Introduction
The decision of the High Court in Sons of Gwalia Ltd (Subject to Deed of Company Arrangement) v Margaretic & Anor [2007] HCA 1 (Sons of Gwalia) has sparked significant debate as to whether shareholder claims against a company should be postponed until the claims of the company's ordinary creditors have been satisfied.
Despite the passage of almost 3 years since the decision was handed down, and the publication of a report by the Corporations and Markets Advisory Committee (CAMAC) in which CAMAC stated that it was not convinced of the need for change, the Federal Government announced on 19 January 2010 that it would amend the Corporations Act 2001 (Act) to reverse the effect of Sons of Gwalia. These amendments are expected to be introduced into Parliament in the first half of this year. In light of the challenges presented by the global financial crisis, this legislative amendment comes at an opportune time and will improve the accessibility of debt financing and ensure that Australia's external administration processes are more efficient and cost-effective.
The Decision
One of the key issues before the Court in Sons of Gwalia was the interpretation of section 563A of the Act. This section specifies that:
This section clearly contemplates that, where a company is subject to external administration, the payment of certain debts owed to members of the company will be postponed until those debts owed to persons who are not members of the company have been satisfied. However, this raises the question of whether section 536A results in the postponement of all debts owed to members of the company, or whether it only results in the postponement of certain debts owed to members. The High Court considered this question in the context of a claim brought by a member, Margaretic, against a publicly listed gold mining company, Sons of Gwalia Ltd.
On 18 August 2004, Margaretic purchased 20,000 shares in Sons of Gwalia Ltd at a cost of $26,200. Merely 11 days later, on 29 August 2004, administrators were appointed to the company and it appeared that, at that time, the shares in the company were worthless. Margaretic alleged that, in breach of the company's continuous disclosure obligations, the company had failed to notify the ASX that its gold reserves were insufficient to meet its delivery contracts and therefore could not continue as a going concern. Margaretic alleged that he was a victim of misleading and deceptive conduct and was therefore entitled to compensation.
The critical question before the Court was whether Margaretic's claim against the company was properly characterised as a claim which arose in Margaretic's capacity as a "member" of the company (and should therefore be postponed in accordance with section 563A of the Act), or whether Margaretic's claim arose in Margaretic's capacity otherwise than as a member and that (because 563A would not apply) his claim would therefore rank equally with other unsecured non-member creditors.
By a 6-1 majority, the High Court held that Margaretic was not claiming in his capacity as a member of the company and that, accordingly, section 563A did not result in the postponement of his claim. The Court stated that:
- section 563A did not embody a general principle that "members come last" in an insolvency; and
- the critical factor is the "character" of the debt and not the identity of the claimant.
In relation to the latter point, Kirby J stated that where a member claims against the company for "debts" such as dividends or profits, the member is making that claim in his or her capacity as a member. However, where a member claims that he or she has been misled by the company and is entitled to compensation, that claim does not arise by virtue of the member's status as a member. Such a claim could be brought even if the member had ceased to be a member at the time the claim was made or if the member's name was not entered into the company's members register. Accordingly, the claim is independent of any of the members' rights or obligations as a member of the company.
The Court's decision in Sons of Gwalia has made it clear that section 563A does not result in the postponement of all claims which a member can bring against a company. Instead, section 563A only postpones those claims which members bring against a company in their capacities as members. This interpretation has opened the door for members, who have been misled or deceived as Margaretic had been, to have their claims rank equally with those of the ordinary unsecured creditors of the company.
Reversing the Decision
While Sons of Gwalia has provided an important degree of clarity regarding the operation of section 563A, the intense debate following the decision has raised the question of whether the decision be allowed to stand or should it be reversed by legislative intervention.
In its December 2008 report entitled "Shareholder Claims against Insolvent Companies: Implications of the Sons of Gwalia decision", CAMAC stated that its members, as a whole, were not persuaded of the need for change. CAMAC recognised, as the Court did in Sons of Gwalia, that the case arose in the context of intensifying corporate regulation which required companies to comply with rigorous disclosure obligations while simultaneously arming members with rights of action against companies and their officers where corporate fraud or misconduct has occurred. As such, the Court's decision to recognise the availability of an additional "remedy" to members such as Margaretic was consistent with these changes in corporate regulation.
CAMAC also considered that:
- submissions that the risks adopted by investors (when purchasing shares in companies) include the risk of corporate fraud or misconduct are contestable;
- in some large listed companies, investors have limited power to direct the company and practically may have no more power than creditors. These investors should, therefore, be afforded a comparable level of protection in an insolvency situation; and
- the issues which arose in Sons of Gwalia are only likely to arise in certain circumstances. Claims of the type described in Sons of Gwalia are only likely to arise in the external administration of publicly listed entities. Further, the decision does not affect shareholders who have or intend to bring claims in their capacities as shareholders (it merely reinforces that, by virtue of section 563A, these claims are postponed until the claims of ordinary unsecured creditors are satisfied).
Despite CAMAC's position in respect of Sons of Gwalia, the Minister for Financial Services, Superannuation and Corporate Law has stated that "any direct benefits to aggrieved shareholders arising from non-subordination are outweighed by the negative impacts on shareholders generally as a result of the restrictions on access to, and increases in, the cost of debt financing for companies". These "negative impacts" can arise where lenders demand better security and lend money to corporations on more stringent terms in order to protect themselves against the risk that (in the event that the company becomes subject to external administration) their claims may be diluted by the claims of aggrieved shareholders. These measures can result in an increase in the cost of obtaining finance and may restrict a company's ability to access this finance.
The Minister also stated that the decision has the potential to adversely impact upon "business rescue procedures" and increase the cost and uncertainty associated with external administrations. By permitting the claims of aggrieved shareholders to rank equally with those of unsecured creditors, external administrators are likely to incur further (and in some cases, significant) costs to consider and adjudicate upon these shareholder claims. In circumstances where there is a high volume of shareholder claims or where these claims are particularly complex, the efficiency and cost-effectiveness of the external administration process can be reduced.
While the proposed reversal of Sons of Gwalia may be inconsistent with the recent trend in corporate regulation in Australia, the intervening global financial crisis has arguably changed the necessary focus of this regulation. In the wake of the global financial crisis, it is important that Australia's external administration procedures are as efficient as possible and that any restrictions upon a company's ability to obtain debt finance (including the cost of obtaining such finance) are relaxed. Accordingly, it is in the interests of the Australian economy as a whole that the Court's decision in Sons of Gwalia be reversed to facilitate efficient and cost-effective external administrations and reduce the cost of obtaining debt finance in an environment where the cost of debt is already high.
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.