Australia: Developments in Insolvency Law: Sons of Gwalia Overturned

Commercial Disputes eBulletin - 25 January 2011
Last Updated: 28 March 2011
Article by Greg McKenzie

The Sons of Gwalia decision

In Sons of Gwalia v Margaretic; ING Investment Management v Margaretic (2007) 232 ALR 232 (Sons of Gwalia), the High Court held that a shareholder pursuing remedies for misleading or deceptive conduct and non-disclosure inducing him to purchase shares in Sons of Gwalia Ltd, was entitled to prove in the administration of the company and rank equally with general unsecured creditors.

The decision has been the subject of extensive legal, academic and parliamentary attention and fuelled intense debate about the need for law reform.

Recently legislation has been passed by the Australian Parliament in the form of the Corporations Amendment (Sons of Gwalia) Act 2010 (Cth) (Sons of Gwalia Act) which amends the Corporations Act 2001 (Cth) (Corporations Act) and means that in future all such shareholder claims will once again be subordinated.

Commencement - the Sons of Gwalia Act

The Sons of Gwalia Act amendments took effect on 18 December 2010. However, the amendments will not operate retrospectively meaning that:

  • subordination of shareholder claims under the amended s563A of the Corporations Act will only apply to claims arising after 18 December 2010; and
  • the restrictions on voting rights and access to notices under the new s600H of the Corporations Act will apply only to external administrations commenced after 18 December 2010.

Overview - the Sons of Gwalia Act

The Sons of Gwalia Act makes three important amendments to the Corporations Act:

  1. The new s247E provides that a person is not precluded from bringing a claim only because the person "holds, held or has subscribed for shares in the company".
  2. However, the amended s563A provides that a claim which "arises from a person buying, holding, selling or otherwise dealing in shares in the company [is] postponed [such that only once] all other claims made against the company are satisfied [can the] subordinate claim [be satisfied]".

    This change, in effect, reverses the decision in Sons of Gwalia and given that less than 5% of insolvencies see a payout to unsecured creditors of 10c in the dollar or more, means that typically there will be no funds available for distribution to shareholder creditors of an insolvent company.

  3. A new section 600H has been included in the Corporations Act and provides that a person whose claim has been postponed under s563A is entitled to receive copies of notices sent to creditors only if they request the notice in writing and may only vote as a creditor if ordered by the Court.

This latter change is likely to be of particular significance in the context of meetings of creditors in voluntary administrations, when large blocs of small creditors can exercise significant control over the future of the insolvent company. It remains to be seen in what circumstances the Court will allow shareholder creditors to vote, but one probable scenario is where it is likely that there will be adequate funds for a distribution to be made to postponed shareholder creditors.

Analysis - the Sons of Gwalia Act

The new shareholder subordination regime introduced by the Sons of Gwalia Act will be one of the strictest in the world. However, there are two features which may give rise to uncertainty.

  1. By only including claims arising from dealings in "shares" in the subordination regime, the door is left open to claims by investors who have purchased other "securities" (as defined by the Corporations Act). This inconsistency may be particularly problematic in claims arising out of dealings with stapled securities.
  2. There is an apparent contradiction between s562 and the amended s563A of the Corporations Act. Section 562 requires that, in appropriate circumstances, insurance proceeds held by a company be paid as a priority payment to the third party whose claim triggered the insurance policy. However, we query how this would operate in circumstances where the third party's claim is a shareholder action falling within the s563A subordination regime. That is, it is not clear which provision is intended to prevail in such circumstances and this anomaly may cause confusion and require legislative clarification.

Leaving aside these two issues, the Sons of Gwalia Act should generally alleviate pressure on liquidators and administrators by making shareholder claims against insolvent companies far less attractive. This in turn should assist insolvency professionals to avoid the enormous cost and complexity associated with large scale shareholder class-action type claims in an insolvency setting.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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