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Contract Law News October 2012

The role of misleading conduct in corporate collapse

The recent case of Wingecaribee Shire Council v Lehman Brothers Australia Ltd (In Liq) saw the Federal Court rule that Grange Securities Ltd, acquired by Lehman Bros Holdings Inc in 2007, was liable to compensate three Councils for losses that resulted from investments in Grange's Synthetic Collaterised Debt Obligations (SCDOs). The SCDOs were highly complex financial products with high risks that justified the high interest rates offered. These products essentially bet on whether or not certain credit events would take place within the period of investment. Where these credit events did take place the capital provided by the investor would be lost.

Each of the Councils involved in these proceedings, Wingecarribee Shire Council, Swan Shire Council and Parkes Shire Council, had a history of conservative risked investments. While it had become possible for Local Councils to invest in a broader range of financial products with a rating deemed high enough by changes made in 2000, each of the Councils made it clear to Grange, when the company approached the Councils after this change, that they were concerned with the risks of losing their capital. Grange made representations to the Councils that the SCDOs were a form of floating rate note and that they would suit the Councils' prudent capital protective investment policies that were required under law. The representations made by Grange also indicated that these products were liquid and could be easily sold on a secondary market. Generally the representations made indicated that the financial products offered by Grange were appropriate for the Councils to invest in given their financial policies, inducing the Councils to each make agreements to purchase these products from Grange.

After the global financial crisis began in 2007, many of the SCDOs that had been purchased suffered credit events, causing capital to be lost either completely or in part. The Councils brought an action against Grange claiming among other things that Grange had engaged in misleading and deceptive behaviour. The Federal Court handed down a decision in early September agreeing that Grange had engaged in misleading and deceptive conduct in relation to the financial products as they were not, as had been claimed, appropriate investment strategies as they carried a high degree of risk, were not liquid and ran the risk of decreasing in value if sold.

This case emphasises the importance of properly representing the potential consequences and risks involved in investments at the time they are sold to investors.

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