Financial forecasts in a capital raising or business sale and proving reasonable grounds

If your business is raising capital or going on the market, the financial forecasts in your pitch deck, information memorandum or sale documents are not just marketing. They are legal representations, and Australian law treats them strictly. A forecast that turns out to be wrong can expose the business, and the people who made it, to claims for misleading and deceptive conduct under the Australian Consumer Law (the ACL), which is Schedule 2 to the Competition and Consumer Act 2010 (Cth).

The good news is that a forecast does not have to come true to be lawful. The law does not punish honest prediction errors. What it punishes is making a forecast without reasonable grounds for it, and here the law stacks the deck against the person making the forecast: if you cannot prove you had reasonable grounds, the forecast is taken to be misleading. This article sets out who the obligation applies to, the two duties you must satisfy, what reasonable grounds actually means, and the practical steps to protect your business before a forecast goes out the door.

Who must comply, and when forecasts are caught

The core prohibition in s 18(1) of the ACL applies to any person who, in trade or commerce, engages in conduct that is misleading or deceptive or is likely to mislead or deceive. In practice this means the obligation reaches:

• Businesses selling themselves or their assets: statements in sale documents, information memoranda and vendor due diligence are made in trade or commerce, even when addressed to a single sophisticated buyer.
• Companies and founders raising capital: forecasts in pitch decks, investor presentations and offer documents are classic in trade or commerce conduct.
• Directors and individual managers: the ACL binds persons, not just companies. A director or founder who personally makes the forecast can be liable in their own right, and conduct by employees is generally attributed to the business.

The trigger is simple: any statement about a future matter. That covers profit and revenue projections, earnings forecasts, growth targets, completion dates and promises about what the business will achieve. It does not matter whether the recipient is a consumer, an angel investor, a bank or a private equity firm. It also does not matter how sophisticated the recipient is: experienced investors rely on forecasts too, and their sophistication goes to whether they were actually misled, not to whether you needed reasonable grounds.

The first duty: do not mislead

Section 18(1) of the ACL is the foundation. A forecast is conduct, and it carries an implied representation: that it is honestly made and based on reasonable grounds. If the forecast, read in context, would lead a reasonable recipient to a false conclusion, the conduct is misleading or deceptive, even if the words used were technically accurate. The question is objective: would the ordinary reader in the recipient's position be led into error?

In Global Sportsman Pty Ltd v Mirror Newspapers Ltd (1984) 2 FCR 82, decided under s 52 of the Trade Practices Act 1974 (Cth), the predecessor of s 18, the Federal Court made the point that matters: a prediction proving inaccurate does not, of itself, establish that the maker did not believe it would eventuate, or that the belief lacked any adequate foundation. An honest forecast that misses the mark is not automatically misleading. What makes it misleading is the absence of a proper basis, and that is where the second duty comes in.

The second duty: have reasonable grounds for every forecast

Section 4 of the ACL deals specifically with representations about future matters. It provides that if a person makes a representation about any future matter, and the person does not have reasonable grounds for making it, the representation is taken to be misleading for the purposes of the ACL.

This is a deeming provision: the forecast is treated as misleading if the maker lacked reasonable grounds, without the recipient having to prove dishonesty or carelessness. Subsection (2) is the part that should worry forecasters. In any proceeding about a future matter, the maker of the representation is taken not to have had reasonable grounds unless evidence is adduced to the contrary. The practical effect is a reverse onus: if a buyer or investor later challenges your forecast, you carry the burden of proving your grounds were reasonable, not them of proving they were not.

Two qualifications in the section itself are worth knowing. First, adducing some evidence of reasonable grounds does not automatically win the day: the court still decides whether the grounds were in fact reasonable (s 4(3)). Second, having reasonable grounds does not automatically make a forecast lawful, because a forecast can still mislead in context even if it was carefully made (s 4(4)). The section works alongside s 18, not instead of it.

What counts as reasonable grounds

There is no statutory checklist, and what is reasonable is judged case by case. The decided cases give clear guidance on how the question is approached.

The time of assessment is when the forecast was made

Reasonable grounds are assessed on the information available and relied on when the statement was made, not with hindsight. That follows from Global Sportsman, which located the enquiry in the state of mind of the maker at the time the statement was made. Courts have repeatedly warned against judging a forecast with the benefit of hindsight: a forecast that later proves wrong is not, by itself, evidence that you lacked grounds when you made it.

The size of the claim matters

The more specific and ambitious the forecast, the more you will need to be able to show. In Awad v Twin Creeks Properties Pty Limited [2012] NSWCA 200, buyers of a residential lot in a western Sydney resort development were told the development would include a Peppers resort hotel opening in 2007. The trial judge found the representations about the number and size of the lots were made with reasonable grounds, but the representation about the resort was not: the developer could not point to evidence of financial capacity to build it, and damages were awarded. On appeal the decision was reversed on the sufficiency of the evidence, but the case remains the clearest illustration of the core rule: a promise about what will happen is only as safe as the evidence you hold to back it.

Care and expertise count

A forecast prepared carefully, using a defensible methodology, consistent with the available data, and with assumptions that were checked, will generally satisfy the standard. Forecasts made on the run, without analysis, or in disregard of conflicting information known to the maker, will not. Where the maker holds themselves out as having particular expertise, they will be measured against the standard of that profession.

Assumptions must be disclosed

If a forecast rests on assumptions, say so, and say what they are. A recipient who is told the key assumptions can assess the forecast for what it is. A recipient who is not told is left with an impression the assumptions may not support.

Document the basis of your forecasts as you go

Because of the reverse onus in s 4(2), the question in any dispute will be: what evidence can you produce that your grounds were reasonable? Records made at the time are the answer. In practice:

• Keep the working papers behind each forecast: the source data, the methodology and the identity of whoever prepared or reviewed it.
• Record the assumptions and test them for realism before publication.
• Note any conflicting information you considered, and why you rejected it.
• Keep board or management approvals that show the forecast was scrutinised before it went out.
• If litigation follows, you may have to plead and particularise your grounds. In Skiwing Pty Ltd v Trust Company of Australia Ltd (Stockland Property Management Ltd) [2009] FCA 347, the Federal Court confirmed the onus a corporate representor carries in establishing reasonable grounds. A file you can hand to your lawyer is the difference between mounting that case and conceding it.

The timing rule is the golden rule: create the evidence file before the forecast is sent, not after the complaint arrives. Notes made after a dispute begins are far less persuasive, and documents created for the purpose of litigation can raise problems of their own.

Using forecasts prepared by accountants or advisors

Many forecasts are prepared by external accountants or business advisors, and engaging a reputable professional is one of the strongest things you can do. It shows care, and it brings expertise to bear. But the protection is not automatic:

• Satisfy yourself that the advisor is competent for the task and independent of the outcome you are hoping to sell.
• Do not pass on a third-party forecast you have reason to doubt. If you know of information that contradicts it, you cannot shelter behind the expert.
• When you relay a professional's forecast, relay it accurately and fairly. Truncating, editing or repackaging an expert's numbers so they read more favourably is conduct of your own, and it is judged on its own terms.

What happens if a forecast is misleading

A contravention of s 18 exposes the business to a range of remedies:

• Damages: under s 236 of the ACL for loss suffered by recipients who relied on the forecast, which in a capital raising or sale context can run to the value of the investment or the gap between what was promised and what was delivered.
• Injunctions: under s 232, restraining the conduct or requiring corrective statements.
• Compensation orders: under s 237, and other orders the court considers appropriate.

Two points about penalties are often misunderstood. Section 18 itself is not a pecuniary penalty provision: the penalty table in s 224 of the ACL does not include it, so the exposure under s 18 is damages and court orders rather than fines. However, the same conduct may also breach penalty provisions. False or misleading representations about goods or services under s 29 of the ACL (in Part 3-1) attract pecuniary penalties of, for a body corporate, the greater of $100 million, three times the benefit obtained, or 30% of adjusted turnover, and up to $2.5 million for an individual. And if the forecast sits inside a prospectus or other disclosure document under the Corporations Act 2001 (Cth), separate disclosure obligations apply with their own consequences.

Beyond remedies, the practical cost is high: a misleading forecast can derail the transaction, trigger warranty and indemnity claims under the sale agreement, attract regulator attention from the ACCC or ASIC, and become a matter of public record.

Compliance checklist

Before any forecast leaves the business:

• Confirm the obligation applies: if you are selling the business or raising capital, it does.
• Have a documented basis: data, methodology, preparer and reviewer identified, on file before publication.
• State your assumptions: in the document itself, prominently.
• Check for conflicting information: anything you know that contradicts the forecast must be addressed, not ignored.
• Use appropriate expertise: for substantial forecasts, have a qualified accountant or advisor prepare or review them.
• Treat the forecast as a representation: review it as a regulator would: what impression does it create, in context, for a reasonable reader?
• Update when circumstances change: a forecast that was reasonable when made can become misleading if it is repeated or left standing after you learn it is no longer supportable.

Where a lawyer helps

A commercial lawyer can review your offering documents and forecasts before they go out, stress-test the assumptions, and help build the evidence file that will matter if the forecast is ever challenged. If a dispute has already started, a lawyer can advise on the strength of the claim or defence, the onus you carry under s 4, and how to present the records you kept. Where a prospectus or other regulated disclosure is involved, specialist advice is essential, because the Corporations Act regime operates alongside the ACL.

The presumption to plan around

The reverse onus in s 4(2) decides most disputes before the evidence is heard. A business that kept no records of how a forecast was built starts that fight having already lost the presumption battle: it is taken not to have had reasonable grounds, and it has nothing to adduce to the contrary. The business that built the evidence file at the time, with data, methodology, assumptions and sign-off, at least gets to argue its grounds on the merits. So the first action this week is not to reword your forecast. It is to open the folder for your current fundraising or sale documents and check that the basis for every number in them is on the record, dated and attributable. If it is not, treat that as the risk it is, and fix it before the document goes to a single investor or buyer.