Australian Corporate Law: Earn-Outs and Disclosure

This assignment delves into the complexities of 'earn-out' provisions within the Australian corporate legal framework. It examines the specific disclosure obligations vendors face when incorporating these clauses into share sale agreements. The analysis draws upon relevant case law, such as *Forty Two International Pty Limited v Barnes*, and statutory provisions from the Corporations Act 2001. The assignment also explores the potential breach of statutory duties by directors who fail to disclose personal interests related to earn-out arrangements.

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Business and Corporate Law
Forty Two International Pty Limited v Barnes [2014] FCA 85
22-Jan-18
(Group Details: )

Business and Corporate Law
Introduction
The case of Forty Two International Pty Limited v Barnes [2014] FCA 85 revolves around a
dispute where the director duties were involved regarding the transaction which involved a group
of companies. The issue in this case which had to be decided was whether the director of a
company had breached the duties for the non-disclosure of the personal interest based on section
182 and 191 of the Corporations Act, 2001 (Fernandes, 2014). These sections relate the use of
position and the material personal interest, and cover the director duties in terms of not misusing
the same (Cassidy, 2006). The judgement of this case was handed down on February 18th, 2014
and is relevant owing to the same dealing with issues which are deceptive or misleading due to
the silence or non disclosure during the contractual negotiations, the loss of opportunity
damages, and the application of contract clauses which attempt at excluding the liability for extra
contract representations (Condon, 2014). The following discussion presents a summary of this
case, specifically in terms of the duties breached and the decision given by the court.
Background of the Case
The respondents of this case were the shareholders and the directors of the company, i.e., of
Forty Two International Pty Limited (Forty), who had sold their shares to BlueFreeway Limited
which they held in the company. This was based on the Ashare purchase agreement (Agreement)
which had been created in October 2006. The respondents continued to be the directors of Forty
even after sale. There were some payments to the respondents under the Agreement which had
been calculated by referring to the earnings of Forty in the later years. Particularly the additional
payment became payable only where the earnings before interest and tax for the year of 2007
was either 2.5 million or a higher value (Gadens, 2014).
The earnings of Forty were however less than what had been expected. For the year 2007, the
earnings before interest and tax of Forty got the mark of $2.5 million which resulted in Forty
getting in an intellectual property license in May 2007 with a third party. Based on this, a licence
fee had to be paid on June 30th, 2007 and this fee was around $4.1 million. BlueFreeway Limited
was not involved in or even aware of this license being granted by Forty which had been
approved by the board of directors of BlueFreeway Limited in May 2007. The respondents had
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initially shown to BlueFreeway Limited that an independent third party would be financing the
license fee (Gadens, 2014). Though, this was not done and what actually happened was that the
respondents secured the finance for the license fee and concealed in a deliberate manner that they
had been involved in financing of this fee from BlueFreeway Limited (Taylor, 2015).
After the Licence fee had been paid, the respondents negotiated upon an agreement for
termination of the contractual arrangements with Forty and BlueFreeway Limited which
included the Agreement. As a result of this, the directors resigned from Forty through an exit
agreement which provided that the respondents had to be given the additional payment. Further,
this value had to be calculated based on the earnings before interest and profit of 2007 which
included the license fee. It was claimed by the applicants that the respondents had been in breach
of their implied term in the Agreement, by not disclosing the role which they had in the financing
of Licence Fee, as they had been engaged in deceptive or misleading conduct and this resulted in
the contravention of the statutory and fiduciary duties as the directors of the company (Gadens,
2014).
Duties breached
The Corporations Act, 2001 the directors have been imposed with different duties, which have to
be, followed properly (Gibson and Fraser, 2014). In this regard, section 182 of this act provides
that the directors are not to make an improper use of the position which they have in the
company (ICNL, 2018). This section further provides that this is not to be done for gaining
advantage for someone else or for themselves (WIPO, 2015). Under section 191 of this act, the
directors have the duty of giving the notice to the other directors regarding them holding any
material personal interest which could give rise to a conflict (Jade, 2018).
The allegation made by the applicants was that by funding the licence transactions, there had
been a breach of section 182 by the respondents as they acted towards advancing of their
interests and for gaining an advantage for their own self where they secured an addition earn out
payment of $16 million (Gadens, 2014).
However, the respondents completely denied that there had been a contravention of section 182.
They stated that the conduct in funding of the license transaction did not have or include their
involvement in the usage of position as the directors of Forty, provided that they had actually
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given person guarantee to third party. Despite any situation, the respondents stated that there was
a lack of improper use of position for gaining benefit for them as the purpose of their conduct
was to make certain that the CMUK (which was the party with which the licensing agreement
had been done) did not default in the financial obligations which they owed to Forty. They
further stated that it was Forty which got the benefit from the undertaken licence transaction and
in receiving the additional budgets (Silberberg and Hammerschlag, 2014).
With regards to section 191, it was claimed by the applicants that there was a lack of disclosure
by respondents to Forty that they had funded this licence transaction themselves. However, this
was denied by the respondents where they contended that the applicants had constructive/ actual
notice of the role in the licence transaction funding. In any situation, the respondents stated that
there had been no contravention, since the conduct did not cover with of the individual having a
major personal interest regarding the affairs of Forty since they did not get any interest in fees or
licence. They submitted that the interest in getting the entitlement under the Agreement was only
related to the affairs of BlueFreeway Limited and there was no duty owed to BlueFreeway
Limited for disclosure as they were not the officers of this company (Silberberg and
Hammerschlag, 2014).
Decision of the Court
In this matter, the court dismissed the aspects of claims of BlueFreeway Limited for their claims
for damages which had been caused due to the alleged contraventions by the respondents of the
statutory duties. They also recognized limit regarding the scope of statutory duties which the
directors owed regarding the group of companies in which the director had not been a director of
the other group company which was involved (Silberberg and Hammerschlag, 2014).
It was state by the court that since the respondents had been Forty’s directors, and not that of
BlueFreeway Limited. This meant that the statutory duties were only owed by them to Forty and
not to BlueFreeway Limited. Though, it was determined by the court that due to the conduct
undertaken by the respondents, it was Forty instead of the respondents which got the benefit
from the license transaction. Apart from this, the court also stated that Forty did not have to bear
any loss from the conduct of respondents and refused to recognize the raised duties on part of
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Business and Corporate Law
parent company of Forty, i.e., BlueFreeway Limited for paying to the respondents the additional
$16 million earn out payment as the loss of Forty (Jade, 2014).
Owing to the very same reasons, the court also dismissed the allegations of applicants regarding
the breach of different fiduciary duties by the respondent which existed at the general law, which
were similar to the aforementioned statutory duties (Austlii, 2014).
Despite the aforementioned findings in this matter by the court regarding the alleged
contraventions of the statutory duties, it was ultimately established by the court that the conduct
of the respondents did constitute as a contravention of the implied terms of the Agreement. This
was due to the respondents being bound to make disclosure to BlueFreeway Limited regarding
all the information which they knew and which could have been deemed ass relevant for
calculating the target earnings which secured the payment of earn out based on the Agreement.
This was in addition to the deceptive or misleading conduct due to the licence agreement which
depicted to the board of BlueFreeway Limited and the market to have been undertaken at
genuine arm’s length transaction. A critical approach was adopted by the court towards the
conduct of the respondents in finding that they had been driven by personal concerns for
maximising the “earn out” payments (Silberberg and Hammerschlag, 2014).
With regards to the issue of causation, the decision given by the New South Wales Court of
Appeal in Daniels v Anderson (1995) 37 NSWLR 438. Justice Griffiths stated that for
determining the cause, there was a need to approach based on the proof, which was based on the
balance of probabilities. The view of the court here was that the evidence was enough to show a
causal link in the conduct of the respondents and in the lost opportunity of BlueFreeway Limited
for negotiation a lower termination payment. For the purpose of loss opportunity also, this case
was cited. Justice Griffiths stated that the question of lost opportunity had to be based on degree
of probability of possibility in the case. He further stated that the court had to offer an informed
basis or sound basis for assessing the value of loss which was aided through the pertinent
evidence. And where this evidence was not present, this had to be seen in the materials before it.
It was finally stated that the global approach had to be taken in deciding the value and a lump
sum award had to be made (Condon, 2014).
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This led to the BlueFreeway Limited being awarded the damages which amounted to $2 million.
This was a reflection of the lost opportunity of BlueFreeway Limited or their chancing for
negotiating the termination payment with the respondents, which was a sum quite less in
comparison to the $16 million being actually paid (Silberberg and Hammerschlag, 2014).
Relevance
This discussion showcased the significance of making certain that the earn out provisions had to
be properly structured in transaction in which the respondents continued to involved in an active
manner in the acquired business. Through this decision, the need for company, particularly the
ones which have different subsidiaries having varied management and board members, for
having in place the proper disclosure and reporting procedures was reinforced. This was
particularly in such cases where the management and the directors acted on the company’s behalf
(Silberberg and Hammerschlag, 2014).
This decision is also important for the purpose of clarifying the operation of law based on the
contract’s implied terms, the loss of opportunity damages, and the deceptive and misleading
conduct owing to the silence or non disclosure. This decision reaffirmed the traditional approach
of the courts in implying in a contractual term, where it provides business efficacy to contract
and also complements the express terms covered under the contract (Condon, 2014).
Conclusion
In the preceding segments of this discussion, the different aspects of the case of Forty Two
International Pty Limited v Barnes were discussed. This case involved the director duties being
claimed to have been contravened. Even though the breach of director duties was not established
in this case, the parties were nonetheless made liable and penalties were imposed on them. The
reason for this was the breach of contractual terms in the Agreement which formed the base of
this issue. The damages in this case were awarded for the value of lost opportunity by the
company. This case is a reminder of the courts deploying the traditional approaches in deciding
upon the breach of terms of the contract based on business efficacy. This case saw the judges
referring to the previous judgements in deciding on the value which had to be awarded. This case
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is also a lesson as it presents such situations which would not result in the breach of director
duties.
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References
Austlii. (2014) Forty Two International Pty Limited v Barnes [2014] FCA 85 (18 February
2014). [Online] Austlii. Available from:
http://www.austlii.edu.au/cgi-bin/sinodisp/au/cases/cth/FCA/2014/85.html [Accessed on:
23/01/18]
Cassidy, J. (2006) Concise Corporations Law. 5th ed. NSW: The Federation Press.
Condon, W. (2014) Forty Two International Pty Limited v Barnes [2014] FCA 85. [Online]
Lexology. Available from: https://www.lexology.com/library/detail.aspx?g=208bf581-89ce-
4ce7-ab77-9558ff97e2bb [Accessed on: 23/01/18]
Fernandes, M. (2014) In this Issue. [Online] Butterworths Corporation Law Bulletin. Available
from: https://opus.lib.uts.edu.au/bitstream/10453/44096/4/06772593-5932-4FB6-8678-
34265262D9BF.pdf [Accessed on: 23/01/18]
Gadens. (2014) Disclosure obligations of vendors of shares under 'earn out' provisions. [Online]
Gadens. Available from: http://www.gadens.com/publications/Pages/Disclosure-obligations-fo-
vendors-of-hsares-under-%27earn-out%27-provisions.aspx [Accessed on: 23/01/18]
Gibson, A., and Fraser, D. (2014) Business Law 2014. 8th ed. Melbourne: Pearson Education
Australia.
ICNL. (2018) Corporations Act 2001. [Online] ICNL. Available from:
http://www.icnl.org/research/library/files/Australia/Corps2001Vol4WD02.pdf [Accessed on:
23/01/18]
Jade. (2014) Forty Two International Pty Limited v Barnes [2014] FCA 85. [Online] Jade.
Available from: https://jade.io/article/314106 [Accessed on: 23/01/18]
Jade. (2018) Corporations Act 2001 (Cth). [Online] Jade. Available from:
https://jade.io/article/216652/section/2204 [Accessed on: 23/01/18]
Silberberg, A., and Hammerschlag, G. (2014) Breach of statutory duties by a director under ss
182 and 191 of the Corporations Act by non-disclosure of a personal interest in the context of a
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group of companies. [Online] ABL Sydney. Available from:
http://www.abl.com.au/MediaLibraries/ABL/ABL/Insights%20and%20News/Case%20notes/
ButterworthsCorporationLawBulletin05p16-18.pdf [Accessed on: 23/01/18]
Taylor, G. (2015) You mean that isn't part of the deal? Earn-outs and implied terms. [Online]
Clayton UTZ. Available from: https://www.claytonutz.com/knowledge/2015/march/you-mean-
that-isn-t-part-of-the-deal-earn-outs-and-implied-terms [Accessed on: 23/01/18]
WIPO. (2015) Corporations Act 2001. [Online] WIPO. Available from:
http://www.wipo.int/wipolex/en/text.jsp?file_id=370817 [Accessed on: 23/01/18]
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