The decision of the High Court of Australia in Sons of Gwalia v Margaretic (2007) 231 C.L.R. 160 (“Sons of Gwalia”) needs no introduction. The high-profile and controversial decision of Australia’s highest Court altered the principle of subordination of shareholder claims to allow the claims of a shareholder in respect of losses caused by misleading and deceptive conduct of the company to rank pari passu with the claims of general unsecured creditors. Consequently, the decision had potentially far-reaching implications for creditors of Australian public companies.
Debt investors with an interest in Australia should take note that help appears to be on the horizon. On April 23, 2010, the Government released an exposure draft of the Corporations Amendment (No.2) Bill 2010 (the “Bill”) and explanatory memorandum. The Bill proposes amendments to the Corporations Act 2001 (the “Australian Act”) that are designed to overcome Sons of Gwalia. The key amendments are summarised below.
Postponing Subordinate Claims
The Bill seeks to repeal the current section 563A of the Australian Act and to substitute it with language that makes it clear that payment of a “subordinate claim” against a company is postponed until “all other claims” made against the company are satisfied.
The new provision expressly defines “subordinate claim” as (i) a claim in respect of a debt owed to a person in their capacity as a member of the company (by way of dividends, profits or otherwise) or (ii) any other claim “that arises from a person buying, holding, selling or otherwise dealing in shares of the company.” The broad definition is designed to eliminate the distinction drawn by the High Court in Sons of Gwalia between different types of shareholder claims so that all shareholder claims are subordinated to the claims of creditors. It has been suggested by some commentators in Australia that the definition might extend to derivative shareholder claims such as cross claims brought by the insolvent company’s auditors, although ultimately the precise scope of the definition will not be known until the legislation is implemented and tested before the Courts.
Voting and Information Entitlements
As a flow-on effect of Sons of Gwalia, shareholders with relevant claims against an insolvent company were entitled to be treated in the same manner as creditors for the purposes of receiving communications from the insolvency practitioners appointed in the relevant insolvency administrations, including communications for voting purposes. In consequence, such claims had the potential to significantly complicate, delay and increase the costs of Australian insolvency administrations.
The Bill proposes that the Australian Act be amended so that a shareholder whose claim is subordinated under the new section 563A will not be entitled to receive communications in the insolvency administration unless it first makes a written request to the relevant insolvency practitioner. It further proposes that shareholders will not be entitled to vote in an insolvency administration without leave of the Court.
Abrogating the Rule in Houldsworth’s Case
In Houldsworth v City of Glasgow Bank (1880) 5 App. Cas. 317 (“Houldsworth’s Case”), the U.K. House of Lords held that shareholders were prohibited from proving in the winding up of a company in respect of damages for misrepresentation inducing the acquisition of their shares unless the contract pursuant to which the shares in question were purchased had been rescinded prior to the winding up.
In Sons of Gwalia, the majority of the High Court confirmed that the rule in Houldsworth’s Case did form part of Australian law (although it was held that the rule did not apply to the facts at hand in the Sons of Gwalia case) such that a shareholder’s claim for damages may be affected by the manner in which its shares were acquired and whether the shares were still held at the time of the winding up.
The amending legislation proposed by the Bill provides that a person will not be prevented from obtaining damages or other compensation from a company only because that person: (i) holds, or has held, shares in the company; (ii) has subscribed for shares in the company; or (iii) has a right to be included in the company’s shareholder register.
Whilst this amendment is not related to the subordination issue, it does clarify the previously murky issue as to which classes of shareholder are entitled to make a claim for damages in the context of a corporate insolvency.
The Bill is Not Retrospective
The proposed legislation will not have retrospective effect. The amendments will not come into force until the date upon which the Bill receives royal assent (the “Effective Date”). If the amendments are ultimately passed into Australian law, whether a shareholder’s claim for damages in respect of the misleading and deceptive inducement to purchase shares will be subordinated in an Australian insolvency administration will be determined by the date upon which the shareholder’s damages claim arose. If the shareholder’s claim against the company arises after the Effective Date, the new section 563A will apply and the claim will be subordinated to the claims of the company’s creditors. If the shareholder’s damages claim arose prior to the Effective Date, the principles in Sons of Gwalia will still apply. This will be the case even in circumstances where the company in question is placed into formal insolvency administration in Australia after the Effective Date.
Accordingly, the window remains open for shareholders with existing causes of action in respect of misleading and deceptive conduct by an insolvent entity to launch, or continue, class actions and to assert their rights within the insolvency process alongside unsecured creditors.
Timing and Concluding Remarks
While it is expected that the Government will seek to amend the Australian Act as soon as practicable, at present the likely Effective Date is unknown. The Government has called for any submissions in response to the proposed amendments by May 18, 2010.
It is submitted that the Bill is a welcome step towards achieving greater clarity and efficiency for stakeholders in Australian insolvency administrations and should assist in the promotion of liquidity in the Australian market.
This article was originally published by Bingham McCutchen LLP.