31 January 2007
Sydney, 31 January 2007: Creditors of failed businesses face a setback following a High Court decision this morning.
The High Court's ruling in the long-running Sons of Gwalia case has the potential to reduce the amount of money available to pay an insolvent company's creditors. It may also allow shareholders of insolvent companies to block repayment or reconstruction plans designed to help the company's creditors and employees.
According to insolvency law specialist David Cowling, this interpretation of the Corporations Act completely changes a long-time understanding of how corporate law works.
Mr Cowling, a partner with law firm Clayton Utz, says it has always been accepted that if a company becomes insolvent, shareholders take a back seat to its creditors and employees.
"That's always been the deal," Mr Cowling says. "While the company is a going concern, shareholders share in its profits without any personal liability for its debts. In return for that upside, they accept that, if the company goes broke, the money they've invested in the company is used to pay its creditors and its employees."
In Sons of Gwalia, the High Court has now ruled that shareholders should, in certain circumstances, be treated as creditors. A shareholder who claims to have been misled into buying shares in a company on the stockmarket may be able to claim any loss in the value of his shares. This decision is similar to a 1998 House of Lords decision in England.
"This is a serious concern for the suppliers and employees of failed companies, for two reasons," says Mr Cowling.
"The first is that allowing shareholders to lodge a claim for repayment of their investments will reduce the pool of funds available to pay out the company's trade creditors.
"The second reason is that shareholders will be able to form a voting block against any proposal that isn't in their interests."
Mr Cowling points out that insolvent companies often enter into reconstruction arrangements with their creditors. Trade creditors may favour a reconstruction, because it is in their business interests as a customer to keep the company alive.
"The company's shareholders have no such interests. They can invest in any company they want, so their only concern will be squeezing as much cash out of the company as quickly as they can. They're unlikely to want to hang around to support the company over the long term.
"This gives them the ability to use their voting power against any reconstruction proposals. It won't take a particularly canny insolvency administrator to work out that the only way to overcome this will be the risk of a court fight with the shareholders ... or the quicker route of a sweetener to the shareholders.
"Whichever option is taken, there may be an adverse impact on the small businesses who supplied the company with goods and services and the employees who work for it."
Mr Cowling says the issue is now one that can only be addressed by an amendment to the Corporations Act.
