Corporations and Markets Advisory Committee (CAMAC) upholds decision ranking shareholder claims equally with unsecured creditors.
A further potential obstacle has been thrown in the path of distressed companies looking to restructure or re-finance, following the release of CAMAC's much anticipated report last week supporting the High Court decision in Sons of Gwalia v Margaretic  (Sons of Gwalia).
The High Court in the case held that shareholder claims against a company for misleading conduct would rank equally with claims by unsecured creditors in an external administration; a decision which has attracted significant controversy. The Federal Government responded to submissions from financiers and insolvency practitioners for a change in the law by commissioning its independent adviser, CAMAC, to review the issue.
Whilst recognising that the decision has significant implications, particularly for corporate lenders and the conduct of external administrations, CAMAC has not recommended any action to overturn the Sons of Gwalia decision. However, CAMAC members were notably divided in their individual views regarding the decision.
Corporate Law Minister Nick Sherry said that 'the Government would closely examine CAMAC's recommendation', but it remains to be seen which aspects of the committee's recommendations will be adopted.
We consider below certain of the implications for the market if the Sons of Gwalia decision stands.
ENHANCED INVESTOR CONFIDENCE
The issue of how shareholder claims should rank in an external administration or liquidation arose against a backdrop of moves over the last few years towards greater rights of action for investors against companies and their officers in relation to corporate misconduct.
Under the Corporations Act 2001 (Cth), generally, any debts due to shareholders of a company (in their capacity as such) are subordinated to claims of other creditors. This arguably reflects the distinction between equity investors, who accept risk in return for potential dividends, capital growth and the power to appoint directors to run the company, with trade creditors who simply provide services for a fixed sum without control over the company or potential upside.
However, in Sons of Gwalia, the High Court drew a distinction between shareholder claims with respect to matters such as misleading conduct which stem from investor protection provisions, which it considered should rank equally with unsecured creditors, and shareholder claims that arise 'in its capacity as a member' (eg rights to dividends), which are subordinated.
In reviewing the decision, CAMAC considered that the introduction of corporate misconduct laws and strengthening of continuous disclosure provisions in the recent past would be undermined if the decision was reversed. CAMAC noted that all things being equal, prospective investors will be more likely to invest in the share market where they feel they have a meaningful remedy should the companies they invest in not make proper disclosure to the market. The effects of misleading disclosure are most often felt in an insolvency situation. Therefore, if such claims were subordinated to other creditors, in practice there would be no real prospect of recovery for investors.
Accordingly, CAMAC considered that the Sons of Gwalia ruling should increase investor confidence in the equity market, which may result in much needed increased liquidity.
CORPORATE DEBT MARKETS
In issuing its report, CAMAC acknowledged that the Sons of Gwalia decision could impact on borrowing costs and limit lending in an already very tight credit market due to the risk of shareholder claims competing with lenders' unsecured claims in the event of insolvency. In particular:
- companies may have difficultly procuring unsecured finance, which may limit the ability of financially stressed companies to implement successful reorganisations or work-outs;
- lenders may impose onerous restrictions or charge higher interest on financing and are more likely to seek security in the form of fixed or floating charges over company assets; and
- unsecured debt capital in overseas corporate bond markets may become more expensive or harder to attain for Australian companies as investors may be increasingly reluctant to invest in Australian corporate bonds due to the reduced prospect of recovering their debt in an insolvency situation.
Trade creditors may also be less willing to extend credit to listed companies (who are most likely to be the subject of shareholder actions) or may push for retention of title clauses given the potential reduced recovery in the event of insolvency. If they aren't in a position to negotiate these protections, such creditors may experience greater exposure due to an inability to safeguard their interests.
IMPLICATIONS FOR EXTERNAL ADMINISTRATION
Again, CAMAC recognised in its report that the inclusion of shareholder claimants as unsecured creditors will have implications for the complexity of external administrations. The voluntary administration process is intended to provide a quick, efficient procedure to allow an administrator to recommend whether a company will be in a position to trade out of its difficulties, should execute a deed of company arrangement to restructure the company's debts or should be wound-up. Insolvency practitioners consider that this process could be severely impacted by the additional time and cost incurred in determining the validity and value of what can be complex claims for damages with respect to corporate misconduct. In addition, there are concerns that large numbers of shareholders involved in such claims may play a disproportionately influential role at creditors' meetings during voluntary administrations.
Whilst shareholder claims have not been very prevalent in the past and are likely to be largely confined to listed companies, litigation funders such as IMF have noted they expect to see an increase in class actions, such as those launched against Centro Properties Limited, Westpoint and the potential actions against Octaviar Limited (formerly MFS Limited) and ABC Learning Centres Limited due to the current economic climate and the corresponding increase in corporate collapses. A decision by the Government not to overturn Sons of Gwalia would doubtless fuel this movement.
The existence of potential unquantified shareholder claims, which rank equally with unsecured creditors, may also indirectly increase the number of external administrations as such claims may limit the prospects of companies seeking to complete a corporate workout. This may result in companies being pushed into voluntary administration due to insolvency risks and directors' concerns about personal liability for insolvent trading.
In order to address some of these issues, CAMAC has recommended the introduction of certain administrative measures to streamline the process for assessment of shareholder claims including:
- the use of a standardised proof of debt form for shareholder claims to assist administrators make a 'just estimate' of the value of the claims;
- giving courts general powers to make orders in a liquidation, extending to the determination of shareholder claims and the conduct of creditors' meetings; and
- the introduction of a rebuttable presumption whereby judicial determinations regarding questions of fact common to shareholder claims apply to later proceedings.
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