Financial forecasting and the Coronavirus: legal principles

Huge amounts of ink have been spilled about the Coronavirus (or, more precisely, COVID-19).  As well as social and personal impact and distress, this virus has triggered enormous damage to markets and business conditions.  The impact on consumer and market confidence, supply chain logistics and related issues has been profound and widely reported.   Preliminary economic models by Warwick McKibben and Roshen Fernando predict that in Australia the GDP loss due to the impact of COVID-19 could be from 2 to 8%.¹

However, amidst the fear and uncertainty caused by COVID-19, the business world continues.    Businesses continue to be bought and sold, shares continue to be traded and equity finance raised.  It’s timely to consider how Australian law applies to these activities in a COVID-19 world.

Some key legal questions are:

1. do vendors and equity issuers need to factor in the effect of Coronavirus in their financial forecasts and business projections; and
2. how can this be done on a practical basis, given the situation is evolving so rapidly.²

Legal background

Section 769C of the Corporations Act states that when a person makes a representation about future matters (including the doing of, or the refusing to do, any act), that representation is taken to be misleading if the person did not have reasonable grounds for making the relevant representation.³  It is generally considered insufficient to make forward-looking statements based only on an officer’s subjective opinions and without some objective or independent basis to do so.

These rules apply in a commercial context where companies are increasingly expected to articulate their environmental, social and governance (ESG) strategies.  The ASX Corporate Governance Council recommends that “a listed entity should disclose whether it has any material exposure to economic, environmental and social sustainability risks and, if so, how it manages or intends to manage those risks”.⁴

For example. recent history on environmental matters provides a useful analogy.  There has been a rising global trend in class actions against companies with respect to climate-related risks and social conscience issues.⁵  Australia has the second highest number of cases of climate-related litigation in the world.⁶ (Interestingly, the US has experienced by far the most climate-related litigation to date.)

It’s generally understood that companies providing financial forecasts or projections must factor ESG matters into those forecasts.  This includes where a vendor is selling its business, or a company is issuing securities, as these will often be accompanied by statements as to projected revenues or profitability.

Because forecasts and other forward-looking statements must be based on “reasonable grounds”, it is considered best practice to commission independent expert reports before making statements about valuation or prospects to a third party.

While this is generally good advice, it is not easy to follow for COVID-19.  The (newly announced) pandemic is developing so rapidly and with so many conflicting opinions that it is extremely difficult to find independent, empirical opinions on its probable effect on valuations and business matters generally.  For companies which are mid-transaction, there is little precedent or guidance as to its probable effect.

Legal approach to business forecasts

The legal requirement in these cases is that the relevant forecast must be based on reasonable grounds at the time it is made.  Below are some of the factors which businesses or vendors should consider in this regard.

Should a forecast on a particular matter be disclosed at all?

ASIC states that “the general test of whether prospective financial information must be disclosed is whether it is relevant to its audience and reliable”.  Information is not material to investors if it is “speculative or based on mere matters of opinion or judgment”.⁷

What is meant by “reasonable grounds”?

ASIC considers that there must be a sufficient objective foundation for the forecast.  To demonstrate this, the statement must contain some objectively reasonable facts or circumstances, which existed at the time of publication of the information, and which support the information.  ASIC recommends that the information is underpinned by independent industry expert opinion.⁸  Omitting a materially relevant matter from a forecast such as the probable business effect of the Coronavirus is unlikely to be considered reasonable in this context.

Conclusions

We cannot yet fully assess the business impact of Coronavirus.  What is clear is that vendors and companies raising equity finance must factor in COVID-19 when making any projection or forecasts to others.  The extent to which this is required will depend on the circumstances; for example, the type of business, whether a forecast is short- or long-term, and other material factors.

However, economic modelling is now beginning to emerge, for example the Centre for Economic Policy Research and VoxEU have jointly published the “Economics in the Time of COVID-19” ebook.   Businesses and vendors will need to have regard to such publications, and should also consider whether specific research should be commissioned for particular market segments of business.⁹

1 Eds Richard Brown and Beatrice Weder di Mauro, Economics in the time of COVID-19 (A VoxEU.org Book, CEPR Press, 2020).  In: Warwick McKibbin and Roshen Fernando, Chapter 3, The Economic impact of COVID-19 <https://cepr.org/sites/default/files/news/COVID-19.pdf>.

2 Of course, there are many other legal considerations arising from the coronavirus pandemic, for example, entities subject to continuous disclosure regime will fall under an obligation to disclose the effect of COVID-19 on operations and business in the usual way.

3 See also s728(2) of the Corporations Act in respect of fundraising.  See also (more generally) s 1041H and related provisions.

4 ASX Corporate Governance Council’s Corporate Governance Principles and Recommendations (2019) 4th edition, Recommendation 7.4  https://www.asx.com.au/documents/regulation/cgc-principles-and-recommendations-fourth-edn.pdf.

5 In 2017, shareholders sued Commonwealth Bank of Australia for failing to disclose environmental change risks of its investments in its 2016 Annual Report.  The case was withdrawn after the CBA produced detailed risk analyses in subsequent reports.

In 2018, a 23 year old sued the Retail Employees Superannuation Pty Ltd (REST) for inadequate disclosure about the company’s investment strategies in light of climate change risks.

Examples of litigation with companies over social conscience statements are found in the recent (unsuccessful) US class actions against Mars, Nestle and Hershey; and Costco, both cases centring around perceived inconsistencies between the companies’ stated and actual stances, on ESG matters such as sustainability, child labour; and human trafficking, respectively.

6 Setzer J and Byrnes R, ‘Global Trends in Climate Change Litigation: 2019 snapshot’, July 2019, 3 Table 1, http://www.lse.ac.uk/GranthamInstitute/wp-content/uploads/2019/07/GRI_Global-trends-in-climate-change-litigation-2019-snapshot-2.pdf.

7 ASIC Regulatory Guide 170 Prospective financial information, April 2011; RG 170.11, https://download.asic.gov.au/media/1240943/rg170-010411.pdf.

8 ASIC Regulatory Guide 170 Prospective financial information April 2011; RG 170.26.  https://download.asic.gov.au/media/1240943/rg170-010411.pdf.

9 See https://cepr.org/sites/default/files/news/COVID-19.pdf for an in-depth expert analysis of the coronavirus impact, chapter 3 pertains to economic models of the impacts.