Committee backs Sons of Gwalia ruling

A federal committee has endorsed a High Court decision related to the collapse of WA miner Sons of Gwalia that allows certain shareholders to rank equally with creditors.

The Corporations and Markets Advisory Committee released its report today after receiving a request for advice on the effect of the decision.

"While recognising that the decision has significant implications, including for providers of corporate debt finance as well as the conduct of external administrations, CAMAC has not recommended action to overturn its effect," CAMAC said.

In early 2007, the High Court upheld a Federal Court ruling following a claim lodged by Sons of Gwalia shareholder Luke Margaretic.

Mr Margaretic argued that the company had failed to notify the ASX of its inability to meet its sale contracts and thus he, as a purchaser of company shares, was a victim of misleading and deceptive conduct in contravention of the Trade Practices Act, the Corporations act and the Australian Securities and Investments Commission Act.

The court ruling overturned traditional arrangements with failed companies where shareholders had been ranked lower than secured creditors for damages.

Sons of Gwalia was one of Australia's largest gold miners and the world's biggest tantalum producer in the 1980s but collapsed in August 2004 owing more than $700 million after falling short of its gold hedge book commitments.

Today, CAMAC convenor Richard St John said the ruling reflects a significant shift in regulation and has "in effect turned shareholders into potential unsecured creditors as well".

"Any move to curtail the rights of recourse of aggrieved shareholders where a company is financially distressed could be seen as undermining legislative initiatives to provide shareholders with direct rights of action in respect of corporate misconduct," CAMAC said.

The Australian Bankers Association said today it was disappointed with CAMAC's report because it did not recommended overturning the High Court decision in the Sons of Gwalia case.

"Fortunately, the federal government still has the opportunity to consider this report and decide it's not in Australia's best interests," ABA chief executive David Bell said.

"The ABA still believes that urgent law reform is required to restore certainty to insolvency processes.

"We need to return to the legal position before the decision - namely that the claims of shareholders should rank behind debt in an insolvency."

Announcements by Senator Nick Sherry, Minister for Superannuation and Corporate Law and CAMAC are below:

NICK SHERRY

Senator Nick Sherry, Minister for Superannuation and Corporate Law, has today acknowledged the release of the report of the Corporations and Markets Advisory Committee (CAMAC) on the implications of the High Court decision in Sons of Gwalia v Margaretic [2007] HCA 1 (Sons of Gwalia).

The Sons of Gwalia decision reinterpreted a longstanding provision of the law, making it easier for shareholders to recover funds in insolvency proceedings where they were misled in the lead-up to a corporate collapse. The previous Government sought advice from CAMAC on the effects of the Sons of Gwalia decision in February, 2007.

"The Government recognises that the development of a response to the decision was a challenge given widely divergent views expressed by the business community. CAMAC has provided a carefully considered analysis of the Sons of Gwalia decision," Minister Sherry said.

The CAMAC report recommends that the current law, as reflected in the Sons of Gwalia decision, be retained and thus has important ramifications for shareholders, financiers, bankers, general creditors and insolvency practitioners.

"The Government is committed to ensuring that company laws afford optimal protection to investors and creditors. This includes the provision of a fair and efficient insolvency regime which addresses the consequences of business failure; treats creditors, investors and employees fairly and distributes assets of insolvent businesses among stakeholders in the fairest possible way."

"The Rudd Government believes Australian insolvency laws are among the best in the world and also appreciates that this matter is of considerable importance to the business community. The Government will closely examine CAMAC's recommendations for responding to the High Court decision in Sons of Gwalia," Minister Sherry said

CAMAC

The Corporations and Markets Advisory Committee (CAMAC) has released its report Claims by shareholders against insolvent companies: implications of the Sons of Gwalia decision (December 2008).

The report responds to a request for advice on the effect of the High Court decision in Sons of Gwalia Ltd v Margaretic [2007] HCA 1 (Sons of Gwalia).

While recognising that the decision has significant implications, including for providers of corporate debt finance as well as the conduct of external administrations, CAMAC has not recommended action to overturn its effect.

The High Court held, in effect, that a claim by a shareholder for loss to the value of shares caused by failure of the company to inform the market would rank equally with the claims of other unsecured creditors in an external administration. It was not a claim in the shareholder's 'capacity as a member of the company', which would be postponed behind claims by unsecured creditors.

While clarifying the law, it brought into focus the largely unanticipated conflict between the provision to shareholders of statutory remedies for corporate misconduct and the traditional notion of shareholder interests being postponed behind those of conventional unsecured creditors in a liquidation.

The Convenor of CAMAC, Richard St John, said:

The empowerment of shareholders to hold a company to account in damages reflects a significant shift in regulation. It has in effect turned shareholders into potential unsecured creditors as well.
The views of respondents to CAMAC's earlier discussion paper were polarised on the question whether the current position should be maintained or changed.
The Committee as a whole is not persuaded of the need for change in the legal position. Any move to curtail the rights of recourse of aggrieved shareholders where a company is financially distressed could be seen as undermining legislative initiatives to provide shareholders with direct rights of action in respect of corporate misconduct.

In effect, the facilitation of private remedies has added to the enforcement armoury, encouraging self-help by affected parties to complement the role of the regulators in relation to corporate disclosures. Shareholders and creditors share an interest in the promotion of an efficient and informed market.

The Committee acknowledges the possible consequences of Sons of Gwalia for companies seeking funds in the unsecured debt market and in the rehabilitation of financially distressed companies. The High Court decision has provided a measure of certainty and it is likely that changes have already occurred as the market has adapted to the legal environment.

The Committee recognises that shareholder claims may add to the complexity of corporate external administrations. It has proposed measures to assist with those claims :

a standardised proof of debt form for claims by aggrieved shareholders, which administrators may choose to use in making a 'just estimate' of the value of those claims
a rebuttable presumption that a determination in one proceeding of a question of fact common to other aggrieved shareholder claims applies in any subsequent proceedings
giving the court a general power to make orders in a liquidation, which would cover creditors' meetings and the determination of shareholder claims.

The Committee also provided advice on the following options if, notwithstanding its view, some change to the present position were considered necessary:
postpone all, or some, claims by aggrieved shareholders behind claims by conventional unsecured creditors
maintain those claims as creditor claims but subject them to a monetary cap
prohibit claims by aggrieved shareholders altogether.

The Committee's reasons for supporting the current position, and its approach towards the other policy options, are set out in the attachment.
CAMAC considered possible measures to assist aggrieved shareholders if their current rights, as recognised in Sons of Gwalia, were postponed. It did not favour the introduction, by legislation, of a fraud on the market principle (which would overcome the need to prove reliance on a corporate misrepresentation) in the context of claims by aggrieved shareholders against insolvent companies.

The report also recommended:

abrogation of the rule in Houldsworth's case, which in some cases prohibits claims by shareholders who have purchased shares from the company, rather than from a third party
that shareholders making claims as members of a company in liquidation, for unpaid dividends for example, should not, on that basis, receive information or be able to vote as creditors.

Copies of the Report
Click here to view or download the Report (PDF file, 535 KB)

To receive a bound copy, please send your postal details to: mailto:camac@camac.gov.au

Further information

For any further information, please contact John Kluver, Executive Director on (02) 9911 2950 or by email: mailto:john.kluver@camac.gov.au

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Attachment
Advisory Committee position

The issue that came to a head in Sons of Gwalia -- how claims for damages by aggrieved shareholders should rank in a voluntary administration or liquidation -- is one that called for resolution.
The issue arose in consequence of the move over recent years to provide shareholders and others with direct rights of action against a company, as well as against officers and others involved in the company's affairs, in relation to various forms of corporate misconduct. As shareholder claims of that kind emerged in relation to companies that became financially distressed, it was not clear whether those claims should rank alongside the claims of ordinary unsecured creditors or should be postponed in accordance with the provision -- s 563A -- which manifests the established principle that shareholders rank behind creditors in a winding up.

This is an area where certainty is required. The decision of the High Court -- while it may have surprised some and given rise to legitimate concerns -- has provided a useful measure of certainty about the legal position. While recognising a tension in underlying policy considerations, the Court held as a matter of statutory construction that claims by aggrieved shareholders for damages were not claims 'in their capacity as a member' that should be postponed. It followed that they should be treated on a par with the claims of ordinary unsecured creditors. Shareholders and those who extend credit to companies now know the position that will apply in the event of aggrieved shareholder claims in an external administration.

The question is whether the legal position as laid out by the High Court is appropriate as a matter of policy or whether overall it has adverse consequences that call for legislative intervention. The views of interested parties on this policy question are polarised. Strong arguments have been put forward for maintaining the current position on the one hand or postponing or limiting the claims of aggrieved shareholders in an external administration on the other.

Maintain the current position

While members were not of the one view, the Advisory Committee as a whole is not persuaded of the need for change.

The Committee notes that the issue has arisen in the context of a significant shift in Australian corporate regulation. The provision to shareholders and others over recent years of direct rights of action in respect of corporate misconduct, and the strengthening of the regime for timely and reliable corporate reporting, reflect clear legislative objectives.

The High Court itself noted that:

modern legislation ... has extended greatly the scope for 'shareholder claims' against corporations, with consequences for ordinary creditors who may find themselves, in an insolvency, proving in competition with members now armed with statutory rights. Corporate regulation has become more intensive, and legislatures have imposed on companies and their officers obligations, breach of which may sound in damages, for the protection of members of the public who deal in shares and other securities.
In effect, the facilitation of private remedies has added to the enforcement armoury, encouraging self help by affected parties to complement the enforcement role of the regulators.
While there has not been a rash of private litigation, we are now seeing cases emerge, such as Sons of Gwalia itself, in which shareholders seek to bring a company to account for failures in disclosure or other corporate misconduct. Claims by aggrieved shareholders can serve as a market based deterrence, enforcement and recovery mechanism in support of required standards of corporate conduct.

Any move to curtail the rights of recourse of aggrieved shareholders where a company is financially distressed could be seen as undermining the apparent legislative intent to empower investors.

Given the rights of recourse that have been conferred on shareholders, among others, the view put in some submissions that shareholding includes as one of its elements acceptance of the risk of being misled as a result of corporate misconduct is contestable. Likewise, as a practical matter, arguments that shareholders, unlike ordinary creditors, have it within their means to avert corporate misconduct are not clear cut.

While the distinction between shareholder and creditor is of course important, there may be some overlapping of interests in particular circumstances. Where corporate regulation seeks -- including through the provision of private rights of recourse -- to enhance the timeliness and reliability of corporate disclosures, shareholders and creditors may share an interest in the promotion of an efficient and informed market.

The Committee is cognisant of the significant implications of Sons of Gwalia for providers of debt finance to companies, as well as for other unsecured creditors, and for the conduct of external administrations of companies in financial distress.

While these issues will only arise in a limited number of cases -- where there is scope for claims by aggrieved shareholders -- those cases will tend to involve public listed companies and may be large in scale.

The Committee acknowledges the views put forward in various submissions about the possible consequences of Sons of Gwalia for companies seeking funds in the unsecured debt market. Lenders can be expected to factor into their assessment of the risk of lending to Australian companies, particularly listed public companies, the possibility that aggrieved shareholders may compete with conventional unsecured creditors in the event that the company goes into external administration. This may influence the readiness of lenders to advance funds or the terms on which they will do so, and this against the current background of a tight credit market following global financial market developments. While it may not be easy to quantify these effects, some respondents indicated that lenders were taking steps to protect their position having regard to Sons of Gwalia. It is likely that changes have already occurred as the corporate finance market has adapted to the legal environment following Sons of Gwalia.

The Committee also understands that difficulties could arise in attracting investors to assist in the rehabilitation of financially stressed companies. However, prospective investors in these companies may have other ways to protect their financial interests, including through creditors' schemes of arrangement whereby aggrieved shareholders agree to restrictions on their claims in return for the injection of further capital.

The Committee is aware of the concerns raised in submissions about possible complexities and delays in the conduct of external administrations, with implications for conventional unsecured creditors, given the possible growth in class actions by aggrieved shareholders. The procedures involved in the conduct of external administrations are not without their challenges in any event. In cases where there are claims by aggrieved shareholders, administrators will face additional challenges and possible delay and expense.

In cases where claims by aggrieved shareholders are forthcoming, external administrators now have to estimate the likely number and size of those claims and the proportion of those claims that will prove to be successful. However, it needs to be kept in mind that, even with the assistance of class actions and litigation funding, aggrieved shareholders will still have to substantiate their claims, with significant evidential and procedural issues to face, including establishing reliance on corporate misconduct. The fact that a claim is asserted does not mean that it will succeed or should be accorded weight in the external administration process.

The Committee outlines elsewhere in this report (Chapter 4) some possible ways to facilitate the efficient conduct of external administration proceedings involving claims by aggrieved shareholders. The position should continue to be monitored with a view to identifying difficulties in insolvency administrations that cannot satisfactorily be resolved by administrators or the courts and may require some legislative initiative.

Postpone claims

The Committee next considered issues that would arise if, notwithstanding its view, a decision is taken to change the law to postpone all or some aggrieved shareholder claims.

One matter for consideration is whether any move to postpone shareholder based claims should distinguish, in some way, between purchasers, sellers, and continuing holders, of shares.

The Committee notes that the Sons of Gwalia decision, and the terms of reference, related to claims by purchasers of shares. While it would be possible to confine any postponement of claims to claims by purchasers, such an approach may be too narrow. It may seem anomalous, for instance, to postpone claims by purchasers of shares, but not by holders of shares, given that in both instances the claim would be based on corporate misconduct affecting the value of the shares. Likewise, it is arguable that any postponement should extend to a claim by a seller of shares, although the Committee notes that, even before Sons of Gwalia, such a claim by a former shareholder would not have been postponed, as it would not have been made in the capacity of member within the meaning of s 563A.

One proposal put forward in submissions would be to postpone all shareholder claims, other than by persons who had no shareholding in the company at the time they purchased the shares to which their claim related. The argument put forward was that new investors had no capacity, prior to the purchase, to exercise the voting or other controls available to shareholders. By contrast, registered shareholders have certain powers, including to attend and vote at company meetings, to seek court approval to inspect books of the company, to sue for oppression, or to enforce company rights through a derivative action.

The Committee is not persuaded that these differences justify a carve out of new investors from any postponement. In practice, existing shareholders may have little or no real day-to day capacity to monitor or control corporate disclosures or other corporate conduct and may be as misled as new investors by corporate misconduct.

The Committee also considered a proposal put forward in submissions that any postponement of shareholder claims should include claims relating to other equity linked interests, such as options over shares, units in managed investment schemes and equity derivatives. The US and Canadian postponement provisions seek to include at least some equity linked interests going beyond shareholders.

The Committee notes that it was clear, even before Sons of Gwalia, that claims relating to this broader category of equity linked interests did not fall within the class of member claims that were postponed. If, notwithstanding the Committee's view, it is decided to postpone shareholder claims, the Committee would not favour an attempt to extend the postponement to this broader category of equity linked interests. It would be difficult to devise a definition that included all equity interests, including complex derivatives that combine elements of equity and debt.

The Committee notes that shareholders may also have remedies against individual directors and others involved in a corporate breach. Directors and other officers may have indemnity rights against the company, thereby giving shareholders indirect access to corporate assets. In effect, even if claims by shareholders against a company are postponed, it is possible that some corporate funds could still be available through the indemnity. To the extent that this might appear anomalous, it has always been the position, including before Sons of Gwalia. Any attempt to interfere with indemnity rights in this regard would be unduly harsh on directors and other officers and, in effect, treat them as personal insurers of a company's conduct or liabilities.

Cap on claims

The Committee also considered whether, if a decision is taken to ameliorate the current position, a cap on shareholder claims may be a better compromise compared with the postponement of all such claims.

A cap might be seen as a pragmatic solution. It would maintain the voting and other participation rights of aggrieved shareholders and provide them with access to some part of the available corporate assets, while affording a liquidator the means to distribute most of the available funds to conventional unsecured creditors without first having to resolve claims by aggrieved shareholders. An early return can be particularly important for small trade creditors.

While a cap would have practical attractions in ameliorating concerns about the effects of Sons of Gwalia, it would be arbitrary in effect and difficult to justify in principle. The position of aggrieved shareholder claimants would be largely undermined -- assuming their potential recovery would be capped at a relatively low percentage of available assets -- without overcoming all of the complexities of external administrations. The Committee as a whole is not persuaded of the merits of capping as a compromise approach.

Prohibit claims

One proposal put forward in submissions was that all claims by aggrieved shareholders against a company, whether solvent or insolvent, should be prohibited. It was argued that, when shareholders successfully sue a solvent company, the persons who indirectly bear the financial loss are the remaining shareholders. On this approach, claims by aggrieved shareholders against a solvent company would be barred, and there would be no question of allowing them if a company went into insolvent liquidation.

An argument might be developed in conceptual terms against allowing claims against a company by aggrieved shareholders. Such an argument presumably underlies the Canadian legislation by which the liability of solvent companies is capped in relation to such claims. However, this would raise issues going well beyond Sons of Gwalia and the Committee has not considered this question further in the context of shareholder suits against insolvent companies. The Committee also notes that a general prohibition of claims by aggrieved shareholders would fly in the face of recent legislative initiatives to provide greater remedies for shareholders against corporate misconduct.