In Sons of Gwalia Ltd v Margaretic; ING Investment Management LLC v Margaretic [2007] HCA 1; (2007) 231 CLR 160, the High Court of Australia ruled that shareholder insolvency claims can be ranked on the same level as those of unsecured creditors under a deed of company arrangement to distribute funds. Making a critical appraisal of the case itself, and the corporations law amendments that followed it, make a reasoned argument in favour or against the decision as legal policy. What does the case indicate about the distribution of risk in a capitalist system? Does it get the balance right?
As per the facts of the case, Mr. Margaretic purchased shares in Sons of Gwalia Ltd which went into administration, leaving the shares worthless. Margaretic alleged that the company did not unveil essential undesirable information in contrary to the incessant disclosure rule stipulated under the ASX principles, deceiving or misleading him to purchase shares.
One of the creditors and the administrator claimed that the being a shareholder, Mr. Margaretic’s claim was not provable and shall be held back until the debts owed to the creditors are satisfied as per section [563A] of the Corporations Act 2001 (Cth)[1].
The Federal court held that in regards to insolvency administration, if the shareholders who have been induced to purchase the shares of an insolvent company owing to its deceptive or misleading conduct claims damage, it must be treated equally with the claims of the company creditors.
According to Omar (2016), this decision turned over the fundamental corporate principle related to insolvency, which stated that the claims of the shareholders are to be satisfied at the last. Besides, this decision though creates a prospect of the claims made by certain shareholders but resulting in reduced returns to the claims made by the creditors of the company.
However, Byrne and Thomas (2017) states that the decision given in Gwalia case shall have a distinct impact on subscribing shareholders and transferee shareholders of the insolvent company[2]. As a general rules, the rights and interests of the members or shareholders of a company shall be settled at the last and such claims cannot be competed with the creditors of the company which shall be discharged in full, in the event a company goes into liquidation.
Nevertheless, the issue that were to be decided in this case was whereas shareholder claims damages against insolvent company whether such claims shall be treated as unsecured claim or it should be settled after discharging the claims of the unsecured creditors, given that the shareholders are members who are seeking claims or the loss of it investments in the company. Byrne and Thomas (2017) states that in Australia, the damage claims made by shareholders are usually treated as subordinate claims to claims made by the creditors or that the shareholders are not competent to make damage claims against the insolvent company at all. However, this principle has been overturned in the Gwalia case where the court held that this general principle related to insolvency of companies is only applicable for the subscribing shareholders and not the transferee shareholders. The claims made by the subscribing shareholders shall be subordinated to the claims of the unsecured creditors of the insolvent company[3].
The rationale for the ‘shareholder come at last’ principle stipulated under section [563A] of the Corporations Act 2001 (Cth) is based on the enumerated grounds:
Maintenance of share capital- the damage claims made by the shareholders of the company shall weaken the fundamental principle of corporate law according to which the share capital of an organization is important to discharge the claims of the creditors of the company[4].
Consequences of limited liability- in regards to the limited liability of the corporation, it is stated that the members of the company instead of relying on their accountability to the share value held by them, they must be liable to the creditors to the extent of that amount as was held in Victoria v Hodgson
Legal contract- as per the legal contract between the company and its members, the legal contract is applicable equally to the transferee and the subscribing shareholders. In Houldswroth v City of Glasgow [1880][5], a principle was established which states that a shareholder enters into the contract to make monetary contributions into the company and to claim the amount back is inconsistent with the legal contract, unless he repudiates the contract.
Now, rescission of contract is not possible in the event the company goes into liquidation and it would affect the rights and interests of the creditors as well. Hence, a member in his capacity as the member of the company is not competent to claim damages against an insolvent enterprise[6].
Rights and Interests of the creditors and shareholders’- the shareholders are the owners of the company hence, have an interest in the probable profits of the company and other related privileges of the company unlike the creditors. Therefore, it would be unfair to permit the shareholder to claim damages and acquire the role of creditors during the insolvency of a company even if such shareholder has been deceived or misled to purchase shares of the insolvent company.
According to section [563A] of the Corporations Act 2001 (Cth), the payment of a debt that a company owes to a person in the capacity of the person as the member of the company shall be postponed until all the debts made by the creditors are fully discharged. However, section [563A] has modified the Houldsworth principle as the principle precluded any action being followed whereas the legal provision under section [563A] only postpone the claim until the claims of the creditors are discharged and does not preclude any action from being pursued.
Kock, Carl and Byung (2016) states that though both the creditors and shareholders bear certain level of risk related to the insolvency of the company. The shareholders bear the major risk as the interest of the shareholder lies in the ‘value’ of the company[7]. When a company goes into liquidation, the company has no ‘value’ and the existing assets are available to discharge the claims of company creditors without any competing claims on part of the members/shareholders of the company. Further, Turner (2015) argues that during insolvency, the company is left with no value and its existing assets are used to meet the claims of the creditors[8].
Under such circumstances, it shall become difficult for the liquidators and the administrators to assess the claims of the shareholders who being the owner of the company has their interest in the ‘value’ of the company. It would become inconvenient for the liquidators to assess such shareholder claims especially if they are huge in number and in quantum. The discharge of claims made by the shareholders might affect the rights and interests of the creditors and the assessment of the claims by the administrators and the liquidators might result in huge legal expenses as well[9].
The decision in Gwalia case, which has overturned the general principle of insolvency that the claims of the shareholders shall be discharged until the claims of the unsecured creditor, is has led to the following implications during the insolvency of the company:
Firstly, while he shareholders of an insolvent company can make successful claims, it might affect the return of the creditors given that during insolvency there is already deficiency in the assets of the company to discharge the claims of its creditors.
Secondly, Finch, Vanessa and David (2017) states that if the shareholders claims are to contend with the claims of the creditors, the Australian enterprises may experience inconvenience and will have to incur more expenses in accumulating funds in the debt markets, given the fact that debt market is unsettled.
Thirdly, Hannigan (2015) asserts that the administrators and the liquidators may incur extra expenses as well as cause delay in evaluating whether to accept evidence that establishes the claims made by the shareholder and in tackling with the challenges in respect to their decision[10].
Fourthly, the decision held in the Gwalia case gives rise to several realistic questions for the liquidators as well as for the administrators. For instance, in case the claims of the shareholders are not subordinated to the claims made by the creditors, how will the liquidator and administrator will evaluate the loss and the damage claimed during the insolvency of the company.
Fifthly, the outcome of the decision led to an incline in the shareholder class actions as the ‘litigation funding groups’ have been acknowledging and organizing the prospective shareholder pretender to declare causes of actions in several insolvent companies[11].
Sixthly, the decision in the Gwalia case may entitle the shareholder claimants to attend creditor meetings and vote at such meetings. The additional potential creditors shall enhance the administrative expenses, given that the claims of every creditor shall be considered individually. Moreover, if the potential new creditors (shareholder claimants) are capable of proving their claims for voting purposes and such claims turn out to be substantial, the shareholder claimants may become potentially entitled to exercise control over the voting power at the creditor meetings and eventually, over the outcome of the administration[12]. Furthermore, if these claims are established to be significant, it may jeopardize the returns of the creditor claims.
Lastly, Finch and David (2017) asserts that the decision regarding treating shareholder damage claims along with the claims of the creditors may affect investments from abroad making it more costly for the Australian companies to raise funds.
The decision in the Gwalia case alerts the companies that become insolvent to avert being involved in deceptive or misleading conduct that would lead a shareholder to claim damages against the company. However, in order succeed in making such claims, it is mandatory that the potential shareholder claimant prove that such claims include all the essential elements like false and misleading nature of the conduct, dependence on such misleading and deceptive conduct and the loss suffered due to such misleading or deceptive conduct. The establishment of all these essential elements to succeed in making damage claims against the insolvent company was upheld in the case of Johnston v McGrath [2005][13].
However, the Full Court of the Federal Court had made a distinction between subscribing shareholder and transferee shareholder based on the ground that former shareholder claims shall be postponed until the discharge of the creditor claims unlike the latter that are capable of proving their claims. However, the decision in Gwalia case must not have any distinct impact on the shareholders depending on the fact whether such shareholder is a transferee or a subscribed shareholder. The claims for damage made by both the subscribed and the transferee shareholder should be treated equally with the general body as was held in Webb Distributors (Aust) Pty Ltd v The State of Victoria (1993)[14].
Synes (2016) argues that this may not strike a balance between the rights and interests of the creditors and the shareholders of the company that has become insolvent. This is because it might affect the returns of the creditors and considering the distribution of risk between them, it can stated that the interest of the shareholder lies in the value of the company. During liquidation, the company loses such value, hence, the assets that are available must be used to discharge the claims of the creditors of the company.
Hence, it is only appropriate that the court should adopt the approach where the shareholders are caught by section [563A] irrespective of the fact whether such shareholders have acquired the shares on market or through subscription. The rationale for using this approach is that it shall remove the non-commercial division between transferee and subscribing shareholders and will maintain the general principle of corporate rule that the claims made by the shareholders against a insolvent company shall be settled after the claims of the unsecured creditor of such company is settled
References
Byrne, Julie, and Thomas O’Connor. “Creditor rights, culture and dividend payout policy.” Journal of multinational financial management 39 (2017): 60-77.
Coggins, Jeremy, Bianca Teng, and Raufdeen Rameezdeen. “Construction insolvency in Australia: reining in the beast.” Construction Economics and Building 16.3 (2016): 38-56.
Corporations Act 2001 (Cth)
Du Plessis, Jean Jacques, Anil Hargovan, and Jason Harris. Principles of contemporary corporate governance. Cambridge University Press, 2018.
Finch, Vanessa, and David Milman. Corporate insolvency law: perspectives and principles. Cambridge University Press, 2017.
Gullifer, Louise, and Jennifer Payne. Corporate finance law: principles and policy. Bloomsbury Publishing, 2015.
Hannigan, Brenda. Company law. Oxford University Press, USA, 2015.
Houldsworth v City of Glasgow Bank and Liquidators (1880) 5 App Cas 317
Johnston v McGrath [2005] NSWSC 1183; (2005) 195 FLR 101
Kock, Carl J., and Byung S. Min. “Legal origins, corporate governance, and environmental outcomes.” Journal of business ethics 138.3 (2016): 507-524.
Omar, Paul. “Aggrieved Shareholders as Creditors: An Unmapped Coordinate in the Cartography of Australian Insolvency Law.” International Insolvency Law. Routledge, 2016. 191-216.
Qi, Yaxuan, Lukas Roth, and John Wald. “Creditor protection laws, debt financing, and corporate investment over the business cycle.” Journal of International Business Studies48.4 (2017): 477-497.
Sons of Gwalia Ltd v Margaretic; ING Investment Management LLC v Margaretic [2007] HCA 1; (2007) 231 CLR 160
Symes, Christopher F. Statutory priorities in corporate insolvency law: an analysis of preferred creditor status. Routledge, 2016.
Turner, P. G. “Equitable Doctrines in Business Associations.” (2015).
Webb Distributors (Aust) Pty Ltd v The State of Victoria (1993) 179 CLR 15 at para 18 – 20.
Corporations Act 2001 (Cth) at section [563A].
[2]Byrne, Julie, and Thomas O’Connor. “Creditor rights, culture and dividend payout policy.” Journal of multinational financial management 39 (2017): 60-77.
Gullifer, Louise, and Jennifer Payne. Corporate finance law: principles and policy. Bloomsbury Publishing, 2015.
Omar, Paul. “Aggrieved Shareholders as Creditors: An Unmapped Coordinate in the Cartography of Australian Insolvency Law.” International Insolvency Law. Routledge, 2016. 191-216.
Houldsworth v City of Glasgow Bank and Liquidators (1880) 5 App Cas 317
Journal of International Business Studies48.4 (2017): 477-497.
Kock, Carl J., and Byung S. Min. “Legal origins, corporate governance, and environmental outcomes.” Journal of business ethics 138.3 (2016): 507-524.
Turner, P. G. “Equitable Doctrines in Business Associations.” (2015).
Finch, Vanessa, and David Milman. Corporate insolvency law: perspectives and principles. Cambridge University Press, 2017.
Hannigan, Brenda. Company law. Oxford University Press, USA, 2015.
Du Plessis, Jean Jacques, Anil Hargovan, and Jason Harris. Principles of contemporary corporate governance. Cambridge University Press, 2018.
Finch, Vanessa, and David Milman. Corporate insolvency law: perspectives and principles. Cambridge University Press, 2017.
Johnston v McGrath [2005] NSWSC 1183; (2005) 195 FLR 101.
Webb Distributors (Aust) Pty Ltd v The State of Victoria (1993) 179 CLR 15 at para 18 – 20.
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