Are misled shareholders now to be treated equally with ordinary creditors in an insolvency? The High Court has recently answered this question in the affirmative.
BACKGROUND
Luke Margaretic had the misfortune to purchase shares in Sons of Gwalia (“SOG”) a few days before that company went into voluntary administration which rendered his shares worthless. Margaretic made a claim against SOG for damages on the grounds that the company had breached its continuous disclosure obligations and, by reason of the non-disclosure, had engaged in misleading and deceptive conduct.
ISSUE FOR THE HIGH COURT
The High Court had to consider Section 563A of the Corporations Act which confirms the long held legal doctrine that when a company is insolvent, debts owed to a shareholder in their capacity as a shareholder are postponed to all other debts of the company i.e a claim by a shareholder stands behind all other debts owed by the company.
The essential question for the High Court was whether Margaretic’s claim was to rank equally with other creditors of that company or was to be postponed to its “non-member” creditors under SOG’s deed of company arrangement.
THE DECISION
The High Court has now ruled by a majority of six to one that Margaretic was to be treated as a creditor of SOG and that, if proved, any claim which he may have against SOG was to rank equally with its other creditors.
The majority held that Section 563A of the Corporations Act did not operate to postpone the debts owed to shareholders with claims against a company for misleading or deceptive conduct. The misleading and deceptive conduct engaged in by SOG was its failure to keep the market fully informed in relation to its financial position (i.e its continuous disclosure obligation). Shareholders with such claims were not owed debts in their capacity as members of the company. Rather, they were seeking to enforce against the company remedies to which they were entitled under various statutes providing protection to consumers and investors.
It is important to keep in mind that not all shareholders will be able to recover as creditors. Not all companies that become insolvent necessarily mislead or deceive their shareholders. Further, even where misleading or deceptive conduct has occurred, each individual shareholder has the onus of proving that the company engaged in unlawful conduct and that conduct led to his or her loss or damage.
IMPACT ON INSOLVENCY ADMINISTRATIONS
Much concern has been expressed that the decision has created immense practical problems for current insolvency administrations and future administrations. Liquidators and administrators are likely to incur additional costs and delays assessing whether to admit proofs in respect of shareholder claims, and in dealing with challenges to their decisions.
Litigation funders will also now have an added string to their bow to bring class actions against insolvent companies.
The precedent set by the SOG decision is likely to result in claims being filed in future on behalf of both on-market buyers and subscribers. The pool of assets previously thought to be available for creditors will now be shared with all classes of misled shareholders, thereby diluting the return available to ordinary creditors.
Overall, the general management of insolvency administrations will clearly be made more difficult.
LIKELY FUTURE DEVELOPMENTS
In response to the SOG decision, the federal government on 7 February 2007 referred the issues raised in that decision to the Corporations and Market’s Advisory Committee (“CAMAC”) for review.
Considerable debate has also raged in the financial press since the SOG decision was handed down by the High Court. The dominant view among commentators is that the traditional status of shareholders should prevail upon an insolvency i.e shareholders who can participate in the “upside “ of a company’s performance should have greater exposure to the “downside” than unsecured creditors (usually suppliers) who have no such ability to participate in gains generated by the company. Shareholders, it is argued, should therefore rank behind unsecured creditors upon insolvency.
Without wishing to be seen as predicting the outcome of CAMAC’s review, it is our opinion that legislation will be introduced which will ensure the traditional status of shareholders is restored.
If you would like any further information in relation to this decision, please do not hesitate to contact at EKM legal on 9829 0999.
