Commonwealth of Australia Explanatory Memoranda Commonwealth of Australia Explanatory Memoranda[Index] [Search] [Download] [Bill] [Help]
2008-2009-2010
THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA
HOUSE OF REPRESENTATIVES
corporations amendment (sons of gwalia) bill 2010
EXPLANATORY MEMORANDUM
(Circulated by the authority of the Minister for Financial Services,
Superannuation and Corporate Law, the Hon Chris Bowen MP)
Table of contents
Glossary 1
General outline and financial impact 3
Chapter 1 Subordination of claims arising from shareholdings 5
Chapter 2 Regulation impact statement 11
Glossary
The following abbreviations and acronyms are used throughout this
explanatory memorandum.
|Abbreviation |Definition |
|Corporations Act |Corporations Act 2001 |
|Bill |Corporations Amendment (Sons |
| |of Gwalia) Bill 2010 |
|CAMAC |Corporations and Markets |
| |Advisory Committee |
General outline and financial impact
Outline
The Corporations Amendment (Sons of Gwalia) Bill 2010 (the Bill)
amends the rights of persons bringing claims for damages in
relation to shareholdings under the Corporations Act 2001
(Corporations Act). The amendments contained in the Bill give
effect to a decision of the Government to reverse the effect of the
High Court's decision in Sons of Gwalia Ltd v Margaretic[1] and to
make other amendments to streamline external administrations. The
Bill contains three key measures:
. It provides that all claims in relation to the buying,
selling, holding or otherwise dealing with shares are to
be ranked equally and after all other creditors' claims.
. It removes the right of persons bringing claims regarding
shareholdings to vote as creditors in a voluntary
administration or a winding up unless they receive
permission from the Court. They will also not be entitled
to receive reports to creditors unless they make a request
in writing to the external administrator.
. It eliminates any restriction on the capacity of a
shareholder to recover damages against a company based on
how they acquired the shares or whether they still hold
the shares.
Date of effect: The Bill commences on a single day fixed by
proclamation. The Bill does not have retrospective effect.
Proposal announced: The measures are based on proposals announced
by the Minister for Human Services; Minister for Financial
Services, Superannuation and Corporate Law in a media release dated
19 January 2010.
Financial impact: The Bill has no significant financial impact on
Commonwealth expenditure or revenue.
Compliance cost impact: Low. The measures will provide minimal
additional compliance costs for those bringing subordinated claims
who will be required to incur the cost of a written request to the
external administrator for communications to creditors; and the
cost of a court application should they wish to vote in an external
administration. It is, however, very unlikely that such request or
application will be made, as almost always, those bringing
subordinated claims are very unlikely to be able to participate in
any distribution to creditors due to there being insufficient
assets to meet their claims. Any costs imposed on those bringing
claims, in the rare circumstances where claims are brought, would
be offset by the reduced costs of conducting external
administrations. External administrators would have reduced
costs, as unless a written request was made, they would no longer
be obliged to provide communications to those bringing subordinated
claims. Any reduced costs of an external administrator leads to
greater returns for creditors.
Summary of regulation impact statement
Regulation impact on business
Impact: The amendments will have an ongoing regulatory impact on
credit providers and corporations who obtain credit, shareholders
and on the external administration of insolvent corporations.
Main points:
. The amendments will facilitate the provision of credit to
companies; the reduction of the risk premiums charged; and
the extent of onerous terms and conditions imposed in
order to offset the effects on non-subordination.
. The amendments will reduce the costs for insolvency
practitioners to carry out external administrations; both
costs that they ultimately bear themselves and those that
they are able to pass onto creditors claiming in the
administration (through reduced distributions).
. The amendments will improve the efficacy of external
administration, both in terms of the reallocation of
capital to productive uses and the promotion of business
rehabilitation
Chapter 1
Subordination of claims arising from shareholdings
Outline of chapter
1. The Corporations Amendment (Sons of Gwalia) Bill 2010 (the Bill)
amends the rights of those bringing claims for damages in relation
to shareholdings under the Corporations Act.
Context of amendments
2. The amendments contained in the Bill give effect to a decision of
the Government to reverse the effect of the High Court's decision
in Sons of Gwalia Ltd v Margaretic and to make other amendments to
streamline external administrations.
Summary of new law
3. The Bill postpones any claim arising from a person dealing with a
shareholding until all other claims against a company are
satisfied.
4. The Bill also provides that a person bringing a subordinated claim
does not have an entitlement to a copy of any notice, report or
statement to creditors unless they make a written request to the
external administrator, nor do they have a right to vote as a
creditor of the company unless given leave by the Court.
5. The Bill also ensures that a person's ability to bring a claim for
damages against a company is not restricted by how they acquired
shares and whether they continue to hold the shares when bringing
an action.
Comparison of key features of new law and current law
|New law |Current law |
|All claims against an |In accordance with Sons |
|insolvent company arising|of Gwalia v Margaretic |
|from buying, selling, |some shareholder claims, |
|holding or otherwise |for example, compensation|
|dealing with a |claims, would not be |
|shareholding are to rank |postponed by section 563A|
|equally and be postponed |of the Corporations Act. |
|until all other claims |Instead they would rank |
|are paid. |equally with unsecured |
| |creditors in any |
| |distribution to |
| |creditors, after secured |
| |creditors and payment to |
| |priority creditors as |
| |listed in subsection |
| |556(1) of the |
| |Corporations Act. |
|Persons bringing |Persons bringing |
|subordinated claims would|subordinated claims are |
|not be able to receive |treated as creditors and |
|communications to |entitled to receive |
|creditors from an |communications to |
|external administrator |creditors from external |
|without making a written |administrators, without |
|request, nor would they |making a written request,|
|be able to vote in an |and are able to vote in |
|external administration |the external |
|without leave of the |administration. |
|Court. | |
|There is no restriction |A person's capacity to |
|on the ability of a |bring a claim for damages|
|shareholder to recover |could be affected by how |
|damages against a company|they acquired the shares |
|based on how they |and whether they still |
|acquired the shares or |hold them. In Sons of |
|whether they still hold |Gwalia v Margaretic, the |
|the shares. |High Court confirmed that|
| |the rule in Houldsworth v|
| |City of Glasgow Bank |
| |forms part of the |
| |Australian law. |
Detailed explanation of new law
6. The current section 563A of the Corporations Act subordinates any
claims made by a person in their capacity as a member of the
company, whether by way of dividends, profits or otherwise, below
the claims of other unsecured creditors against the company. The
High Court determined in Sons of Gwalia Ltd v Margaretic, that a
compensation claim by a shareholder against a company was not
subordinated by section 563A of the Corporations Act. This went
against the commonly understood meaning prior to the High Court's
decision.
7. The Bill changes this position so that any claim brought by a
person (not just a shareholder) against a company that arose from
the buying, selling, holding or otherwise dealing with a
shareholding is to be postponed in an external administration until
after all other claims have been paid. Claims that are postponed
include claims for payment of a judgment debt entered against a
company. [Schedule 1, item 2, section 563A]
8. Section 9 of the Corporations Act provides that dealing in
financial products, which includes shares, has the meaning provided
for in Chapter 7 of the Corporations Act. Section 766C of the
Corporations Act lists various activities which fall within the
definition of dealing, including applying for the issue of a share
in a company.
9. The Bill does not postpone any derivative claim for indemnity or
contribution made against a company that follows a claim made by
shareholders. Examples of such derivative claims that are not
postponed by this Bill include auditors or officers of a company
making claims against the company for indemnity or for contribution
towards any liability that they may have to persons who have
suffered loss from buying, holding, selling or otherwise dealing
with a shareholding of the company.
10. The Bill also abrogates the rule in the 1880 decision of the House
of Lords in Houldsworth v City of Glasgow Bank by providing that
how a person acquired shares and whether they still hold them,
would not restrict their ability to bring a claim for damages.
[Schedule 1, item 1, section 247E]
11. The Bill also amends the Corporations Act so that any person
bringing a claim that is postponed under section 563A of the
Corporations Act, is not entitled to receive any notice, report or
statement to creditors produced by an external administrator,
unless they make a written request to the external administrator.
The Bill would allow a person to make a single request to receive
all reports, notices or statements that have been or will be
provided to creditors.
12. Also, such persons would not be able to vote in any external
administration, unless they seek leave of the Court. In
determining whether to exercise its discretion, a court might be
expected to have regard to whether the person might reasonably be
considered to possess a real financial interest in the external
administration. [Schedule 1, item 3, section 600H]
13. The following example illustrates the impact of the amendments.
Comparison with the current law
14. A company misclassified the extent of its liabilities and financial
status to the market. The share price drops, and lending covenants
are triggered causing the company to be placed into liquidation.
The report of the liquidator appointed to examine the affairs of
the company discloses that liabilities were classified as non-
current when current. Aggrieved shareholders assert a claim for
compensation based on a breach of continuous disclosure obligations
under the Corporations Act.
15. Prior to Sons of Gwalia v Margaretic, the general understanding was
that any claim by a shareholder would rank after all other
creditors' claims. Post Sons of Gwalia v Margaretic, it is
understood that the aggrieved shareholders compensation claims rank
equally with other unsecured creditors, and above other shareholder
claims subordinated by section 563A of the Corporations Act.
16. Post Sons of Gwalia v Margaretic, it is understood that available
funds would be distributed so that any compensation claim
by members would rank equally in priority with unsecured creditors.
In most liquidations, unsecured creditors receive at best a small
percentage of what they are owed. Most commonly, any available
funds to be distributed are paid to secured creditors and priority
creditors. The Bill will provide that what was generally
considered to be the law prior to Sons of Gwalia v Margaretic will
be in place so that all claims resulting in the buying, selling,
holding or otherwise dealing with shares rank in priority of
distribution after all other creditors.
17. In the scenario above, there could be 5,000 aggrieved shareholders,
all of whom would be entitled to be provided with information by
the liquidator and to attend and vote as creditors at meetings,
notwithstanding that upon subordination they may have no real
interests in the outcome of the liquidation. Given their numbers
and the limited funds available, their votes could significantly
affect the efficacy of the liquidation and reduce the returns to
other creditors. The amendments provide that such shareholders
would now receive reports to creditors only after making a written
request, and would now not be entitled to vote as creditors unless
the Court grants leave.
Application and transitional provisions
18. All provisions in the Bill will take effect on a date fixed by
Proclamation. The Bill does not operate retrospectively.
19. Section 563A of the Corporations Act 2001, as amended by this Bill,
applies to claims arising from the day after the date of Royal
Assent.
20. Section 600H of the Corporations Act 2001, as inserted by this
Bill, applies to claims made against a company in an external
administration that commences the day after the date of Royal
Assent.
21. Section 247E of the Corporations Act 2001 comes into effect the day
after the date of Royal Assent.
Consequential amendments
22. There are no consequential amendments resulting from the measures
in the Bill.
Chapter 2
Regulation impact statement
Background
23. Section 563A of the Corporations Act 2001 (the Corporations Act)
subordinates any claims made by a person in the person's capacity
as a member of the company, whether by way of dividends, profits or
otherwise, below the claims of other unsecured creditors against
the company.
24. However, the High Court decision of Sons of Gwalia Ltd v Margaretic
(2007) 232 ALR 232 determined that a compensation claim for
corporate misconduct made by a shareholder against a company was
not subordinated by this section. The decision ran contrary to the
meaning generally ascribed to the relevant provisions prior to the
High Court's decision.
25. The decision of the High Court turned upon its interpretation of
when a claim is made 'in the person's capacity as a member of the
company'. The High Court held that for the purposes of section
563A a compensation claim for corporate misconduct made by a
shareholder against a company is not such a claim.
26. The court considered the history of the language used in the
section, including case law in respect of the equivalent provisions
in law going back to 1880; the original introduction of the rule in
the context of the preceding rule in relation to partnerships; the
lack of explicit reference to compensation claims by shareholders
in the provision, in contrast to equivalent provisions in the
United States of America's Bankruptcy Code; the recent case of
Soden v British Commonwealth Holdings on similar UK provisions,
which held that the UK provisions did not subordinate shareholder
compensation claims; the plain meaning of wording in the section;
the consistency of various interpretations of the section with the
rule in Houldsworth v City of Glasgow Bank; and an assessment of
the presumed policy behind the section.
27. The effect of the decision is that shareholders with compensation
claims for corporate misconduct against a company are, irrespective
of whether the claims arise in respect of their shareholdings or
not, entitled to share in any proceeds of an external
administration with the same priority as other creditors. In
particular, as was the case in Sons of Gwalia Ltd v Margaretic,
compensation claims against listed companies arising from the
provision of misleading information or the failure to disclose
information will gain equal ranking with creditors.
Problem identification
28. It has been asserted that the non-subordination of compensation
claims for corporate misconduct by aggrieved shareholders may have
significant implications for companies in respect of debt financing
and the conduct of external administrations.
29. Sons of Gwalia v Margaretic gives rise to a number of problems in
respect of debt financing for companies.
The decision may reduce the likely return to unsecured lenders in
the event of insolvency. The decision is likely to increase credit
spreads for unsecured debt and to adversely affect the availability
of credit, particularly in respect of distressed companies and
companies where there have been concerns in respect of corporate
disclosure.
The decision is also expected to increase the complexity and cost
to lenders of assessing risk; monitoring those risks to ensure that
their positions are not eroded by corporate conduct that misleads
investors; and putting in place legal arrangements to mitigate
those risks. Borrowers would be subject to additional costs in
complying with lender's requirements in respect of these matters.
In addition to charging increased risk premiums, lenders may
respond by imposing more burdensome restrictions or requirements on
the provision of funds to companies, such as seeking or requiring
security or guarantees. This may lead to greater costs and
restrictions on the supply of credit.
30. Sons of Gwalia v Margaretic gives rise to a number of problems for
the effective and cost efficient external administration of
companies.
For example, the costs and delays arising due to the complexities
introduced in respect of identifying which parties are creditors
and the quantification of their claims for the purpose of providing
access to information, determining voting rights and making
distributions of funds.
The decision also has the potential to affect attempts at business
rescue which depend upon debt funding to rehabilitate the business
or company; due to its effect on credit costs and availability.
This applies to attempts both prior to external administration and
pursuant to rescue attempts via entry into voluntary
administration.
Delays in the business rescue process may adversely affect efforts
to rehabilitate and reorganize the company. Sons of Gwalia v
Margaretic, by adding complexity and delays, may interfere with the
operation of this regime in respect of companies against which
there are investor claims.
One objective of an insolvency regime is to contribute to the
efficiency of the economy by enabling assets to be reallocated to
productive uses in an expeditious and cost-effective manner.
Another objective is the promotion and preservation of employment.
The non-subordination of shareholder claims interferes with the
achievement of these objectives in so far as it delays and adds
costs to insolvency administration generally and adversely affects
reorganization attempts.
31. The extent and ongoing nature of the adverse reaction by those
stakeholders who are subject to the effects outlined above is
indicative that the effects are substantial.
32. The problems arising out of Sons of Gwalia v Margaretic will
generally only arise in respect of the collapse of listed public
companies. Where it occurs in other situations it is likely to
have far less impact due to the small number of shareholders
involved. The collapse of listed public companies is relatively
uncommon, however when they do occur they tend to involve large
numbers of creditors, shareholders and employees; and are likely to
have a large financial impact. No statistics are collected on the
number of external administrations in which shareholder
compensation claims are asserted.
33. The decision may have some very minor negative influences on the
level of deterrence existing for breaches of directors' duties; as
a result of its peripheral effect on directorial liability.
Potentially, any joint liability of a director and the company for
misconduct will be more likely to be partially satisfied out of
company funds if the shareholders' claim is not subordinated. Non-
subordination would, in those circumstances, reduce the
consequences to directors of any misconduct. However, given the
large numbers of claimants, the size of the claims involved and the
low distribution rates even when shareholder claims are not
subordinated, it is questionable whether in practice the reduction
in liability that might occur would materially alter director
behaviour.
Objectives
34. The objectives of these reforms are to:
. facilitate the provision of credit to companies in an
efficient way for the economic development of Australia.
. reduce the risk premiums charged and the extent of onerous
terms and conditions in relation to credit providers;
. reduce the costs for insolvency practitioners to carry out
external administrations; both costs that they ultimately
bear themselves and those that they are able to pass onto
creditors claiming in the administration (through reduced
distributions); and
. improve the efficacy of external administration, both in
terms of the reallocation of capital to productive uses
and the promotion of business rehabilitation.
Options
Option A: Maintain status quo
35. Under this option, the non-subordinated status of shareholder
compensation claims for loss due to misleading conduct or non-
disclosure would have been retained.
Option B: Subordinate shareholder claims
36. Under this option, the law could be changed to subordinate claims
for compensation by shareholders against a company for loss due to
misleading conduct or non-disclosure below the claims of other
creditors in the event the company is placed into insolvency
administration.
Impact analysis
Option A: Maintain status quo
37. This option would preserve the current effects of the law regarding
the relative ranking of shareholder and creditor claims in external
administration, as they are now understood to be as a result of the
Sons of Gwalia v Margaretic decision.
38. The arguments that have been put forward by stakeholders in favour
of this option (reproduced exactly as stated in the Corporations
and Markets Advisory Committee (CAMAC) report Shareholder Claims
against Insolvent Companies: Implications of the Sons of Gwalia
decision at pages 48 to 51) are listed below. The term 'aggrieved
shareholder' is used to refer to current or former shareholders
making claims against companies for loss due to misleading conduct
or non-disclosure.
Arguments for non-subordination:
'Limited impact of the decision
While aggrieved shareholder claims could potentially be made
against any company, in practice they are most likely to
arise in the external administration of disclosing entities.
Shareholders in these publicly listed companies typically
rely on the company for accurate information affecting the
value of the investment.
Argument based on acceptance of risks invalid
The risk that equity investors take is that the venture in
which they are investing will not succeed (including because
the managers were incompetent). However, shareholders (and
creditors) do not take on the risk that a company may have
concealed information or provided false or misleading
information affecting the investment decision.
Investor protection and market confidence
The High Court decision is consistent with the direction of
investor protection law, including its extension to the
financial services sector. Since the need for shareholder
protection may be most marked in the event of insolvency,
such protection may be illusory if relevant claims are
subordinated to the claims of ordinary creditors.
One of the aims of the continuous disclosure provisions is
to compensate shareholders and potential shareholders for
the losses that might be suffered from undisclosed facts and
to reduce the incidence of such losses. It may not
encourage reliance on financial markets if, in the very
situation (a voluntary administration or liquidation) in
which investors may need to resort to relevant statutory
remedies, their rights are postponed behind those of
conventional unsecured creditors.
Another aim of the continuous disclosure, and other
corporate disclosure, requirements is to promote a properly
informed market, thereby enhancing the integrity and
reputation of that market and encouraging investment. All
things being equal, prospective shareholders will be more
likely to invest in the share market if they feel confident
that they will have a meaningful remedy should the companies
in which they invest fail to make adequate disclosure.
Promoting investor confidence in the equity market may
generate greater liquidity in that market and offset, in
whole or part, increased costs for companies in the smaller
debt market.
Promote market neutrality
Both the debt and equity markets rely on the investor
protection provisions and should receive the same
protections in the event of corporate misconduct.
Corporate control
In some companies, such as large listed companies, ordinary
shareholders, even institutional shareholders, have limited
practical ability to direct the company and in reality may
have no greater power than creditors. They therefore need a
comparable level of protection in an insolvency.
Corporate culture
The Sons of Gwalia v Margaretic decision reminds boards of
the importance of a culture of corporate compliance with
disclosure obligations and the increased possibility of
shareholder claims if these obligations are disregarded.
Private enforcement
Aggrieved shareholder claims can act as a form of private
enforcement and help promote the integrity of corporate
conduct, in particular the reliability of public
disclosures, to the benefit of lenders and the market
generally, not just shareholders.
Implications for debt markets
Lenders in the debt finance market can protect their
interests in various ways, such as by adjusting the terms on
which they provide finance to companies. In the United
Kingdom, the House of Lords decision in Soden a decade ago
(see Section A1.2 of Appendix 1 of CAMAC's report), which is
similar in effect to that of the High Court in Sons of
Gwalia v Margaretic, does not appear to have affected the
market for corporate debt. There is some indication in
American investor restitution legislation of a move away
from blanket subordination of aggrieved shareholder claims.
Fairness and workability in an external administration
Aggrieved shareholders should be in no worse a position in
an external administration than holders of options or
convertible notes who have been similarly deceived into
acquiring their securities at the same time by means of the
same faulty disclosure or non-disclosure (option and note
holders have never been considered to be postponed to other
creditors under section 563A). Although aggrieved
shareholder claims may add a layer of complexity to external
administrations, administrators already have to deal with
complex situations, including determining certain claims by
conventional unsecured creditors (for instance, product
liability claims). Making external administrations simpler,
quicker or more expedient does not justify postponing a
category of shareholder creditors. Any procedural
difficulties may be ameliorated by appropriate
administrative reforms.'
Arguments against the status quo include:
Financing concerns
39. The effect of Sons of Gwalia v Margaretic is to shift losses
suffered by shareholders, due to misleading conduct or non-
disclosure, from shareholders to unsecured creditors.
40. By reducing the likely return to unsecured lenders in the event of
insolvency, the decision is likely to increase credit spreads for
unsecured debt and to adversely affect the availability of credit,
particularly in respect of distressed companies and companies where
there have been concerns regarding corporate disclosure.
41. The decision increases the complexity and cost to lenders of
assessing risk; monitoring those risks to ensure that their
positions are not eroded by corporate conduct that misleads
investors; and putting in place legal arrangements to mitigate
those risks. Borrowers are subject to additional costs in
complying with lender's requirements in respect of these matters.
42. In addition to charging increased risk premiums, lenders are
expected to respond by imposing more burdensome restrictions or
requirements on the provision of funds to companies, such as
seeking or requiring security or guarantees. This is expected to
lead to greater costs and restrictions on the supply of credit.
43. There are particular concerns regarding the effect of the decision
on the corporate bond markets as bonds are typically unsecured (and
sometimes subordinated).
44. The decision has resulted in Australian law differing from that in
place in the United States (where case law to similar effect was
reversed in 1978 by the introduction of section 510(b) of the US
Bankruptcy Code).
45. Concerns are held regarding how the decision may be perceived by
potential American credit providers who are accustomed to such
claims being deferred; and who, due to their exposure to the
American litigation landscape, may be highly sensitive to the
threat posed by shareholder class action damages claims.
46. Inconsistencies in business laws between Australia and the United
States may be expected to increase business costs for enterprises
operating in both jurisdictions, due to the need to maintain
knowledge and processes to meet the needs of both laws.
Investor protection
47. If shareholder claims are not subordinated, the burden of meeting
compensation claims does not fall upon those who are responsible
for or benefited from the misconduct of the company. Instead they
are met by another class of stakeholders (unsecured creditors), who
may also have suffered loss as a result of the breaches of
disclosure obligations or misleading conduct giving rise to
shareholders' claims.
48. As a mechanism that may operate to deter negative corporate
conduct, it is noted that Sons of Gwalia v Margaretic does not
transfer losses arising from misconduct to those responsible for
misconduct (or who take advantage of that misconduct). It does
not, therefore, create any incentive for those who are responsible
for misconduct (or who take advantage of misconduct) to adopt
alternative behaviour.
49. It may be argued that the negative effects on financing referred to
above may result in investors generally being worse off, for
example, due to increases in financing costs and lost investment
opportunities by companies due to restrictions on access to
finance.
50. Any positive investor protection effects apply only to equity
investors who have compensation claims against a company; investors
in debt are adversely affected in a similar way to other creditors.
Corporate governance
51. Some stakeholders have asserted that, from a corporate governance
perspective, as the stakeholder group that is best able to manage
the risk of management misconduct, shareholders as a group should
bear the cost of failing to manage this risk. The inappropriate
allocation of credit risk away from those who are best able to
manage that risk may have the potential to contribute to suboptimal
economic outcomes.
External administration and corporate rescue
52. The decision has had a negative effect on costs and delays in the
conduct of some external administrations, and consequentially a
diminution of returns to creditors.
53. Costs and delays arise due to the complexities introduced into
external administration in respect of identifying which parties are
creditors and the quantification of their claims for the purpose of
providing access to information, determining voting rights and
making distributions of funds.
54. Although there can be significant complexities in determining
certain creditor's claims, ordinarily this process will involve the
insolvency practitioner making an assessment of written agreements
and records setting out the quantum of credit provided by them to
the company.
55. Sons of Gwalia v Margaretic creates a new class of creditors the
claims of which are inherently difficult to determine. Claims are
unliquidated and involve the resolution of complex factual and
legal issues of alleged conduct, causation, reliance and
quantification of damage. Where misleading conduct has occurred
there may be expected to be large numbers of claims to be processed
and, depending on the circumstances, case by case assessments may
be required.
56. The decision also has the potential to affect attempts at business
rescue which depend upon debt funding to rehabilitate the business
or company; due to its effect on credit costs and availability.
This applies to attempts both prior to external administration and
pursuant to rescue attempts via entry into voluntary
administration.
57. The primary method of reorganising and rehabilitating insolvent
companies is the voluntary administration process. Voluntary
administration takes place in a relatively short timeframe,
although the deadlines imposed by legislation can be extended by
the Court. Delays in the business rescue process may adversely
affect efforts to rehabilitate and reorganize the company. Sons of
Gwalia v Margaretic, by adding complexity and delays, may interfere
with the operation of this regime in respect of companies against
which there are investor claims.
58. Insolvency administration is not purely directed at maximising the
amount of any distribution to creditors and investors. One
objective of an insolvency regime is to contribute to the
efficiency of the economy by enabling assets to be reallocated to
productive uses in an expeditious and cost-effective manner.
Another objective is the promotion and preservation of employment.
Factors that delay the conduct of insolvency administrations and
interfere with business rehabilitation processes obstruct the
achievement of these objectives.
Other
59. There is significant potential for the effect of Sons of Gwalia v
Margaretic to be avoided, at least by some creditors in some
circumstances. For example, by lending to subsidiaries of listed
entities rather than those entities themselves any compensation
claims by shareholders of the listed company would (in the absence
of cross guarantees or similar arrangements) remain subordinated.
Such avoidance arrangements have the potential to create additional
costs and distort financing arrangements from what may be
economically optimal.
60. In practice, some creditor groups, such as trade creditors, may
have little scope for protecting themselves by such arrangements
and may therefore be more exposed than other categories of
creditors to the consequences of aggrieved shareholder claims.
61. The impact of Sons of Gwalia v Margaretic is mainly upon business
(debtors, creditors and employees) and investors. There is minimal
impact on Government. Through its effect on business activity and
employment, it may have a minor impact upon the community. To the
extent that it adversely affects business rescue procedures it may
also have a minor impact upon consumers.
Option B: Subordinate shareholder claims
62. This option (to 'reverse' Sons of Gwalia v Margaretic) will negate
both the positive and negative effects arising out of the Sons of
Gwalia v Margaretic decision, as detailed above.
Consultation
63. The primary stakeholders affected by the Sons of Gwalia v
Margaretic decision are: equity investors in companies; unsecured
non-priority creditors of companies; businesses operating under
corporate structures; and corporate insolvency practitioners.
64. In February 2007, the previous Government referred the High Court's
decision to CAMAC for its analysis and advice. CAMAC issued a
public discussion paper in September 2007.
65. Those making submissions to CAMAC who supported a reversal of the
decision included: the Australian Financial Markets Association
(AFMA), the Australian Bankers' Association (ABA), Chartered
Secretaries Australia (CSA), the (self described) 'vast majority'
of the Law Council of Australia's Insolvency and Reconstruction
Committee, the Law Council of Australia's Corporations Committee,
the Law Institute of Victoria, the NSW Law Society Business Law
Committee (divided opinion), the Insolvency Practitioners
Association (IPA); and academics from the University of Melbourne,
the University of Western Sydney and Central Queensland University.
66. Those making submissions to CAMAC who supported retaining the
decision included: Law Council of Australia Insolvency and
Reconstruction Committee (minority opinion), NSW Law Society
Business Law Committee (divided opinion), the litigation funding
firm IMF Australia, the Australian Securities and Investments
Commission (ASIC); and an academic from Monash University.
67. CAMAC issued its report Shareholder claims against insolvent
companies: Implications of the Sons of Gwalia decision in December
2008.
Conclusion and recommended option
68. The adopted option is that claims for compensation by shareholders
against a company be subordinated below the claims of other
creditors in the event the company is placed into insolvency
administration.
69. This position arises out of an assessment of the pros and cons
listed above in respect of maintaining the status quo, weighing
each consideration against the significance of its likely impact on
stakeholders and the economy as a whole.
70. This option is preferred primarily due to the negative effect that
non-subordination of shareholder compensation claims would have on
the cost and access to debt financing for companies, particularly
companies in distress.
71. The additional costs, complexity and delays to insolvency
administration arising from the decision also argue strongly for
subordination, in particular in relation to its expected impact on
attempts at business rescue.
72. Investor protection arguments against subordination are
significantly weakened by the fact that the status quo does not
result in a shift of the losses from shareholders onto those
responsible for the conduct that caused their loss; instead losses
are transferred onto unsecured creditors. Any investor protection
benefits are likely to result from redistributions of losses
amongst those suffering from a corporate collapse, rather than
through deterring misconduct and reducing the risk of loss.
Do not remove section break.
Index
Schedule 1: Amendment of the Corporations Act 2001
|Bill reference |Paragraph |
| |number |
|Item 1, section 247E |1.10 |
|Item 2, section 563A |1.7 |
|Item 3, section 600H |1.12 |
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[1] Sons of Gwalia Ltd v Margaretic (2007) 232 ALR 232