30 September 2005
Key Points:
The Sons of Gwalia decision has focussed attention on the respective positions of creditors and shareholders in corporate insolvencies.
The Federal Court decisions in the Concept Sports and Sons of Gwalia cases have highlighted the comparative legal treatment of creditors and shareholders, particularly in an insolvency situation.
Both cases both involved claims by shareholders for alleged misleading and deceptive conduct by their companies. However, they arose out of very different circumstances.
Concept Sports
Cadence Asset Management subscribed for shares in Concept Sports on the basis of a prospectus.
Cadence began an action for damages under section 729 of the Corporations Act. It claimed that the prospectus had contained misleading and deceptive profit forecasts.
Justice Finkelstein held that the action was barred by the rule in Houldsworth's case - a shareholder can only sue for damages for fraud or misrepresentation inducing his subscription for shares if he first renounces the contract under which he acquired the shares. In this case, Cadence had already sold the shares, so no rescission was possible.
He held Houldsworth's case applied to claims under section 729, and that no amendment to the Corporations Act had ever overturned Houldsworth's case in this respect. Justice Finkelstein also repeated an earlier comment (in last year's Media World case) that Houldsworth would not bar claims brought by shareholders who bought on market.
Sons of Gwalia
Mr Margaretic claimed to have bought shares in Sons of Gwalia on ASX on 18 August 2004.
Less than two weeks later, the directors of Sons of Gwalia appointed voluntary administrators.
Mr Margaretic argued that, at the time of his purchase, Sons of Gwalia was in breach of its continuous disclosure obligations under section 674 of the Corporations Act. As a result, Sons of Gwalia had engaged in misleading and deceptive conduct, so that he was entitled to compensation from Sons of Gwalia.
On 5 June 2005, the administrators officially announced that there was no likelihood that Sons of Gwalia ordinary shareholders would receive any distribution.
On 4 July, the administrators began Federal Court proceedings to determine whether Mr Margaretic could vote as a creditor in the administration and on a proposed deed of company arrangement.
The deed of company arrangement proposed by the administrators would allow for unsecured creditors to have their debts paid pro rata. However, under the deed of company arrangement:
"payment of any debts or liabilities owed by the Company to Members in the Members' capacity as a member of the Company, whether by way of dividends, profits or otherwise are, to the extent contemplated by Section 563A of the Act and the general law, to be postponed until all debts owed to, or claims made by, Creditors have been satisfied."
The administrators argued that the effect of this clause would be to postpone Mr Margaretic's claim to the claims of other "non-shareholder" creditors. In other words, Mr Margaretic would only be paid on his claim if all of the other unsecured creditors had been paid out in full.
The administrators' argument was that Mr Margaretic's claim was for a debt or liability "owed by the Company to Members in the Members' capacity as a member of the Company".
Justice Emmett approached this issue by looking at a series of English and Australian cases about unsuccessful attempts by shareholders to recover the price of their shares from the company.
Justice Emmett distinguished all of these cases, on the basis that they were concerned with shareholders who had bought their shares directly from the company. Mr Margaretic had bought his shares on market. This, in his Honour's view, meant that Mr Margaretic's claim against Sons of Gwalia was not a claim made in his capacity as a member of the company:
"I do not consider that the Shareholder's Claim is a debt owed by the Company to the Shareholder in the Shareholder's capacity as a member of the Company. If it is a debt at all, it is a debt arising as a result of the operation of the consumer protection provisions referred to above [such as s 52 of the Trade Practices Act], which prohibit misleading and deceptive conduct in various circumstances. Section 563A would not require postponement of that debt until debts owed to, or claims made by, persons otherwise than as members have been satisfied. It follows that the adoption of s 563A in the proposed deed of company arrangement would not require the postponement of the Shareholder's Claim in the course of the administration."
What does it all mean?
Upfront, there is one important point to be made about this development: these cases are going to be appealed, quite probably to the High Court. The High Court could simply put the genie back in the bottle, by ruling that all claims by shareholders are postponed to those of other creditors.
Against that, it should be noted that the Corporations Act and other legislation contain many provisions giving remedies to misled investors, so it's equally possible that the High Court could endorse the Sons of Gwalia decision (and maybe go further, by allowing all shareholders to claim, regardless of whether they acquired their shares on market or through a prospectus).
For the moment, therefore, players in this area should be alert, but not alarmed. Ultimately, if the High Court gives shareholders equal rights to claim with creditors in voluntary administrations and liquidations, there will be an impact both on the returns to creditors and, in some cases, the length of time that creditors will have to wait to receive a payment.
One important point to remember is that, even if shareholders' claims are given parity with other creditors, the number of shareholders who stand to benefit may be quite limited: simply claiming to have been misled doesn't give rise to any present liability on the part of the company. The company would only become liable if the claim was proved in court or if the company/administrator/liquidator reached an out-of-court settlement with the shareholder.
Where the claim is for misleading and deceptive conduct, the determination of a value for that claim is likely to be extremely time-consuming, unless the shareholder is willing to accept the liquidator's estimate of the value. This could mean that other unsecured creditors face the prospect of a delay in settlement of their claims, on top of the diminution in the amount of money available to meet those claims.
There have already been reports of calls for the Government to sort this situation out, by amending the Corporations Act. In reality, there is no way that the Act would be amended before the High Court has ruled on this issue. Even then, there is no quick fix. On the one hand, creditors would take the view that their already parlous position shouldn't be further compromised by giving shareholders a share of the asset pie. On the other hand, with every financial advice column and market commentator trumpeting the fact that Australia is becoming a nation of shareholders, who would want to tell Mum & Dad investors that they have no remedy against a company that misled them into buying its shares - especially given the new Superannuation Choice policy and the expected rise in the number of self-managed superannuation funds?
For further information, please contact David Cowling.
