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Westpoint Appeal : No Disclosure Required

Promissory notes not ‘debentures'

It is becoming an all too familiarly story: great investment comes along offering great returns, people invest their retirement savings … and the company goes bust. Often we hear investors crying foul over disclosure – they say they weren't properly informed before making the investment and didn't know the risks. The recent collapse of the group of companies of Perth-based property developer, Westpoint, is case-in-point.

On 15 June 2005, the Full Court of the Supreme Court of Western Australia handed down its decision in Emu Brewery Mezzanine Ltd (In Liq) -v- Australian Securities And Investments Commission [2006] WASCA 105, confirming that Westpoint company Emu Brewery Pty Ltd (Westpoint), by issuing promissory notes with a face value for more than $50,000, was not required to provide investors with a prospectus. The appeal makes it clear that promissory notes are not ‘debentures' under the Corporations Act 2001 (Cth), but offers little hope for investors.

Background

In 2001 we saw a string of high-profile corporate collapses - HIH, Harris Scarf and Ansett Australia. The Federal Government reacted by enacting dramatic legislative reform to the Corporations Act 2001 (Cth). The amendments in the CLERP 9 reforms introduced tougher standards for auditor independence, prospectus disclosure and CEO/CFO sign-off of company accounts.  It was hoped that these reforms would make it harder for situations, like HIH, to arise.

Recently, we have seen the Westpoint group of companies succumb to the same fate. This time, the CLERP 9 amendments won't help. This is not a case of directors being involved in market manipulation or creative accounting. A major contributor to Westpoint's downfall (and the loss suffered by investors), its involvement in mezzanine financing, is legal.  This has raised the question of whether there exists a loophole in the Corporations Act , allowing property developers to offer this kind of high-risk investment to unsophisticated retail investors without adequate disclosure.

Mezzanine finance: Westpoint style

Mezzanine financing is often used by developers to cover the gap between what the bank will lend and the cost of the development. While inherently risky, mezzanine financing is not illegal. It is usually targeted at sophisticated investors (people who are of high net worth (over $2.5 million) or investing more than $500,000) who know what they are doing and realise they are taking on a higher risk.  The money is usually raised through debentures, where the are risks well-disclosed.

The structure of Westpoint's mezzanine financing was a little different. Firstly, Westpoint did not target sophisticated investors. It targeted mum and dad investors – the result being that many people have now lost their retirement savings.

Secondly, the mezzanine finance was in the form of promissory notes that worked like this: investors lent money to Westpoint and in exchange received a promissory note. The promissory notes were supposed to work like fixed-interest investments, with terms of one and two years, and interest paid monthly or quarterly. The investors would get their capital back upon maturity of the note. Westpoint used the notes to raise between $30 million and $35 million.

Third, because it was in the form of promissory notes, there was little disclosure. The Corporations Act , Chapter 6D requires prospectus disclosure for the issue of securities. Westpoint did not issue a prospectus before issuing the promissory notes because it believed the notes were not ‘debentures' and therefore not ‘securities'. Westpoint's disclosure to investors was in the form of an information memorandum – usually considered adequate for the sophisticated investor ­­– which provided limited detail of the risk involved.

ASIC's proceedings

ASIC commenced proceedings against two Westpoint companies ( Australian Investments & Securities Commission v Emu Brewery Mezzanine Ltd and Bayshore Mazzanine Pty Ltd v Australian Securities and Investments Commission [2004] WASC 241), arguing that the promissory notes were ‘debentures' and therefore fell within the definition of ‘securities', and Westpoint had breached its disclosure obligations under Chapter 6D by not issuing a prospectus.

The Supreme Court of Western Australia held that that the promissory notes were not debentures because that definition in the Corporations Act , s 9 expressly excludes promissory notes with a face value of more than $50,000.  All of the promissory notes offered by Westpoint were for more than $50,000.  Accordingly, Westpoint did not beach prospectus disclosure requirements in the Corporations Act .

Appeal

On 15 June 2006 the Full Court of the Supreme Court of Western Australia affirmed the decision at first instance, holding that the promissory notes were not debentures. This means that the provisions of the Corporations Act relating to the issue of debentures, including the requirement for investors to receive a complying disclosure document, and a debenture trust deed and an independent trustee, did not apply to the issue of promissory notes by Westpoint.

Where to now for investors

The decision offers no good news for investors who have together lost around $300 million. ASIC says it is “considering the impact of the decision for investors in Westpoint”, but it remains highly unlikely that investors will be seeing a return of their money.

However, ASIC is continuing its investigation into Westpoint. In late 2005 ASIC instituted proceedings against a number of companies in the Westpoint group, including winding up proceedings. Receivers have been appointed over the property of several directors of Westpoint and three companies associated with Mr Norman Phillip Carey, and the assets of companies associated with Mr Carey have been frozen.

With the tangled mess of Westpoint thought to encompass around 160 inter-related companies, there is no doubt we will be hearing more.

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