Corporate Governance

Current Reports, Disclosure and Stoneridge

By J. Robert Brown

One of our observations about the deplorable reasoning in Stoneridge was that the element of actual reliance would place control over liability not on the vendor but on the customer making the disclosure.  In other words, the Court dismissed the case against the vendors in Stoneridge because the market did not rely on the allegedly fraudulent contracts.  To have reliance presumably requires disclosure of the existence of the contracts and perhaps their terms.  The vendors could disclose the contracts but so might Charter.  As a result, liability of the vendors might depend upon the disclosure made by Charter. 

This is not a fanciful possibility.  Item 1.01 of Form 8-K requires a company to disclose material contracts not in the ordinary course of business.  Thus, had the contracts with Motorola and Scientific Atlanta been material and not in the ordinary course (can a fraudulent agreement ever be in the ordinary course?), it may well have been subject to mandatory disclosure under this Item.  With that in mind, we turn to a set of updated instructions recently issued by the staff on this requirement.   

The disclosure requirement only applies to agreements that are material when made, not to agreements that subsequently become material.  The disclosure requirement also applies to the termination of a material agreement.  This is true once notice of termination has been given, even if the contract won't actually terminate for a specified period of time and the company intends to negotiate in the interim for a resumption of the contract.  As the staff noted:  

• Question: A material definitive agreement has an advance notice provision that requires 180 days advance notice to terminate. The counterparty delivers to the registrant written advance notice of termination. Even though the registrant intends to negotiate with the counterparty and believes in good faith that the agreement will ultimately not be terminated, is an Item 1.02 Form 8-K required when the registrant receives the appropriate advance notice of termination?
• Answer: Yes. Although Instruction 1 to Item 1.02 notes that no disclosure is required solely by reason of that item during negotiations or discussions regarding termination of a material definitive agreement unless and until the agreement has been terminated, and Instruction 2 indicates that no disclosure is required if the registrant believes in good faith that the material definitive agreement has not been terminated, Instruction 2 clarifies that, once notice of termination pursuant to the terms of the agreement has been received, the Form 8-K is required, notwithstanding the registrant’s continued efforts to negotiate a continuation of the contract.

Vendors may, therefore, find themselves subject to the antifraud provisions not because of what they said but because of statements of their customer.

Full post as published by The Race to the Bottom on May 29, 2008 (boomark / email).