Sons Of Gwalia Decision - No Need To Panic

In the Sons of Gwalia case, the High Court has confirmed, in a 6 to 1 majority, that some claims by a shareholder are not postponed to those of unsecured creditors in the winding up of a company.

Before the judgment by the High Court on 31 January 2007, the prevailing view among those in the legal and business fraternity in Australia seemed to have been that section 563A of the Corporations Act 2001 (the Act) subordinates all shareholder claims to those of other creditors. Sons of Gwalia represents a landmark decision by the High Court as it confirms that this is not the case.

The only claims that are postponed are those made by a shareholder in that person's capacity as a shareholder.

Mr Margaretic, a shareholder, bought shares in Sons of Gwalia Limited and 11 days later the company went into administration. He argued that he was the victim of misleading and deceptive conduct by the company which is prohibited by Trade Practices Act 1974, Corporations Act 2001 and the ASIC Act 2001. It was alleged that the company failed to disclose material price sensitive information under the ASX Listing Rules.

Mr Margaretic claimed compensation from the company for the amount of money being the difference between the amount he paid for shares and their actual value (nil).

See our September 2005 Corporate update and the January 2007 paper by Ivan Griscti for more details of the claim.

Mr Margaretic's claim for compensation did not arise from his capacity as a member of the company. To this end, section 563A of the Act was not triggered to subordinate his claim to the debts owed by the company to other creditors. Rather, Mr Margaretic's claim for compensation arose in his capacity as a defrauded investor because of the alleged material non-disclosure to the market.

In the UK, shareholders with a similar claim may rank equally with ordinary creditors in respect of such claims.

In the US and Canada, specific legislation prevents shareholders from ranking equally with ordinary creditors for damages claims for losses arising in respect of the acquisition of their shares.

Following the High Court's decision in Sons of Gwalia, the position in Australia is closer to that of the UK. Since the decision was handed down, there have been calls from business and finance community for legislative intervention to introduce US- and Canada-type provisions into Australian law. That policy matter has been referred to the Corporations and Markets Advisory Committee, however, as explained below, gadens lawyers does not consider that there is a need for legislative change.

• It has been claimed that Australian companies may experience difficulties in attracting investment or finance, especially from overseas markets such as the US, where shareholder claims are always subordinated to those of creditors. The UK experience does not appear to support those claims.

• This case does not change the fact that aggrieved shareholders will still face considerable difficulties of proving causation and other elements necessary to succeed in a claim. However, since the August 2006 High Court decisions in Campbells Cash and Carry Pty Ltd v Fostiff and Mobil Oil Australia Pty Ltd v Tredlen Oty Ltd (see our September 2006 update) shareholders may find it easier to have such claims funded.

• It has also been suggested that the decision might result in greater complexity for administrators and therefore increases in fees for companies in administration. As we do not anticipate a flood of Sons of Gwalia-type claims, gadens lawyers is not convinced that this is a major area of concern.

Recent commentary in the nation's press has included calls from some sections of the business and legal community for legislative change following the Sons of Gwalia decision. It is the opinion of gadens lawyers that a knee-jerk, piecemeal legislative response may cause complications rather than offer a solution to any perceived problems arising from the decision. The factors mentioned above will, in our view, restrict the potential impact of the decision to a relatively small proportion of shareholder claims.
by Scott Higgins

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