Warning for Directors: Don’t Make Promises You Can’t Keep
It’s certainly important to have some level of faith and optimism when it comes to business ventures. However, the recent decision in Semantic Software Asia Pacific Ltd v Ebbsfleet Pty Ltd [2018] NSWCA 12 provides a cautionary reminder to directors not to make audacious promises that can’t be kept.
Facts
In 2012 and 2013, Semantic Software Asia Pacific Ltd (Semantic), a software development company, sought funding from investors. To attract investors, Semantic’s managing director, Mr Mark Bradley, created an Investor Pack which described the shares as a pre-IPO. The Pack made several assertions about the likelihood of IBM, a successful technology company, acquiring Semantic. The Pack went as far as to state that IBM were “studying Semantic for a ‘potential acquisition or partnership’” and that it was likely that IBM, or a similar large technology company, would seek to purchase Semantic.
Ebbsfleet Pty Ltd and McGee Pty Ltd (hereafter Ebbsfleet) act as trustees for respective self-managed super funds established for Simon and Theresa Vinson. Ebbsfleet entered into 10 Share Issue Agreements with Semantic. These Agreements subscribed Ebbsfleet 605 million shares in Semantic with a total value of $1,625,000.00.
Prior to investing, Ebbsfleet attended several meetings with Bradley. During these meetings, Bradley read over the Investment Pack and made several bold representations about the future value of the Semantic shares. The Share Issue Agreements contained warranties that reflected Bradley’s brave promises. These warranties essentially stated that the shares would triple in value within three years. If the shares didn’t triple in value within this time, the Share Issue Agreement warranted that Bradley would personally transfer additional shares to investors to effectively triple the value of their original investment. In order to satisfy this guarantee, the warranty stated that Bradley must personally hold $10,000,000.00 shares in Semantic.
Unfortunately, Semantic was unable to secure any commitment from IBM and thus the shares didn’t triple in value within three years. Instead, they crashed so badly that they came to be described throughout the ensuing litigation as “essentially worthless”. Furthermore, Bradley sold all of his shares soon after executing the Share Issue Agreements for Ebbsfleet.
Supreme Court
Ebbsfleet brought action in the Supreme Court on two grounds. Firstly, Ebbsfleet argued that Semantic and Bradley were in breach of the Share Agreement. Secondly, it was alleged that Semantic and Bradley’s representations were baseless and thus amounted to misleading and deceptive conduct for the purpose of Australian Consumer Law.
The Supreme Court found in favour of Ebbsfleet on both grounds and ordered Semantic and Bradley pay Ebbsfleet a total of $6,500,000.00 for breach of contract and misleading and deceptive conduct.
On appeal
Semantic and Bradly appealed the Supreme Court decision, arguing that that misleading and deceptive conduct was not sufficiently established and that the warranties in the Share Issue Agreement were made solely by Bradley, not Semantic.
The Court of Appeal set aside the original orders with respect to misleading and deceptive conduct, finding that Ebbsfleet had failed to demonstrate sufficient reliance on the representations. Furthermore, the court overturned the claim against Semantic for breach of contract, concluding that it was not Semantic that gave the contractual guarantees. However, the Court of Appeal upheld Ebbsfleet’s claim against Bradley for breach of contract. Accordingly, the total was reduced to $4,950,000.00 and confined to Bradley alone.
Lessons
1. Directors
The lesson to directors is easily the most obvious – be extremely careful about any representations you give and don’t ever make a promise you can’t keep! This is particularly imperative when it comes to promises about future performance.
2. Investors
If you’re looking to invest, make sure you look for external evidence of success and promise. If an Investment Pack makes bold statements about value without backing up with evidence, think twice about the investment. If you really want to go ahead, consider requesting warranties from the company and its principals.
3. Start-ups
If you’re a start-up, it’s important to understand that blind optimism won’t protect you in court. If your value is mostly tied up in your intellectual property, you can demonstrate your value through evidence of income, commercial contracts and commitment from partners and other interested parties. It’s important that you don’t make promises about your success without backing them up, regardless of how much faith you have in your success.
Want to know more about the application of Australian Consumer Law? Looking for an experienced solicitor in Newcastle, Sydney or the Hunter to assist you with your business contracts? Call us on (02) 4929 7002, email us or complete an enquiry form.
