Sent: 01-03-2011 09:32:04
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Do Company Executives Understand their Own Agreements?
Investors rely heavily on companies to describe accurately the content of agreements they enter into with other parties. The ASIC v Fortescue Metals case highlighted why investors should be looking for more assurances before investing.
In 2004, Fortescue Metals (ASX: FMG) and its chief executive Andrew Forrest had contended publicly that agreements with China Metallurgical Construction Corporation, China Harbour Engineering Company and China Railway Engineering Corporation to jointly develop Fortescue's WA iron ore properties were "binding" on the parties involved.
None of the parties to the agreements objected to this construction being placed on the content of the agreements and, in December 2009, a Federal Court trial judge rejected an ASIC claim that Fortescue Metals had overstated the commercial significance of the agreements.
On 18 February, justices Keane, Emmett and Finkelstein of the Federal Court overturned the earlier judgment upon appeal. These judges concluded there were so many matters unresolved in the agreements that they could not be described as binding on any party. The agreements were, in their view, nothing more than agreements to begin discussions.
This difference of opinion alone highlights the difficulties investors face in coming to terms with the real meaning of agreements they have not had the opportunity to read.
The appeal judges noted that all parties to the agreements had a vested interest in having them portrayed as binding. The agreements would help Fortescue to raise finance. As founder and major shareholder, Forrest would benefit financially. The Chinese parties were keen to demonstrate their credentials to develop major projects outside China. The fact that everyone agreed to call the agreements binding was, therefore, unsurprising and irrelevant, according to the judges.
Many Australian resources companies have agreements with potential partners. The strongest form of agreement is a formal joint venture under which development funds have changed hands. The weakest form is a non-exclusive agreement to work together to pursue business opportunities. There are an infinite number of variations between these two extremes.
Early stage Australian resource companies commonly find themselves requiring some multiple of their market value to fund prospective mining developments. Often these companies have little or no relevant track record and face difficulties tapping traditional sources of finance.
One solution to the predicament is to attract another party that might simultaneously add credibility and financial muscle. Chinese companies are attracted to play this role by the potential access to the raw materials being mined. For stock promoters, such partners potentially sweep away some of the risks which should, at least in theory, boost the market value of the listed company.
The stakes could be considerable. Justice Finkelstein concluded that the Fortescue share price rose from 55 cents the day prior to the announcement about the first agreement to as high as $5.55 before falling to $2.83 after questions had been raised in the Australian Financial Review about the actual content of the agreements.
More recently, in another instance of a joint venture being critical to future development, the Sundance Resources (ASX: SDL) share price rose by 71% after the company announced it had signed two memoranda of understanding with Chinese companies interested in developing rail and port facilities for its Cameroon iron ore project. Within three months, the price was up another 100%.
Frequently, agreements are framed so that the joint venturer being introduced is committed to invest only after certain milestones are met.
WA iron ore mine developer Pluton Resources (ASX: PLV) was reported in September 2010 as having as many as 14 expressions of interest from parties looking to become a joint venture partner. In the subsequent four weeks, the share price rose 76%.
The company announced a memorandum of understanding with a still unidentified Japanese trading company on 20 October. However, this agreement only committed the parties "to use all reasonable endeavours to finalize an agreement within 30 days of the completion of the Irvine Island pre feasibility study to a standard determined by the Japanese trading company".
This relatively weak agreement committed the parties to nothing more than talking again in six months. The share price fell 25% in the ten trading days after the announcement.
South American lithium deposit developer Orocobre (ASX: ORE, TSX: ORL) is another company that "has reached agreement to establish a joint venture with Toyota group company, Toyota Tsusho Corporation". Orocobre uses the Toyota motor car symbol prominently in its presentation material to create a link to this high profile international corporate.
The actual connection between the 25% owned Toyota Tsusho trading group and the better known parent is never fully defined. Also unclear is exactly how certain the joint venture will be since it is "subject to the finalization of the terms of a joint venture operating agreement on completion of the Definitive Feasibility Study".
The problem for investors is that they cannot see the agreements for themselves. Nor can they usually rely on independent research to verify their content.
As a practical matter, investors should discount heavily the value of joint venture agreements until they are proven watertight or until the company is prepared to share the full text with investors.
With a Federal court win under its belt, ASIC might match agreements more assiduously with public statements but bear in mind that ASIC only became involved in the Fortescue matter after a newspaper questioned the veracity of the company's claims publicly.
Alternatively, agreements might have to be categorized in the same way as information about mineable resources. An industry-wide standard against which the enforceability of joint venture agreements can be judged would afford investors some protection against the potential for exaggerated claims.
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