When forecast information in an IM is misleading: Full Federal Court highlights the need for reasonable grounds

The Full Federal Court’s decision in The Property Mentors Australia Pty Ltd v Touch for Health Pty Ltd as trustee for Knight Superannuation Fund should be read closely by directors who approve or circulate information memoranda for property trusts and other investment vehicles.

The Property Mentors and the Secret Harbour Unit Trust

The Property Mentors Australia Pty Ltd (TPM) was a property investment education and mentoring business founded by Matthew Bateman and Luke Harris. It generated revenue from membership fees and offered paying members access to ‘members-only’ property investment opportunities, including its ‘Armchair Development™’ co-investment model.

The Armchair Development™ model was TPM’s branded way of letting members co-invest in property developments without doing the development work themselves. It was promoted to TPM members as an opportunity to invest in property development ‘from the comfort of their own armchair, without having to know how to read a plan or lift a hammer’. TPM members were invited to co-invest with TPM in selected projects that were said to have been chosen using ‘strict due diligence criteria’ and to fit the investor’s property strategy.

The first of these opportunities was a proposed development of 18 residential apartments at Secret Harbour in Western Australia. The opportunity was identified by David Polak, a registered builder and business associate of Bateman.

The Secret Harbour Unit Trust (Trust) was established on 1 May 2015 with Davlyn Property Pty Ltd as trustee. Bateman and Polak were the initial directors of the trustee, and PM Asset Holdings Pty Ltd (PM Asset Holdings), an entity controlled by Bateman and Harris, was the initial unitholder.

Shortly before TPM issued an information memorandum (IM) inviting its members to invest in the Trust, the Secret Harbour site was contracted for sale to the trustee for $870,000, with settlement due in June 2015. Polak’s building company, Davlyn Home Group Pty Ltd, was proposed as the builder, while Bateman was to project manage the development.

The introduction to the IM summarised the nature of the Trust as follows (our emphasis added):

‘The Trust will be raising up to $1.25 million for the primary purpose of acquisition & development of the Project Land. PM Asset Holdings Pty Ltd (A.C.N 605 514 814) currently owns 200 units in the Trust and will co-invest, via a unit transfer, with paid members of The Property Mentors Australia Pty Ltd, which will collectively control a maximum of 118 units.’

Even at this early point, the IM revealed a structural flaw in the offer. It presented the transaction as a capital raising for the Trust, while also stating that PM Asset Holdings already owned the 200 units in it and that investors would come in ‘via a unit transfer’. Ordinarily, if existing units are transferred, the consideration is payable to the transferor not the trustee. That flaw helps explain why the projected return analysis later proved difficult to reconcile with the legal structure documented in the IM and trust deed.

The Trust ultimately raised $1.012 million in equity. PM Asset Holdings transferred 93 units to incoming investors and retained 107 units of the 200 on issue.

Problems with the project

Settlement of the land purchase occurred in June 2015.  But then the project unravelled.

By early October 2015, almost all investor equity had been spent and the Trust’s bank balance had fallen below $2,000. By the end of December 2015, the building contract still had not been executed and although development approval had been granted, building approval was still required.  The Trust still had not obtained a building permit.

The project also depended on pre-sales to secure construction finance, but by March 2016 only four of the proposed 18 apartments had been pre-sold, later rising to five. The building contract was not executed until April 2018, and the Trust never obtained the finance needed to proceed to construction.

Matters were then made worse when the trustee company (via Polak) secretly mortgaged the Secret Harbour property for an unrelated business loan. When that loan was not repaid, the mortgagee took possession and sold the property for $395,000. The investors in the Trust lost their investment.

Why the claims focused on the promoter rather than the trustee

Although the trustee’s later conduct (through Polak) contributed to the loss ultimately suffered by investors, the unitholders’ claims were not framed as claims for maladministration by the trustee. The trustee was joined as a defendant, but had no involvement in the proceeding and was later deregistered. Polak, who later became the trustee company’s sole director, also became bankrupt.

Instead, the unitholders focussed on the role of TPM, Bateman and Harris in producing and disseminating the IM. Bateman and Harris tried to shift blame onto Polak’s conduct, including his failure to secure construction funding and his conduct in encumbering the property, to reduce their own liability, but the Court held there was no evidence that Polak had any involvement in drafting, authorising or disseminating the IM.

By contrast, there was evidence that TPM was the promoter of the Trust and issued the IM to its paid-up members as part of its investment promotion business. Bateman wrote and sent the IM to investors while Harris read it and approved it to go out under TPM’s name and livery.

The unitholders’ claims

The unitholders’ case was, in substance, an inducement case.

They alleged that TPM’s IM conveyed two misleading representations:

• that the investment would have a term of 12 to 15 months; and
• that investors could expect returns of more than 20%, with the IM’s return analysis proceeding on figures in the range of 39.67% to 49.59% depending on unit class.

At first instance, the Court held that the IM conveyed misleading representations about both the expected timeframe and the expected return on investment in the Trust, and that TPM was liable for issuing it to investors.

The Court also held that the unitholders had relied on those representations and were entitled to recover their investment amounts. However, Bateman and Harris were not held to be principal contraveners in their own right at trial; they were found knowingly involved in TPM’s contravention in relation to the timeframe representation only. The applicants’ separate claim for a refund of TPM membership fees under a ‘money back guarantee’ also failed.

The appeal

TPM and Harris appealed those findings, challenging the primary judge’s conclusions that the timeframe and profit representations lacked reasonable grounds. The investors cross-appealed, contending that Bateman and Harris should also have been held personally liable as principal contraveners.

Why the projected timeframe statement was misleading

The IM stated that the project offered investors an expected return of greater than 30% ‘over the life of the project which is expected to be 12 to 15 months in duration’. The difficulty for TPM and Harris was that the contemporaneous facts did not support that timeframe.

The IM said the project land was ready for settlement and said a fixed price building contract had been entered into. But the building contract had not in fact been executed and construction could not begin until finance was obtained, with the respondents’ own evidence contemplating a further three to six months after settlement before works could commence. The schedule to the proposed building contract allowed 378 working days for construction. On the primary judge’s analysis, even assuming only a three-month delay before commencement, the earliest completion date was March 2017, outside the represented 12 to 15 month period from the June 2015 settlement.

On appeal, Harris relied on evidence that the builder had verbally indicated the build could be completed in under nine months, with the 12 to 15 month period being used as a buffer.

The Court rejected that as a sufficient answer. It held that the appellants had not discharged their evidentiary onus of showing reasonable grounds, and that this was not merely a case of missing positive support. There was affirmative evidence pointing the other way. In particular, there was no persuasive basis to conclude that the builder had agreed, or would agree, to perform within a timeframe consistent with the representation.

For directors, the significance of this ground is straightforward. A projected investment term in an IM needs to be anchored in the actual project sequence, including contract status, finance, approvals and the delivery timetable. A hoped-for acceleration or informal assurance will not supply reasonable grounds where the objective material does not support the forecast.

Why the projected return statement was misleading

The second appeal ground is the more significant one for directors of investment vehicles because it concerned the IM’s projected returns.

The IM’s introduction referred to an ‘expected return on investment of greater than 30%’. The ‘Unit Holder Returns’ section then presented projected return on investment figures of 49.59% for Class A units, 47.60% for Class B units and 39.67% for Class C units.

The flaw in that analysis was not merely arithmetical, it was structural. The returns model did not reflect the legal effect of the trust deed and the way units were actually held.

The IM said the Trust would comprise 200 fully paid units, that profits and return of capital would be allocated to unitholders in proportion to their unit holdings, and that PM Asset Holdings already owned the 200 units and would co-invest via transfers to incoming investors.

After investors contributed $1.012 million, PM Asset Holdings transferred 93 units and retained 107 units. Yet, contrary to the IM and trust deed, PM Asset Holdings had not in fact paid for its units or contributed capital to the Trust.

That mattered because, once the deed was applied according to its terms, capital and profit on winding up were to be distributed by reference to units held, not by reference to who had contributed cash. If the total equity invested was spread across all 200 issued units, then the return of equity per unit would be only $5,060 against an issue price of $12,500, producing a negative return on investment. The Court therefore concluded that the forecast return representation was misleading.

TPM and Harris argued that the IM was based on an assumption that, on a winding up, capital would in practice be returned only to those who had actually paid capital, and that PM Asset Holdings would effectively stand back from any strict entitlement. That argument failed at trial and again on appeal. The Court held that this ‘so-called assumption’ was contradicted by the trust deed and by the IM’s own statements describing the operation of the structure. A subjective intention expressed later in evidence could not supply reasonable grounds for a future-matter representation made at the time of issue.

The key compliance lesson from the case is that forecast returns in an IM are not just a modelling exercise. They must be reconcilable with the constitutive documents of the vehicle. If the return only works because someone associated with the promoter is assumed to waive rights, accept less than the deed provides, or allow a different distribution outcome to occur in practice, that is not a proper foundation unless the arrangement is built into the legal structure and clearly disclosed.

The broader drafting lesson

Although the appeal dealt with two specific grounds, the broader drafting lesson is easy to state. Verification of offer documents matters because future-matter representations are tested by reference to the facts and legal rights that existed when the document was issued.

ASIC’s guidance is consistent with the Court’s approach that an issuer must be able to point to facts or circumstances existing at the time of publication, relied on in fact, objectively reasonable, and supportive of the prospective financial information. ASIC also warns that reasonable grounds are not established merely by hypothetical assumptions or by statements that something is simply the directors’ best estimate.

That makes this case particularly relevant to directors of boutique investment vehicles. Where IMs are prepared internally and circulated quickly, there can be a temptation to treat the financial model and the legal structure as separate workstreams. This decision shows why that is dangerous. The return analysis, the trust deed, the unit terms and the distribution mechanics all need to be checked together before the IM goes out.

Why directors should care personally

The other reason this decision matters is that the Full Court varied the declarations so that the corporate promoter was not the only contravener. The Court held that Harris and Bateman themselves engaged in the misleading conduct by the IM. The findings were practical, with Bateman preparing and sending the IM, while Harris read every word, approved it and authorised its dissemination. That was enough for personal liability as principals.

For directors, that aspect of the case may be the most sobering. Personal involvement in the preparation, review or approval of an IM can make it difficult to argue later that only the company made the representation.

Key lessons for directors

The decision does not turn on a general hostility to forecasting. It reinforces a narrower and more workable proposition that if an IM conveys a representation as to a future matter, there must be reasonable grounds for making it at the time.

In practice, that means three things:

1. Forecast returns and project timeframes need to be verified against the contemporaneous facts.
2. The modelling in the IM must match the legal operation of the trust deed or other constituent documents.
3. Directors should treat approval of an IM as a substantive legal risk step, not merely a commercial or marketing step.

For more information, email Chris Mee at cmee@cnmlegal.com.au or call 07 3211 4010.

This article is produced as general information in summary for clients and should not be relied upon as a substitute for detailed legal advice or as a basis for formulating business or other decisions. CNM Legal asserts copyright over the contents of this article.