Australia: Shareholder Claims Against Insolvent Companies - Sons Of Gwalia

The government advisory committee CAMAC, ("the Corporations and Markets Advisory Committee") has backed the High Court decision in Sons of Gwalia¹ that ranks shareholders equally with all other creditors for seeking damages in failed companies if they had relied on false or misleading information.

The Sons of Gwalia case arose in the context of legislative developments in recent years to give shareholders remedies against their company, as well as others, where they suffer loss through certain forms of corporate misconduct.

Sons of Gwalia Decision

On 31 January 2007, the High Court handed down its decision in Sons of Gwalia Ltd -v- Margaretic ², igniting a storm of criticism. Sons of Gwalia shareholder, Mr Luke Margaretic argued that the company had failed to notify the Australian Securities Exchange of its inability to meet its gold delivery contracts, and that it could not continue as a going concern, thereby breaching its continuous disclosure obligations by not disclosing price-sensitive market information. As a purchaser of the company's shares, Mr Margaretic alleged that he was a victim of misleading and deceptive conduct in contravention of section 52 of the Trade Practices Act 1974 (Cth), section 1041H of the Corporations Act 2001 (Cth) and section 12DA of the Australian Securities and Investments Commission Act 2001 (Cth).

The High Court held that a claim by a shareholder for loss to the value of shares caused by failure of the company to inform the market would rank equally with the claims of other unsecured creditors in an external administration. The High Court ruling overturned traditional interpretations of section 563A of the Corporations Act, where the payment of a debt owed by a company to a member in their capacity as member is postponed until all non-member claims have been satisfied.

However, it was not a claim in the shareholder's capacity as a member of the company, which would be postponed behind claims by unsecured creditors. Aggrieved shareholder claims against a company arising from investor protection legislation under the Corporations Act and Trade Practices Act which prohibit misleading or deceptive conduct, while connected with their shareholding, do not arise from the statutory rights of membership (including any rights derived from the company's constitution).

Part of the High Court's reasoning for deciding that these shareholder claims were not caught by section 563A of the Corporations Act was that they were based on statutory investor protection provisions, which were not restricted to members. If a claim could be brought against a company by a non-member, then membership of the company was not essential to the claim.

CAMAC Findings

On 29 January 2009, CAMAC released its report Claims by shareholders against insolvent companies: Implications of the Sons of Gwalia decision. The report responded to a request for advice on the effect of the High Court decision in Sons of Gwalia. CAMAC recognised that the decision had significant implications, including for providers of corporate debt finance as well as the conduct of external administrations. However, CAMAC has not recommended action to overturn its effect.

The CAMAC report has recommended that the law be retained in relation to the High Court ruling.

Consequences for Shareholder Claimsoutside Section 563A

Claims by shareholders against a company arising from the operation of investor protection provisions under the Corporations Act and the Trade Practices Act which prohibit misleading or deceptive conduct:

• entitle shareholders to participate as creditors in the voluntary administration or liquidation of the company, with rights to receive information and exercise voting rights as creditors; and

• rank with all other general unsecured creditor claims in a corporate distribution arising from external administration.

In particular, these investor protection provisions relate to:

• the requirement for listed companies to disclose information to the public; and

• misleading or deceptive statements made by the company.

CAMAC considered that the decision brought into focus the conflict between the provision to shareholders of statutory remedies for corporate misconduct and the traditional notion of shareholder interests being postponed behind those of conventional unsecured creditors in a liquidation.

CAMAC acknowledged the significant implications for companies seeking funds in the unsecured debt market and in the rehabilitation of financially distressed companies. In particular, CAMAC acknowledged that this would cause lenders to factor into their assessment of risk of lending to Australian companies, the possibility that aggrieved shareholders may compete with conventional unsecured creditors in the event that the company goes into external administration. This would influence the readiness of lenders to advance funds or the terms on which they would do so, and this against the background of a tight credit market following global financial market developments.

CAMAC also acknowledged that difficulties could arise in attracting investors to assist in the rehabilitation of financially stressed companies. However, prospective investors in these companies could have other ways to protect their financial interests, including through creditors' schemes of arrangement, whereby aggrieved shareholders agree to restrictions on their claims in return for the injection of further capital.

Nonetheless, CAMAC considered that the High Court decision provided a measure of certainty and encourages the self-regulation of companies to complement the role of regulators in relation to corporate disclosures. CAMAC proposed that corporate external administrations self regulate through:

• a standardised proof of debt form for claims by aggrieved shareholders, which administrators choose to use in making a 'just estimate' of the value of those claims;

• a rebuttable presumption that a determination in one proceeding of a question of fact common to other aggrieved shareholder claims applies in any subsequent proceeding; and

• giving the court with a general power to make orders in a liquidation, which could cover creditors' meetings and the determination of shareholder claims.

Conclusion

As a result of the High Court decision and the subsequent CAMAC findings, a person who buys shares in a company relying on misleading or deceptive information from that company, or was misled as to the company's worth by its failure to make disclosures, may have a claim for damages against the company that ranks on a par with other creditors.

Footnotes

1 Sons of Gwalia Ltd -v- Margaretic (2007) 232 ALR 232 (Sons of Gwalia)

2 (2007) 232 ALR 232

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