In a recent case in the NSW Supreme Court, a former company director of the Dick Smith group was held personally liable for a truly eye-watering sum of $43 million for misleading and deceptive representations he made to Dick Smith’s lenders in connection with its debt financing arrangements. This decision provides a sharp reminder that company directors, officers and advisers of corporate borrowers must take the upmost care in their communications with lenders.
In this client update, we consider the circumstances of the case and the potentially broad application of Australia’s misleading and deceptive conduct laws in the context of facility agreements, loan arrangements, and debt negotiations, including before conclusive and binding documents are even entered into.
1. What led up to the court case?
After a period of negotiation on the terms of the financing and the financing documents, on 22 June 2015 Dick Smith Holdings Limited (Dick Smith) entered into a secured syndicated facility agreement with lenders National Australia Bank Limited (NAB) among others.
On 4 January 2016, Dick Smith went into voluntary administration, owing money to the lenders under that syndicated facility agreement. On the same day, the lenders appointed receivers to the Dick Smith group. Dick Smith went into liquidation on 25 July 2016.
2. What were the claims made against Dick Smith, Mr Potts, and other company directors and officers?
Following the liquidation of Dick Smith, both lenders sued two of its former directors (including Mr Michael Potts) personally. The lenders argued that during the loan negotiation process those directors engaged in misleading and deceptive conduct when responding to direct questions from the lenders as to the nature, and reasons, for Dick Smith stores’ (very high) inventory levels. NAB in particular asserted that:
- the directors did not properly disclose, or made misstatements as to, Dick Smith’s true financial position; and
- the information that Dick Smith provided to the lenders (or lack thereof), and the answers it gave (or decided not to give) to the lenders’ questions during the loan negotiation process, was a key component of NAB’s decision to provide its loans to Dick Smith.
The Supreme Court considered the claims of misleading or deceptive conduct for the purposes of section 18 of the Australian Consumer Law, section 12DA of the Australian Securities and Investments Commission Act 2001 (Cth), and section 1041H of the Corporations Act 2001 (Cth) (together, the Acts).
3. What is 'misleading and deceptive conduct' under the Acts?
The Acts each prohibit a person (which includes a company, or anyone acting or providing information on behalf of that company, such as its officers and other employees and advisers), in trade or commerce, from engaging in conduct that is misleading or deceptive or is likely to mislead or deceive. These provisions are cast extremely broadly and apply to almost all forms of communication that take place in the course of business. Misleading and deceptive conduct can include a failure to disclose information, creating a false impression, or causing confusion or uncertainty for a counterparty.
These prohibitions apply regardless of the intention of the party making the statement; that the misleading or deceptive conduct was due to an honest mistake is no defence.
Finally, in order to ground an action for misleading and deceptive conduct under the Acts, it will be necessary for the wronged party to demonstrate that they suffered loss as a result of the misleading and deceptive conduct.
4. What did the Supreme Court decide on the elements of misleading and deceptive conduct?
In its decision, the Supreme Court agreed with NAB that the elements of misleading and deceptive conduct under the Acts were made out with respect to the conduct of Mr Potts during his loan negotiation discussions with NAB, in that:
- Mr Potts’ communications with NAB were made in the context of “trade or commerce”;
- Mr Potts had engaged in misleading and deceptive conduct by deliberately withholding information from NAB on the issues around inventory levels in response to specific questions asked of him by NAB ; and
- Mr Potts’ misleading and deceptive conduct induced NAB to enter into the syndicated facility agreement and lend Dick Smith money, which caused NAB loss when Dick Smith defaulted on its loan under the syndicated facility agreement and when Dick Smith ultimately went into liquidation, with amounts recovered by NAB during the receivership being less than the value of the loans it had advanced.
The Supreme Court ordered Mr Potts to personally pay NAB approximately $43 million, being the balance of the amounts owing to NAB under its loan agreement with Dick Smith (and associated interest, fees, and expenses incurred or due and payable to NAB).
5. What does this decision mean for lenders, borrowers, and loan negotiations?
This case, and the sheer quantum of the personal liability the Supreme Court imposed on Mr Potts, is a cautionary tale for individuals involved in the management or representation of a company in the context of a loan transaction.
It is a very real example of the severe personal financial consequences for those that make misleading and deceptive statements in trade or commerce and for those that fail to fully answer a lender’s queries accurately, or without a reasonable grounds, on a company’s behalf.
Given the breadth of the misleading and deceptive conduct test, borrowers would be wise to consider the implications of this case not only in their negotiations with lenders in the context of negotiations for new loans or refinancing processes but also in terms of ongoing obligations throughout the life of existing debt facilities.
For example, a typical loan agreement includes several information undertakings and representations that could (if misleading and deceptive) lead to liability for the borrower company or those acting on its behalf, including:
- customary reporting obligations including the requirement to deliver financial statements, business plans and budgets;
- delivery of compliance certificates, verification certificates and utilisation requests which confirm and certify certain representations and warranties in the loan agreement are true and correct; and
- representations and warranties that repeat throughout the life of the loan on a recurring basis without any positive action from the Borrower (for example, on the last day of any Interest Period).
As the present case shows, a lender may be willing to take action against a borrower and, potentially, its officers and directors personally, if misleading and deceptive statements made in these contexts lead to it suffering a loss, especially after hearing of NAB’s success (and the quantum of the liability imposed on Mr Potts) in the Supreme Court. The remedies available to a lender for misleading and deceptive conduct are in addition to any rights of the lender under the loan agreement (for example, calling an event of default and enforcing that default).
As such, in each of these instances (and in all communications with its lenders), a borrower should ensure that information and statements provided are accurate and not misleading – and in relation to representations as to future matters, that they have reasonable grounds for making such representations.
Authors: Stuart Cormack, Travers Morony and Justin Sprogis.