In its long-awaited judgment, the English High Court1 has found that the British software firm Autonomy defrauded the US tech giant Hewlett-Packard (HP) and induced its own acquisition for the price of US$11.1bn. The judgment – following a ten-month trial – shines a spotlight on the boundary between ambitious forecasts and dishonest accounting practices and serves as a reminder that the actions and public statements of directors made after a transaction has completed can still impact future claims.
Summary
The Claimants were a group of HP entities ("HP")2 that acquired all of Autonomy's shares in 2012. The first Defendant, Mike Lynch, was Autonomy's former Chief Executive Officer and the second Defendant, Sushovan Hussain, was its former Chief Financial Officer (together, the "Defendants"). At the time of the acquisition, Autonomy was the largest British software company by market capitalisation on the FTSE 100 and specialised in unstructured data analysis through its core product, Intelligent Data Operating Layer (IDOL). Following the acquisition, HP claimed it had been misled as to Autonomy's true value from Autonomy's published financial information and by the Defendants' dishonest representations.
HP alleged fraud in respect of Autonomy's description as a "pure software company" as well as improper practices across six areas of Autonomy's business and accounting, resulting in artificially inflated and accelerated revenue. These practices included understating the costs of goods sold, misrepresenting the rate of organic growth, misrepresenting the nature and quality of revenues, as well as overstating gross and net profits and misrepresenting the nature of Autonomy's core business.
HP issued claims against the Defendants pursuant to the statutory regime for issuer liability (Schedule 10A of the Financial Services and Markets Act 2000 ("FSMA")),3 for misrepresentation (under section 2(1) of the Misrepresentation Act 1967 and/or the tort of deceit); and for breach of the directors' fiduciary and contractual duties.
(i) Issuer liability claims
HP claimed approximately US$4.5 billion under Schedule 10A of FSMA. It was the first time a claim under these provisions had gone to a full trial, despite the relevant provision being in force since 2007. HP alleged that the former directors (Lynch and Hussain) made misleading statements in relation to: the description of Autonomy as a pure software company when it had substantial undisclosed hardware sales (the "Hardware Case");4 the use of value-added resellers to accelerate revenue in Autonomy's accounts (the "Reseller Case");5 the dishonest use of reciprocal transactions with resellers to boost high margin software sales (the "Reciprocal Transactions Case");6 and the use of illusory customer licences to accelerate the recognition of revenue (the "Hosted Case").7
These claims entitled HP to sue the issuer of securities (Autonomy) for loss incurred due to the untrue and/or misleading statements or omissions that had been published in relation to the Hardware Case, Reseller Case, Reciprocal Transactions Case and Hosted Case described above.8 This caused some difficulty for HP, as it wholly owned Autonomy by the time the claims were issued;9 it was clearly not in HP's interests for Autonomy itself to be liable for the loss. To overcome this, Autonomy admitted liability for the statements/omissions and then sued the two former directors as persons discharging managerial responsibilities (PDMRs)10 in order to recover the loss. This "dog-leg" structure enabled HP to sue for misstatements or omissions of fact of which the Defendants were aware in their professional capacity.
(ii) Misrepresentation claims
The claims for fraudulent misrepresentation amounted to US$420 million against the former directors for the losses attributable to the shares and options that had been sold by the Defendants to HP.11 HP relied on eight sets of pre-acquisition representations that were made in meetings and presentations over the course of 2011. The factual basis of these claims mirror that of the FSMA claims and included Autonomy's improper reporting of one-off software licence sales within the metric used to measure royalties and recurring revenue generated by IDOL (the "OEM Case").12
(iii) Directors' duties claims
HP claimed c. US$76.1 million from the former directors on the basis of alleged breaches of their fiduciary and contractual duties, which it alleged caused Autonomy (and its related companies) to enter into transactions which were not in their best interests. The factual basis of these claims also covered the Hardware Case, Reseller Case, Reciprocal Transactions Case and the Hosted Case as described above.13
The Judgment
In respect of the issuer liability claims, Autonomy's admission of liability did not bind the Court, meaning it first had to establish Autonomy's liability on the facts before determining what damages HP were entitled to recover. Mr Justice Hildyard accepted HP's arguments on all but one head of claim. While admitting he was initially sceptical of HP's case14 given Autonomy's success as a cash-generating enterprise with a "world-beating software product",15 he found that the Hardware Case, the Reseller Case,16 the Reciprocal Transactions Case, the Hosted Case and the OEM Case had been sufficiently made out. Accordingly, the relevant claims under FSMA, the Misrepresentation Act 1967 and breaches of directors' duties succeeded.17
Hildyard J found that the Defendants were well aware of the dishonest representation of financial information, and directed and encouraged the use of all five improper practices to meet revenue forecasts. Under their direction, Autonomy met revenue targets by selling hardware at a loss through transactions that were not commercially justified, and had not been disclosed to the market. They further sold software and illusory licences to counterparties who were later effectively reimbursed by Autonomy buying products from those same counterparties that Autonomy did not need, in order artificially to boost revenue. The aggregate result of these misrepresentations was that HP bought a "smaller and less successful company than it was represented to be".18
Judgment is reserved on quantum pending further submissions from the parties.19 However, Hildyard J has already indicated that while still substantial, the total damages to be awarded to HP will be "substantially less"20 than the full amount sought. Significantly, even adjusted for fraud, Hildyard J held that HP still considered Autonomy a "suitable acquisition whereby to effect transformational change"21 due to its signature and ground-breaking product, IDOL.
Significance of the Decision
This decision serves as a warning for start-ups against using targeted management and accounting strategies to optimise their pitch to investors, particularly in the tech industry. In a culture that is increasingly attuned to visionary CEOs, market-changing innovation and ambitious mission statements, it is a reminder that the law creates a stricter framework for investor communications. Companies must ensure that published financial information justifies all statements made to investors, whatever their stage of development.
The judgment also sheds light on how public statements made by senior directors after a transaction can nevertheless impact future claims. In particular, the description of the acquisition as "almost magical"22 by a HP employee who later became CEO was relied upon by Hildyard J as evidence that HP would have acquired Autonomy, regardless of fraud, because of the innovative IDOL product. Buyers should be mindful of what statements their directors communicate to the public shortly after a high-profile transaction, and should ideally wait until the financial details are independently verified before making descriptive claims.
Finally, the success of the "dog-leg" structure will be of interest to purchasers of a company's entire share capital considering bringing claims for misleading and/or untrue statements (or omissions) issued by the company prior to its acquisition. With the Court accepting the viable use of such a structure, such purchasers may consider using Schedule 10A FSMA to seek compensation as an alternative head of claim.
The Defendants have indicated their intention to seek permission to appeal the decision.23 If they do, the HP v Autonomy saga is far from over, and where the dust will settle on the law in this matter is yet to be seen.
1 Autonomy Corporation Limited and others -v- Lynch and another [2022] EWHC 1178 (Ch). Unusually, the Court (Mr Justice Hildyard) published a summary of its conclusions on 28 January 2022, with the approved final judgment only handed down in full on 17 May 2022.
2 Among other Claimants, ACL Netherlands B.V. and Autonomy Systems Limited.
3 As well as under its predecessor, section 90A of the Financial Services and Markets Act 2000.
4 Autonomy Corporation Limited and others -v- Lynch and another [2022] EWHC 1178 (Ch) [16(1)].
5 Supra. [16(2)].
6 Supra. [16(3)].
7 Supra. [16(4)].
8 Schedule 10A, ss.3(1)(b) of the Financial Services and Markets Act 2000.
9 Via a special purpose vehicle used for the acquisition.
10 Schedule 10A, ss.3-5 of the Financial Services and Markets Act 2000.
11 Autonomy Corporation Limited and others -v- Lynch and another [2022] EWHC 1178 (Ch) [3821].
12 Supra. [16(5)].
13 Supra. [22].
14 Autonomy Corporation Limited and others -v- Lynch and another [2022] EWHC 1178 (Ch) [4116].
15 As above.
16 With the exception of one impugned transaction, see Supra. [4122].
17 Supra. [4116-4127].
18 Supra. [4127].
19 Supra. [4135].
20 Appendix 6 (Summary of Conclusions), Autonomy Corporation Limited and others -v- Lynch and another [2022] EWHC 1178 (Ch) [98]
21 As above.
22 Autonomy Corporation Limited and others -v- Lynch and another [2022] EWHC 1178 (Ch) [4116].
23 Supra. [4148].
Zarlush Zaidi (Trainee Solicitor, White & Case, London) and Emma Thatcher (Senior Professional Support Lawyer, White & Case, London) co-authored this publication.
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