The Media World Communications decision and debt capital markets

There has been considerable speculation amongst investors in the Australian debt capital market regarding the recent decision of Justice Finkelstein in the Federal Court of Australia of Crosbie (in his capacity of administrator of Media World Communications Ltd (administrator appointed) and Media World Broadcasting Pty Ltd (administrator appointed)) v Naidoo.

The decision does not, as suggested by some, upset the long established principle that on a winding up shareholders are subordinated to the interests of unsecured creditors. It was limited to whether a shareholder with a claim against a company in administration is entitled to attend a meeting of creditors.

The Court applied the existing law in holding that a subscribing shareholder with a claim against the company is not a creditor.

The Court also expressed a non-binding view that a transferee shareholder with a claim against the company is a creditor on a company's administration. This is the same as the position in the United Kingdom.

In this briefing we consider the decision and some of its implications.

The facts

The application to the Court was made by the administrator of Media World Communications Ltd ("MWC"). A number of MWC shareholders had made claims against MWC, alleging that they were induced into subscribing for shares in MWC through a false prospectus and had they known the real position they would not have subscribed. The administrator sought instructions from the Federal Court whether the subscribing shareholders making the claims against MWC could be treated as "creditors" of MWC for the purpose of a proposed meeting to consider a deed of company administration for MWC.

The decision

The Court noted that for the purposes of an administration, the expression "creditor" is to be given its meaning in section 553(1) of the Corporations Act - that is, a "creditor" is a person who at the commencement of the administration has a debt or claim against the company which is "present or future, certain or contingent, ascertained or sounding only in damages".

Based on longstanding English and Australian authorities, the Court reaffirmed the principle that a subscribing shareholder cannot recover damages against a company on the grounds that they were induced to subscribe for their shares by fraud or misrepresentation, if the shareholder has not rescinded the contract under which the shares were acquired.

The Court held that the shareholders had not rescinded their contracts to subscribe shares in MWC and were unable to do so during the administration (and would be unable to do so during a winding-up). Accordingly they were unable to bring an action against MWC based on any false statement in the prospectus and therefore were not creditors of MWC for the purposes of the administration provisions of the Corporations Act.

The afterthought - transferee shareholders

At the request of the administrator, the Court went on to consider the position of shareholders who acquired MWC shares in the open market on the basis of the false prospectus. The Court did so even though the point was moot, as no such member had made such a claim. The Court expressed a non-binding opinion that transferee shareholders could be treated as creditors for the purpose of the administration.

Implications for capital markets investors

The implications of the case have been sensationalised in some quarters.

The decision was limited only to determining the "creditors" of a company for the purposes of its administration. The decision is not relevant to the general statutory subordination of shareholders to creditors if ultimately the company leaves administration and is wound up. Accordingly, the case does not stand for the proposition, as suggested by some, that shareholders may now prove as unsecured creditors in the winding-up of a company. Rather, the decision clarifies who can attend a meeting of creditors when it is in administration.

The case is not contentious in relation to the conclusion that the shareholders who subscribed on the basis of an allegedly defective prospectus cannot be categorised as "creditors". This result is based on an old English decision, which had long been accepted in Australia. Interestingly, the relevant English case has been overturned by legislation in the UK so such shareholders are now entitled to be treated as creditors in the UK. In this respect, therefore, the Australian position is more favourable for the other unsecured creditors than in the UK. The Australian position is also the same as under section 510 of the US Bankruptcy Code.

The opinion expressed by the Court regarding the shareholders who acquired their shares in the secondary market was based on an English House of Lords decision in Soden v British Commonwealth Holdings plc. The position, therefore, that they could be treated as creditors for the purposes of the administration is the same in both Australia and the UK. Since the date of Soden's case there have been a number of major overhauls of the insolvency laws in the UK. If the decision was considered problematical in the UK it is likely that it would have been legislatively overridden, but it has not been. In the UK, Soden's case is also authority for the proposition that the claims of transferee shareholders can be proved as the claims of unsecured creditors in a winding-up. However, Soden's case was not cited in this context in the MWC decision.

From the perspective of the other unsecured creditors of a company, the Australian position is therefore no worse than in the UK. In fact it is better, as the claims of subscribing shareholders cannot be taken into account for determining the creditors of the company in administration.

If the view expressed by the Court is correct, the transferee shareholders who have a claim against the company can attend and vote at a creditors' meeting while the company is in administration. The practical effect may be to make it more difficult to achieve agreement amongst creditors on a deed of company arrangement, particularly if the deed is not acceptable to these shareholders in respect of their claims. If agreement cannot be reached, the company will then go into liquidation and the usual statutory subordination rules will apply (which are not affected by the decision).

If the view of the Court in relation to the position of transferee shareholders can be regarded as new and contentious, it is important to appreciate that this was only an observation by the relevant judge. It is not binding on any other court and represents only the opinion of one judge in one court.

While shareholder claims for misleading conduct against their company are common in the United States, it is important to appreciate that they are less so in Australia. Accordingly, it is unlikely that the fact situation in the MWC decision will be a common feature of future insolvencies in Australia.

Finally, securitisation investors also should have little concern with the decision. The share capital in Australian corporate securitisation issuers is only nominal and is issued, typically, to a charitable trustee. Therefore there is little prospect of a similar issue arising in their context or having any substantive effect. Further, the typical non-petition language in securitisation programme documentation should preclude such issuers from going into administration.