therein. Discuss the provisions under s 728, 729, 731, 732 and 733 to the facts in the question. Student should summarise these provisions under CA and apply them to the facts given in the questions above. Discuss if the prospectus contains totally unrealistic profit forecast made by the directors and supported by a quote from an independent industry expert. Is there any restrictions on using profit forecasts in the prospectus? Flywell Ltd., had included unrealistic profit forecast in the prospectus. ASIC would have cautioned Flywell against using profit forecast. Refer to the principle in the case of GIO Australia Holdings Ltd v AMP Insurance Investment Holdings Pty Ltd (1998) 30 ACSR 102 – when a profit forecast is provided, ASIC had cautioned against its incorrect use. The prospectus lodged with ASIC was supported by a quote from an independent industry expert. Flywell’s expansion was a disaster because market demand for domestic travel slumped unexpectedly soon after the prospectus timeframe closed due to the Covid-19 pandemic. If the disclosure document contained materially deficient information or supporting information from an independent industry expert that was incorrect then this would be misleading and deceptive. Section 728 prohibits offering securities under a disclosure document that is materially deficient and information that is misleading or deceptive. Section 729 deals with liability for breaches of s 728. Sections 731, 732 and 733 set out the defences that may be raised. Discuss these defences. If Flywell is successful in raising any one of the defences under s 731, 732 or 733 then it will not be liable. If the defences do not apply to Flywell then Flywell will be liable for breach of s 728 CA. Conclusion: Flywell would have breached Remedies for investors: compensation for defective disclosure

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(b) The investors have commenced legal action on the basis that the profit forecast statement in the prospectus were misleading or deceptive. Assuming this to be the case, advise the following parties on their respective rights and liabilities: (i) (ii) (iii)

the investors of Flywell Ltd; Flywell Ltd; and Flywell Ltd.’s directors.

Issue 1: What are the rights of the investors of Flywell Ltd? Law: s 140 CA, Fraser v NRMA Holdings Ltd Remedies – common law and statutory remedies Application: In the application part of the answer, students should apply the relevant law to the facts in issue. Section 140 creates a contractual relationship between the investors and the company. Discuss the contents of the prospectus and what should and should not be included and the principle in the case of Fraser v NRMA Holdings Ltd. Conclusion: If Flywell Ltd is liable, the investors will be able to rescind the contract and Flywell Ltd. will have to return the money paid for the securities subscribed. Remedy: Common law and statutory remedies available to the investors. The remedy will rescission of contract and damages (compensation). Issue 2: Will Flywell be liable/ what are the liabilities of Flywell Ltd, if any? Law: Refer to Ch 21 [21-160], and liability for defective disclosure, ch 21, Table 21.2 Application: Usually, there is a general restriction on advertising and publicising the issue of securities, before the lodgement of the disclosure document with ASIC. However, a limited direct advertising campaign may be allowed before the lodgement of the disclosure document under s 734, and the extent of the advertising will depend on whether a company is quoted on the ASX. If ASIC is satisfied that a disclosure document is misleading or deceptive, ASIC may issue an interim stop order. Such an order prevents the offer, sale, issue or transfer of securities under the disclosure document, while the order is in force. If the company lodges a supplementary or replacement disclosure document, then ASIC may revoke the stop order, if its concerns have been satisfied, otherwise it will hold a meeting to determine whether a final stop order should be made. Conclusion: Flywell will be liable for breach of s 729 Remedy: if any 6

Penalty: Civil liability under s729 – Civil penalty provision under s 729 - Compensation for effective disclosure – case Credence Asset Management Pty Ltd v Concept Sports Ltd (2005) 56 ACSR 309 Issue 3: Are the directors of Flywell Ltd. liable? Law: Breach of directors duties, s 180, s 588G, defences s 189 CA, also see prescribed text book chapter 21, Table 21.3 Defences for liability, refer to pg. 443. Application: Discuss the duties of a director under s 180, s 588G. Conclusion: Conclusion: Defence: and if any of the defences will apply (i.e. due diligence for prospectus, lack of knowledge as a defence s 732– refer also to s 189 CA. Penalty: civil for defective disclosure document under s 729 or criminal penalty under s 728 (3) CA.

2. [Note: Question 2 is from Tutorial 8 Breach of Directors Duties and Members Remedies] Apollo Ltd (Apollo) specialises in the creation of computer games. The company has three directors: Hong, Lin and Winnie. Hong is the managing director. The board of director of the company wanted to raise capital through the issue of shares because they need to use the capital to finance a new game (‘Orion’) they are launching. They ask Emily, who is a renowned expert in the gaming community, to assess ‘Orion’ and they receive her consent to include her statements in the prospectus. Emily states the following: ‘Orion is a computer game that will revolutionise the world. It will create a new generation of player. The game has no glitches or faults in it. It runs smoothly and has excellent design.’ In reality, Emily was too busy to check the game. She actually wrote her statement based on past games produced by Apollo. A number of investors bought shares based on her statement. When the game is launched, it is a total disaster. The game was not designed properly and had a number of glitches and faults in it that did not allow the users to play the game. The investors would like to take action against Emily. Advise Emily on her liability. Issue: Is Emily liable under the Corporation Act 2001 (Cth) for the misstatement on the prospectus? Law: Fraser v NRMA Holdings Ltd (1995) 127 ALR 543 Federal Court of Australia Full Court (“Fraser’s Case”). Misstatement in or omission from, disclosure document – see s 728, s 728 (1), (2), (3) and (4) CA. Right to recover for loss or damage resulting from contravention – s 729 (1) CA

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Application: Fraser’s case demonstrates that information contained in the disclosure document (a prospects in this case) which set out the benefits of this motoring group so they vote in favour of demutualisation must be balanced (fairly presented) and not exclude material information that is relevant to enable an informed decision to be made – otherwise liability can be attracted under s 728 CA for misleading and deceptive statements. Experts named with their consent as having made a statement, which is included, or on which, a statement made in the disclosure document is based, will be liable for the loss or damage caused by the inclusion of that statement. Accordingly, the experts are only liable to the extent that their statement caused damage and losses: s 728 (1) CA.

Conclusion: Emily will be liable for misleading and deceptive statements Remedy: Compensation for loss or damage caused to investors. Penalty: if any – civil penalty under s 729 or criminal penalty under s 728 (3) CA.

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