Legislative response to the 2007 High Court of Australia's decision in the Sons of Gwalia case | Practical Law

Legislative response to the 2007 High Court of Australia's decision in the Sons of Gwalia case | Practical Law

This article is part of the PLC Global Finance July 2010 e-mail update for Australia.

Legislative response to the 2007 High Court of Australia's decision in the Sons of Gwalia case

by Richard Mann and Nigel Clark, Minter Ellison
Published on 29 Jul 2010 • Australia
This article is part of the PLC Global Finance July 2010 e-mail update for Australia.
Speedread

Speedread

In 2007, the High Court of Australia in Sons of Gwalia v Margaretic decided that the claims of a shareholder against a company for misleading and deceptive conduct by it which resulted in the shareholder purchasing shares in the company were not subordinated to the claims of unsecured creditors or the company. This controversial decision ran contrary to the widely accepted view that Section 563A of the Corporations Act 2001 (Cth) postponed debt claims owed by a company to a person in his or her capacity as a member of that company, until all other debts or claims against the company are satisfied. In a recent development, however, the Commonwealth Government has now announced that it will legislate to abolish the general law principle established in the Sons of Gwalia decision. New legislation amending the Corporations Act has been introduced to the Commonwealth Parliament and considered without comment by the Senate Economics and Legislative Committee.
In 2007, the High Court of Australia in Sons of Gwalia v Margaretic (2007) 81 ALJR 525: [2007] HCA1 decided that the claims of a shareholder against a company for misleading and deceptive conduct by it which resulted in the shareholder purchasing shares in the company were not subordinated to the claims of unsecured creditors or the company.
This decision caused some controversy, being contrary to the widely accepted view that Section 563A of the Corporations Act 2001 (Cth) postponed debt claims owed by a company to a person in his or her capacity as a member of that company, until all other debts or claims against the company are satisfied. Section 563A currently states that "payment of a debt owed by a company to a person in the person's capacity as a member of the company, whether by way of dividends, profits or otherwise is to be postponed until all debts owed to, or claims made by, persons otherwise than as members of the company have been satisfied."
Market and commentator response to the decision, which potentially elevated a new body of claimants to the same level as unsecured creditors, was that it could:
  • Be detrimental to the efficiency of insolvent administrations (as shareholder claims, especially relating to misleading conduct, were deemed more expensive and time consuming to assess).
  • Spark an increase in class action litigation.
  • Deter lenders from lending, and increase capital funding costs generally by creating return risk uncertainty.
Particular concerns were raised by US lending market participants for three reasons. First, they are accustomed to shareholders claims being legislatively deferred (since 1978). Secondly, US lenders are more sensitive, through longer and deeper experience, to the possibility of shareholder class actions. Thirdly, concerns were raised in relation to the effect on the corporate bond market (particularly US bond issues) as bonds are typically unsecured and subordinated.
In 2008, the Commonwealth Government commissioned its Corporations and Markets Advisory Committee (CAMAC) to review the Sons of Gwalia decision in the light of the market response. In January 2009, CAMAC decided that the decision should not be overturned by legislation preferring to uphold a decision which promotes the rights of shareholders in distressed companies and the investor empowerment principles which have grown in Australian legislative and regulatory primacy in recent years.
In a new development, however, the Commonwealth Government has now announced that it will legislate to abolish the general law principle established in the Sons of Gwalia decision that shareholders claims for compensation are not subordinated to the claims of ordinary unsecured creditors. New legislation amending the Corporations Act has now been introduced to the Commonwealth Parliament and has been considered without comment by the Senate Economics and Legislative Committee.
Of interest are the statements of key impacts in the explanatory memorandum to the new bill, which states that the bill should:
  • Facilitate the provision of credit to companies and reduce the risk premiums charged.
  • Improve the efficacy of external administrations by reducing costs.
Key features of the amendments are:
  • A new section 247E in the Corporations Act 2001 (Cth) will be enacted, confirming that a person is not prevented from obtaining damages or other compensation from a company simply because they are a shareholder. In other words, the reform does not abolish what have come to be called Sons of Gwalia style claims.
  • Instead the claims are subordinated. Section 563A will be repealed and a new provision inserted to the effect that the payment of a 'subordinate claim' is to be postponed until all other claims made against the company are satisfied. A 'subordinate claim' is defined as a claim for a debt owed by the company to a person in the person's capacity as a member of the company or any other claim that arises from a person buying, holding, selling or otherwise dealing in shares in the company.
  • The shareholders affected are entitled to receive copies of notices, reports or statements to creditors which they must ask for in writing. They can only vote at a creditors' meeting if they first obtain a court order (new section 600H).
  • The amendments are not retrospective. They will only apply where the shareholders' claim arises after the amendments come into effect. This means they will not apply to current administrations. The rights of shareholders to participate as creditors noted in the previous paragraph will apply to all future administrations. The claims will only be subordinated where the conduct giving rise to the shareholders' claim occurred before the amendments came into effect (section 4 of the Bill). This means that on the question of subordination, the previous law will continue to apply to all current administrations, and it will apply in future administrations where the shareholders' claim arises through actions that occurred before the amendments came into effect.