Australia – Mineral Sands Class Action On Shaky Ground.

27 July, 2015

 

Bonham v Iluka Resources Limited [2015] FCA 713

 

WHAT YOU NEED TO KNOW

 

• In Bonham v Iluka Resources Limited, the Federal Court refused a preliminary discovery application and was critical of the speculative basis on which the proposed claim was founded.
• Iluka demonstrates that in a continuous disclosure case, an inference drawn from a falling share price following a company announcement and the content of the announcement may be insufficient to obtain orders for preliminary discovery.
• The decision may make it difficult for a speculative class action to proceed, as there may be an absence of information sufficient to plead a claim, but also no practical means of obtaining it.
• The applicant's solicitors were criticised for seeking preliminary discovery (to assist in deciding whether to commence proceedings against Iluka) while at the same time making statements in the course of their "book building" process to the effect that they had already decided to commence a proceeding. Potential defendants should monitor and, where appropriate, seek to correct, such announcements.
• The fraud on the market doctrine remains uncertain in Australian law.

 

In Bonham v Iluka Resources Limited [2015] FCA 713, Kerr J dismissed an application for preliminary discovery in relation to a contemplated shareholder class action against Iluka Resources Limited (Iluka).

 

The decision puts the proposed class action into jeopardy. The Judge also made important observations about the conduct of plaintiff lawyers in book-building potential class actions and the fraud on the market doctrine.

 

Background: the proposed class action

 

Iluka is a mineral sands producer listed on the ASX.

 

In addition to quarterly and half yearly reporting, it also had a practice of publishing occasional updates under the banner: "Key Physical & Financial Parameters". These updates were published subject to the caveat that they were intended to assist sophisticated investors and that the reports should not be relied upon as a predictor of future performance. The court observed that in this respect Iluka was regarded by analysts as making "special efforts to disclosure" to help the market understand the "rather opaque" mineral sands sector.

 

On 8 May 2012 Iluka published an ASX notice and "Key Physical & Financial Parameters Iluka 2012 – May Update". In each, Iluka moderately downgraded its guidance. In particular, it forecast falls in the production and sale of its core product, zircon, of about 10%.

 

On 15 May 2012 the applicant, Mr Bonham, purchased shares in Iluka. On 9 July 2012 Iluka published a further notice to the ASX in which it forecast significantly lower sales, reflecting below expectation second quarter sales and a deteriorating economic outlook. Revised guidance forecast annual zircon sales of between 50% to 75% of that forecast in May 2012. Following this announcement, Iluka's stock price fell by 24%.

 

In March 2014 ACA lawyers announced that it had obtained funding (from UK based Harbour Litigation Funding) to commence a class action against Iluka and that the action would allege that Iluka had failed to comply with its continuous disclosure obligation and engaged in misleading or deceptive conduct. The action was to be commenced on behalf of shareholders who had purchased shares in between 8 May 2012 and 8 July 2012. The thrust of the proposed action was that in providing or failing to withdraw its 8 May 2012 guidance, Iluka had misled the market and created a false expectation as to its prospects.

 

In November 2014 ACA lawyers wrote to Iluka, informally seeking access to documents in order for Mr Bonham to decide whether to commence a class action. Iluka declined to provide the requested documents (as was its right). Mr Bonham then made an application in the Federal Court seeking preliminary discovery from Iluka.

 

Application for preliminary discovery

 

Preliminary discovery may be ordered where the prospective applicant in a proceeding:

 

• reasonably believes that he or she may have the right to obtain relief from a prospective respondent;
• after making reasonable enquiries, does not have sufficient information to decide whether to start a proceeding; and
• reasonably believes that the inspection of documents likely to be held by the prospective respondent would assist in
• deciding whether to proceed with the claim.

 

Critically, preliminary discovery is not available in a state of complete uncertainty as to whether a claim arises, depending on what is contained in the documents sought by the applicant. There must be a specific basis for a reasonable belief that all of the material facts necessary for relief may be made out.

 

Counsel for Iluka resisted the application principally on the basis that there was no evidence before the Court to demonstrate that Mr Bonham reasonably believed that he may have a right to relief from Iluka. Iluka put forward affidavit evidence which sought to explain why it stood by its 8 May guidance until the reconsideration which led to the 9 July downgrade.

 

Preliminary discovery rejected

 

The Court rejected the application principally on two related bases.

 

Firstly, the applicant had failed to demonstrate the facts or circumstances that would give rise to an objectively reasonable belief. The Court said that the facts and circumstances put forward amounted to no more than conjecture, suspicion or speculation. It observed: "a cable of belief cannot be woven exclusively from the threads of mere speculation or conjecture".

 

Importantly, it was not sufficient merely to point to circumstances which, viewed through the lens of hindsight, suggested that there might have been misleading or deceptive conduct. While it was recognised that, if an order for discovery were made, evidence to support the claim might emerge, to obtain preliminary discovery, the applicant needed to point to some existing specific evidence that Iluka knew or ought to have known of the circumstances giving rise to the downgrade prior to 9 July. None was available.

 

On the contrary, the Court concluded that the timing of the 9 July announcement was explicable having regard to the evidence led by Iluka and a careful analysis of the terms of its communications with the market. The evidence did not suggest that Iluka must have known earlier of the matters which motivated the disclosure. Kerr J further noted that the sharp fall in the share price was simply a product of the market's surprise and provided no logical foundation for the inference that there was any failure of disclosure.

 

Secondly, there was no evidence that the necessary belief was held by the applicant. The only evidence was in the form of affidavits from the applicant's solicitors as to their beliefs, together with objective facts which were said to found the reasonableness of the belief. This was, in Kerr J's view, insufficient. In the context of the proposed class action, Kerr J noted that in the absence of a demonstrated belief on the part of Mr Bonham, he (the applicant) could not rely upon the fact that other unidentified shareholders may have held such a belief.

In other cases, class action plaintiffs may well be able to cure the second deficiency by putting on affidavit evidence from the applicant. The first deficiency, however, may frequently pose practical difficulties for potential plaintiffs. Without documentary evidence there may not be a proper basis to plead a shareholder class action, but if the Court will not grant preliminary discovery simply on the basis of the timing of announcements viewed in hindsight, it may be impossible in practice to obtain the documentary evidence, at least where the potential defendant can put forward evidence which plausibly explains the sequence of events. 

 

ACA's conduct in book-building 

 

Kerr J went further and said that he would have declined the application in any event as a matter of discretion, in light of ACA Lawyers' conduct. His Honour's concern was that while prosecuting an action for preliminary discovery of documents to decide whether to proceed, ACA was at the same time promoting the class action – "book-building" – in terms which indicated that they had already decided to commence proceedings. The Court found that various statements on the ACA website to this effect "conveyed at least inaccurate and false impressions".

 

The Court was particularly concerned that these statements continued to be published on the ACA website after the application had commenced and ACA had been put on notice as to the inaccuracy of the statements.

 

His Honour concluded that:

 

ACA Lawyers' conduct cannot be accepted to be usual practice in this area of legal practice. Even if it be usual practice, that practice may nevertheless be wrong and require correction. Kerr J therefore referred his reasons for decision to the Office of the Legal Services Commissioner (NSW).

 

Fraud on the market

 

In the course of his reasoning, Kerr J also noted that the draft statement of claim put forward by Mr Bonham invoked the doctrine of "fraud on the market" as a way of satisfying the requirement of causation. His Honour briefly discussed the doctrine and observed that, to date, there has been no instance where the doctrine has been given effect in Australia to establish causation. Noting recent remarks of Perram J in Grant-Taylor v Babcock & Brown (in Liquidation),

his Honour observed:

 

In my view it goes too far to treat the obiter remarks of Perram J as doing more than endorsing the efficient market hypothesis as an available mechanism to measure loss.