The High Court of Australia’s Sons of Gwalia Ltd v Margaretic (Sons of Gwalia) decision recognised an aggrieved shareholder’s claim for damages (in relation to the acquisition of shares) on equal footing with those of an insolvent company’s other unsecured creditors. Dispute Resolution Associate, Justin Le Blond, examines the Government’s response to the decision.

The Sons of Gwalia decision related to the question of whether a shareholder’s claim against a company for a breach of the continuous disclosure laws or for misleading and deceptive conduct could rank alongside the claims of unsecured creditors in the event of a company’s insolvency.

The High Court held that the shareholder’s claim was not made by him in his capacity as a member of the company and therefore in liquidation, the shareholder could lodge a proof of debt alongside unsecured creditors.

Following the Sons of Gwalia decision, widespread debate ensued which was resolved when CAMAC (Corporations and Market Advisory Committee) recommended in its December 2008 report that “claims by shareholders against insolvent companies: implications of the Sons of Gwalia decision, that there should be no change in the law in the response to the Sons of Gwalia decision”.

Regardless, on 19 January 2010, the Minister for Financial Services, Superannuation and Corporate Law, the Honourable Chris Bowen MP announced the Government’s Corporate Insolvency Reform Package (the Insolvency Reforms) which includes the Government’s intention to amend the Corporations Act 2001 (Cth) to reverse the effects of the Sons of Gwalia decision.

The Insolvency Reforms when enacted are intended to:

  • increase availability and lower the cost of debt funding for Australian companies and by reversing the effect of the Sons of Gwalia decision should encourage lenders to provide unsecured debt finance to Australian companies without pricing in the risk of potential competing shareholder claims, and allow Australian companies and their shareholders to benefit from greater access to and lower cost of unsecured finance;
  • support the growth of the secondary debt market in Australia, as a market which is, in relative terms, in its early stages of development in Australia. The secondary debt market will be helped along by the removal of a layer of risk and uncertainty in the trading of Australian corporate debt; and
  • encourage informal workouts and distressed investments. Distressed investments are a growing market and there are opportunities around the world for potential investors. It is, by its nature, a market characterised by higher levels of risk, but the Sons of Gwalia decision has added to the risks of some such investments in Australia. The reforms, if implemented, may provide greater certainty and lower transaction costs associated with distressed investments.

Overturning the Sons of Gwalia decision should also lower the cost and complexity, and improve the efficiency of large insolvency administrations, particularly those involving listed companies. Whilst the decision has been widely applauded by financial and legal commentators alike, litigation funders are likely to suffer for obvious reasons.

Presumably the Insolvency Reforms will not impact the ability of shareholders to pursue companies for damages for misrepresentation(s) or for breaches of continuous disclosure laws in connection with the acquisition of securities issued by the companies, whether those companies are solvent or insolvent.

It appears the Insolvency Reforms will only have the effect of subordinating those claims to the claims of the company’s unsecured creditors. Importantly, however, shareholders will not receive any return from an insolvent estate in respect of such claims unless all other unsecured creditors have been paid in full.