SECTION 761D
22 As we have said, the operation of s 761D(3) is of substantial importance in this case. If the forward contracts fell within s 761D(3) of the Corporations Act, then they were neither derivatives nor financial products for the purposes of Ch 7. Section 761D provides:
Meaning of derivative
(1) For the purposes of this Chapter, subject to subsections (2), (3) and (4), a derivative is an arrangement in relation to which the following conditions are satisfied:
(a) under the arrangement, a party to the arrangement must, or may be required to, provide at some future time consideration of a particular kind or kinds to someone; and
(b) that future time is not less than the number of days, prescribed by regulations made for the purposes of this paragraph, after the day on which the arrangement is entered into; and
(c) the amount of the consideration, or the value of the arrangement, is ultimately determined, derived from or varies by reference to (wholly or in part) the value or amount of something else (of any nature whatsoever and whether or not deliverable), including, for example, one or more of the following:
(i) an asset;
(ii) a rate (including an interest rate or exchange rate);
(iii) an index;
(iv) a commodity.
(2) Without limiting subsection (1), anything declared by the regulations to be a derivative for the purposes of this section is a derivative for the purposes of this Chapter. A thing so declared is a derivative despite anything in subsections (3) and (4).
(3) Subject to subsection (2), the following are not derivatives for the purposes of this Chapter even if they are covered by the definition in subsection (1):
(a) an arrangement in relation to which subparagraphs (i), (ii) and (iii) are satisfied:
(i) a party has, or may have, an obligation to buy, and another party has, or may have, an obligation to sell, tangible property (other than Australian or foreign currency) at a price and on a date in the future; and
(ii) the arrangement does not permit the seller's obligations to be wholly settled by cash, or by set-off between the parties, rather than by delivery of the property; and
(iii) neither usual market practice, nor the rules of a licensed market or a licensed CS facility, permits the seller's obligations to be closed out by the matching up of the arrangement with another arrangement of the same kind under which the seller has offsetting obligations to buy;
but only to the extent that the arrangement deals with that purchase and sale;
(b) a contract for the future provision of services;
(c) anything that is covered by a paragraph of subsection 764A(1), other than paragraph (c) of that subsection;
(d) anything declared by the regulations not to be a derivative for the purposes of this Chapter.
(4) Subject to subsection (2), an arrangement under which one party has an obligation to buy, and the other has an obligation to sell, property is not a derivative for the purposes of this Chapter merely because the arrangement provides for the consideration to be varied by reference to a general inflation index such as the Consumer Price Index.
23 The term "arrangement" is defined in s 761A as follows:
arrangement means, subject to section 761B, a contract, agreement, understanding, scheme or other arrangement (as existing from time to time):
(a) whether formal or informal, or partly formal and partly informal; and
(b) whether written or oral, or partly written and partly oral; and
(c) whether or not enforceable, or intended to be enforceable, by legal proceedings and whether or not based on legal or equitable rights.
24 Section 761B provides:
If:
(a) an arrangement, when considered by itself, does not constitute a derivative, or some other kind of financial product; and
(b) that arrangement, and one or more other arrangements, if they had instead been a single arrangement, would have constituted a derivative or other financial product; and
(c) it is reasonable to assume that the parties to the arrangements regard them as constituting a single scheme;
the arrangements are, for the purposes of this Part, to be treated as if they together constituted a single arrangement.
25 The primary Judge understood the relevant "arrangements" to be the forward contracts, although his Honour also recognized that the applicants were seeking to find some support for their case in s 761B. That section provides that in certain circumstances, two or more "arrangements" may be treated as, together, constituting a single arrangement. Before us, the applicants assert that the relevant "arrangements" might include "arrangements or undertakings" as to performance or breach of the contracts occurring after they were made. Given that the applicants' case depends upon the existence of an obligation to give a PDS at or before the making of each contract, it is difficult to see how events after the contract date can be relevant. In any event, it is fairly clear from paragraphs 31, 32, 41 and 42 of the amended statement of claim that the relevant financial products, as there pleaded, are the forward contracts. Similarly numbered paragraphs in the proposed second amended statement of claim are to similar effect. The applicants' written submissions also proceed generally on that basis. See para 6. It is at para 12-16 that they implicitly seek to establish a wider case, but without alleging any specific additional aspects of the relevant "arrangements". In the absence of any pleaded or otherwise identified arrangements going beyond the forward contracts, we proceed on the basis that they are the relevant arrangements.
26 One may doubt whether such contracts satisfy the requirements of s 761D(1) so as to be derivatives, quite apart from the operation of s 761D(3). Clearly, the amount of the consideration will not vary. The applicants rely on the words "the value of the arrangement". The meaning of that expression is obscure. One immediately asks: "The value to whom?" It may be arguable that if prices rise, the value of the contract to the buyer will rise. It may similarly be arguable that if prices fall, the value to the seller will rise. In each case, the value depends upon the enforceability of the contract. If the arrangement in question is not a contract, then how is it to be valued? Yet the definition of the term "arrangement" clearly contemplates non-contractual arrangements. This line of reasoning might provoke questions concerning the meaning of the term "consideration" in a non-contractual arrangement, leading in turn to an inquiry as to how a party might be required to provide consideration for the purposes of s 761D(1)(a) in a non-contractual context. It may be that it is impossible to work out the actual operation of s 761D(1) other than for a specific "arrangement". If his Honour was correct in concluding that s 761D(3) was decisive of the matter, it will not be necessary further to consider that question.
27 Section 761D(3), as applied by s 765A(1), plays a significant role in the operation of Ch 7, the object of which is set out in s 760A as follows:
The main object of this Chapter is to promote:
(a) confident and informed decision making by consumers of financial products and services while facilitating efficiency, flexibility and innovation in the provision of those products and services; and
(b) fairness, honesty and professionalism by those who provide financial services; and
(c) fair, orderly and transparent markets for financial products; and
(d) the reduction of systemic risk and the provision of fair and effective services by clearing and settlement facilities.
28 The term "financial product" is critical to the operation of the chapter. The express exclusions contained in s 765A are designed to ameliorate the effect of the very broad language used in the other definition sections which seek to capture many kinds of financial transactions. Section 765A narrows the operation of Ch 7 so as to keep it within the intended bounds. Section 761D(3) is important because it leads to the exclusion of a very large number of everyday transactions, namely sales of tangible property for future delivery. Such transactions are not generally thought to be financial transactions. However it is well-known that there are markets in which contracts for the sale and purchase of "tangible property" are traded. Such markets are more readily seen as being "financial" and therefore appropriately regulated. Where the price of tangible property fluctuates significantly over time, there is always the likelihood that people will seek to profit from such fluctuations. For that reason s 761D(1) catches "arrangements" for the supply of tangible property where the prices are not fixed or the "values" of the arrangements may fluctuate. However s 761D(3) narrows that effect. Broadly speaking, it does so by excluding from the definition of "derivative" arrangements for the supply of tangible property where one of the parties is actually expected to deliver the relevant property, and where rights and obligations under such arrangements are not usually traded, or not traded in a recognizable market.
29 The question, then, is whether, assuming that the forward contracts satisfy the requirements of s 761D(1), they are nonetheless excluded from the definition of the word "derivative" by s 761D(3)(a). It is common ground that those contracts satisfy the requirements of s 761D(3)(a)(i). Section 761D(3)(a)(ii) requires that the relevant arrangement "not permit the seller's obligation to be wholly settled by cash, or by set-off between the parties …". The applicants submitted at first instance that it was arguable that the applicants' obligations under the forward contracts could be wholly settled by cash because the buyer's remedy for default would be in damages and not specific performance, the applicants' paying such damages in cash. Alternatively, they submitted that the so-called "washout provisions" meant that their obligations could be wholly settled by cash. The term "washout provisions" refers to both cl 12 and NACMA r 17.1.
30 As to the first submission, the primary Judge concluded that the availability of a remedy in damages for breach of contract did not mean that the relevant contract permitted a party's obligations to be wholly settled in cash rather than by performance. His Honour referred to the observation of Windeyer J in Coulls v Bagot's Executor & Trustee Co Ltd (1967) 119 CLR 460 at 504 that:
The primary obligation of a party to a contract is to perform it, to keep his promise. That is what the law requires of him. If he fails to do so, he incurs a liability to pay damages. That however is the ancillary remedy for his violation of the other party's primary right to have him carry out his promise. It is, I think, a faulty analysis of legal obligations to say that the law treats a promisor as having a right to elect either to perform his promise or to pay damages.
31 In other words, an award of damages for breach of contract is compensation for failing to meet one's obligations. It does not reflect an implied contractual arrangement which permits an obligation under the contract to be wholly settled in cash. It may be rare for a court to order specific performance of a contract for the sale of goods, but the theoretical availability of that remedy also says much, in principle, against the applicants' argument.
32 His Honour then considered the "washout provisions". He noted that in the ABB Grain first forward contract cl 12 only operated if the applicant suffered production failure. His Honour also noted that NACMA r 17.1 only applied if the seller discovered that it was going to be in default, and that, "in essence, the washout provisions operate at the option of the buyer, not the seller". Thus the seller was not "permitted" by the contract to discharge its obligations by paying cash. Thirdly, his Honour pointed out that the washout provisions "result in a measure of damages similar to that specified in s 50(3) of the Sale of Goods Act 1895 (SA)". His Honour characterized the washout provisions as "contractual provisions as to the buyer's remedies in the case of breach and the measure of damages or compensation payable to the buyer in those circumstances". His Honour concluded that s 761D(3)(a)(ii) was satisfied.
33 His Honour then considered s 761D(3)(a)(iii). Both sides led evidence concerning this matter. The operation of s 761D(3) was not addressed in the amended statement of claim or in the proposed second amended statement of claim. In many ways both pleadings are unsatisfactory in dealing with the complex statutory regime which we are discussing. However it was probably appropriate for the applicants to leave the operation of s 761D(3) to be raised by the respondents. ABB Grain filed an affidavit by Stephen Anthony Howells, a senior employee with substantial experience in the grain industry. In para 24 he swore that:
There is no market in which Forward Contracts are traded or can be traded. Because there is no market, there is no usual market practice".
34 Superficially, this statement may appear to be an inadequate basis for asserting that s 761D(3)(a)(iii) was, from the respondents' point of view, satisfied. Whilst the affidavit excluded any relevant market practice and, perhaps, the existence of any licensed market and, therefore, the existence of any rules of a relevant licensed market, it said nothing about the rules of a licensed CS facility. That term is defined to mean "a clearing and settlement facility the operation of which is authorized by an Australian CS facility licence". It may be that a clearing and settlement facility which deals in derivatives would be within the meaning of the word "market" as used by Mr Howells in his affidavit, but the matter is not absolutely clear. However the applicants appear to have dealt with the matter on the basis that the operation of s 761D(3)(a)(iii) had been raised and had to be addressed. To do so, they relied upon the affidavit of Timothy Douglas Keynes filed on 17 February 2009.
35 Mr Keynes at least implied that there was a market for grain in the Port Lincoln "zone" or "area", and that in that zone, area or market, he could deal with liability under a forward contract in a particular way which could be accommodated within the grain storage systems operated by ABB Grain and others in that location. He gave an example which postulated a forward contract for the sale of grain which he could not honour. He said that he would go to another grower in order to acquire the necessary grain. Assuming that such grain had been delivered to ABB Grain or a similar body, he would then direct it to deliver the acquired grain in satisfaction of his obligation under the earlier contract. He would do this in order to "close out my position". Mr Keynes' example postulates a sale price under the earlier contract of $400 per tonne, a fall in the price to $300 per tonne, and a purchase by him at $310 per tonne. Of course, if the price rises, and the structure of the transaction is similar, Mr Keynes would be out of pocket. It is also possible that he would not be able to find sufficient grain for sale at a price which he could pay.
36 As the primary Judge understood the applicants' case, it was that s 761D(3)(a)(iii) would not be satisfied if:
… it is possible, or known, or not uncommon, for a seller who is facing a production failure to agree to buy an amount equivalent to what he has agreed to sell, thereby capping a loss in a rising market or making a profit in a falling market.
37 His Honour concluded that Mr Keynes was not describing a usual market practice permitting the closing out of the seller's obligations. Rather, he was describing "a means of making a profit or capping a liability in a market where goods are readily obtainable". His Honour observed that, "(i)t is the nature of the goods, not usual market practice, which permits the seller to act in the way specified". The primary Judge considered that s 761D(3)(a)(iii) contemplated the termination, "for all practical purposes", of the seller's obligations under the original contract. Such termination was not a feature of the arrangement identified by Mr Keynes. It rather assisted him to perform his obligations.