Raising money under false pretences
Good Company July 2014 edition
- Transparency and trust: seeing the way to reform
- Service of English legal proceedings on overseas directors
- Personal guarantees by directors
- Raising money under false pretences
- Holding company liability for health and safety
- Proper purpose test for access to register of members
- When not to be a de facto director
The High Court has recently ordered a company director to pay damages to an investor. The investor had relied on a private placement memorandum issued by the company, which failed to disclose that it intended to use the investment monies to discharge historic liabilities to the directors. The case is Gilbert v Holms.
Dr Holms, together with a colleague, set up a company called Medezrin Limited to exploit a new drug they were developing. In late 2004, the company wanted to raise new funds by way of a private placement. To that end, the directors issued a private placement memorandum, drafted principally by Dr Holms, giving information about the company to potential investors.
The memorandum contained a statement in the usual form that the directors had taken all reasonable care to ensure that the facts stated in it were true and accurate in all material respects and that there were no material facts, the omission of which would make any statement in the memorandum misleading. Dr Holms accepted that he had assumed a duty of care to the recipients of the memorandum in relation to the accuracy of the facts stated in it and any material omissions.
Mrs Gilbert was one of the new investors, subscribing £200,000 for shares in the company in early 2005. Unfortunately, the company was not successful and its shares became worthless. Mrs Gilbert brought a claim for damages against Dr Holms, alleging that she had made her investment in reliance on misrepresentations he had made.
The High Court decision
The court found that there was a misrepresentation in the private placement memorandum. This was the statement that there were no material omissions from it.
The memorandum stated that the new money invested in the company would be used for clinical trials and associated manufacturing, registration and similar costs. It mentioned "general administrative and travel expenses", but implied that these would not be a main expense. Overall, the memorandum indicated to a reasonable investor that liability for reimbursement of historic costs to the company's directors (for which the new money might be used) did not significantly exceed £15,000.
In fact, the outstanding liabilities of the company to its directors at the date of the memorandum were approximately £70,000, and by the time of Mrs Gilbert's investment they amounted to £125,000 in total. This difference was material to Mrs Gilbert, as she might have been the only investor - investments pursuant to the private placing were not conditional on subscriptions being received for the full amount that the company hoped to raise. Therefore, any individual investment might have been applied wholly, or in large part, towards the reimbursement of historic liabilities and not the development of the new drug.
The court therefore found that material facts were omitted from the private placement memorandum which rendered misleading the statements it did contain about the use of the placement proceeds. Further, the increase in historic liabilities between the date of the memorandum and the date of Mrs Gilbert's investment was relevant, because the representation as to material omissions continued throughout the period until closure of the placement.
The court rejected Mrs Gilbert's allegation that this misrepresentation had been made fraudulently, but concluded it had been made negligently, without exercising reasonable care. The court also accepted that Mrs Gilbert had relied on the misrepresentation, and would not have invested if the full scale of the historic liabilities had been disclosed.
Dr Holms was ordered to pay Mrs Gilbert £200,000 in damages, equivalent to the amount she had invested in the company.
Points to note
Directors seeking to raise new investment for their company must take care to disclose all material information to the potential new investors. Although there was no finding of dishonesty in this case and at the time of the private placement there was no reason to believe the company would fail, Dr Holms had simply failed to ensure that the true financial position of the company was disclosed. As a result, he had to pay damages to Mrs Gilbert out of his own pocket, in addition to losing his own investment in his company.
Danielle Harris is a senior associate and professional support lawyer in the corporate group of Fieldfisher in London.