Insolvency: The outcome of the Sons of Gwalia case is good news for shareholders, but it can cause uncertainty in insolvency administration, writes John Purcell.
The facts of the case
Sons of Gwalia was a publicly listed gold mining company to which external administrators were appointed on 29 August 2004. Eleven days earlier on 18 August 2004, Luka Margaretic had bought 20,000 shares in Sons of Gwalia at a cost of $26,200. However, it was concluded that the company was not at this time a going concern and the shares in the company were thus worthless.
Margaretic alleged that Sons of Gwalia had breached the ASX listing rules by failing to advise the ASX that its gold reserves were insufficient to meet its gold delivery contracts, and that he should thus be compensated by the company by virtue of its breach of misleading and deceptive conduct provisions contained variously in each of the following statutory provisions:
Section 52 of the Trade Practices Act 1974
Section 1041H of the Corporations Act 2001
Section 12DA of the Australian Securities and Investments Commission Act 2001.
Margaretic succeeded in his claim in the Federal Court of Australia and then before the High Court. It's noteworthy that there were many other shareholders of Sons of Gwalia who had similar claims.
The essential legal question
Given the insolvency of Sons of Gwalia, the principal issue dealt with in the appeal before the Full Federal Court and then the High Court, was whether any assumed liability owed by Sons of Gwalia to Margaretic was in his capacity as a member of the company rather than as a general creditor. The outcome of the case thus turned on the construction given to s563A of the Corporations Act 2001, which says:
'563A 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.'
In essence, the legal question relates to whether the law enables the distinguishing of different types of debt owed by a company to a person who is a member, and whether in turn, debts arising not in the nature of the person's capacity as a member are free to be proven in an insolvency (s553) and, most significantly, to rank pari passu (equal and rateable) along with other unsecured creditors (s559).
In these terms three aspects of Margaretic's claim are noteworthy:
The amount of the claim was based on the market price of the shares rather than in relation to any amount of paid-up capital on the shares that Margaretic had purchased. The quantum of the damages sought corresponded to Margaretic's financial outgoing rather than to any presumed underlying capital value.
Consistent with the basis of the claim, in relation to the directors of Sons of Gwalia's alleged breach of statutory based standards of misleading and deceptive conduct, there was no contract between Sons of Gwalia and Margaretic concerning the purchase of the shares.
The operation of s563A was acknowledged as being temporal in nature, lasting only for a time. Therefore, had Margaretic on-sold the shares, any further claim would no longer be made by Margaretic in his capacity as a member, to which the constraint alleged to apply by virtue of s563A would apply.
The analysis and conclusions of the High Court
The appeal by Sons of Gwalia was heard by the full bench of the High Court. The decision in favour of Margaretic dismissing Sons of Gwalia's appeal was given by a six-to-one majority (Justice Callinan dissenting). Key aspects of the majority's decision are summarised below.
Justices Gleeson and Crennan
It was concluded that s563A did not embody a general policy that, in an insolvency, members always come last. On the contrary, when properly construed, s563A rejected such a general policy by distinguishing between debts owed to a member in the capacity as a member and debts owed to a member otherwise than in this capacity. In these terms, s563A requires an analysis of, and a distinction to be drawn between, those claims made in the capacity of a member and such persons' other claims. It was thus insufficient to merely describe the effect on other creditors.
Justice Gummow
There could not readily be discerned why an action for damages should be inconsistent with the features of a contract by which the shares were acquired. While such contract of purchase may require the shareholder to contribute to pay the company's creditors in the eventuality of insolvency, this of itself was not determinative of whether that shareholder could be a creditor whose debt is not due in the capacity as a member. Additionally, there was nothing discerned in s 563A that would prevent the fraud of the directors being imputed to the company, so that the rules in respect of the responsibility of a principal for the frauds of an agent were preserved.
Justice Kirby
Based upon the proper rules of statutory construction as the means of ascertaining the legislative command of parliament, s563A could not give rise to any general presumption of a general subordination of shareholder claims on the assets to the claims of general creditors. Hence it is not every 'debt' owed by the company to a person who is a member that is postponed.
Thus, when applied to the facts of a case, the identity of the claimant is not the chosen criterion for the postponement, the criterion instead is addressed to the character and incidents of the 'debt'. Turning to the statutory expression 'whether by way of dividends, profits, or otherwise', such 'debts' are discerned to be in the nature of ordinary revenue (and indeed possibly capital) and thus do not extend to claims of an extraordinary and exceptional kind arising out of false and misleading conduct.
Justices Hayne and Crennan
The obligation that Margaretic was seeking to enforce, and the basis of the cause of action, was founded in Sons of Gwalia's contravention of various statutory prohibitions against engaging in misleading or deceptive conduct, breach of which gave rise to a liability on the part of the company to compensate those who have suffered loss or damage. Similarly, through application of the related general law obligation of the tort (civil wrong) of deceit, such a claim stood altogether separate from any obligation owed by the company to its members created by the Corporations Act 2001.
The way forward
The decision, which makes it easier for shareholders in an insolvency to recover funds in circumstances where they were induced to acquire the shares through misleading conduct, could arguably cause uncertainty and complexity in insolvency administration. More generally, it further erodes the capacity for recovery by unsecured creditors, with whom shareholders who have such claims now rank equally. The then parliamentary secretary to the treasurer, Chris Pearce MP, referred the matter to the Corporations and markets advisory committee (CAMAC), the government's peak advisory group on corporate law development, seeking consideration of the following questions:
Should a shareholder, who acquired shares as a result of misleading conduct by a company prior to its insolvency, be able to participate in an insolvency proceeding as an unsecured creditor for any debt that may arise out of that misleading conduct?
If so, are there any reforms to the statutory scheme that would facilitate the efficient administration of insolvency proceedings in the presence of such claims?
If not, are there any reforms to the statutory scheme that would better protect shareholders from the risk that they may acquire shares on the basis of misleading information?
Among the various matters canvassed by CAMAC the following three key options are presented:
Option 1: Retain the current law, as determined in the light of the High Court decision.
Option 2: Amend the Corporations Act to reverse the effect of the law as determined in the High Court decision.
Option 3: As per Option 2, with an internal ranking of shareholder claims.
John Purcell is CPA Australia's policy adviser, corporate regulation
