The High Court of Australia’s ruling in the Sons of Gwalia case early in 2007, which established conditions where shareholders rank beside unsecured creditors in making claims against an insolvent company, was always an unpopular decision in banking circles. Increasingly we are seeing why.

Last week the litigation funder IMF Australia said that it entered into litigation funding agreements with Centro Properties stapled security holders and Centro Retail stapled security holders. IMF will fund claims that relate to alleged breaches of continuous disclosure obligations by Centro and by Centro Retail. Claims will be in the form of representative actions.

IMF also announced that it proposed to fund claims by MFS shareholders, alleging breaches of continuous disclosure obligations, and that it proposed to fund claims by Allco Finance Group shareholders, alleging that AFG breached its continuous disclosure obligations.

A partner at Henry Davis York, Roger Dobson, said the Sons of Gwalia decision would increase the propensity of shareholders to take representative action.

For other unsecured creditors, including banks and finance companies, that means messier, more drawn-out and more costly company administrations. Bankers fear that it will take longer for them to get their money back and there will be less of it.

Dobson said: “The High Court created a new class of claimants. Many shareholders will find themselves in a different position in relation to the assets of the company.”

In Sons of Gwalia v Margaretic the High Court overturned the convention that shareholders rank behind creditors in an insolvency. The court ruled that a shareholder in a failed company had the same right as an unsecured creditor to pursue a claim against the company in cases where the shareholder had suffered loss as a result of misleading and deceptive conduct by the company.

Luka Margaretic, an investor, bought shares in the gold miner Sons of Gwalia in August 2004, just 11 days before administrators were appointed to the company.

In 2005 Margaretic filed a claim in the Federal Court based on the grounds of misleading and deceptive conduct arising from an alleged failure by the company to disclose information to the Australian Securities Exchange.

The Federal Court ruled for him. The company’s administrator and a creditor appealed the decision. In 2006 the full bench of the Federal Court upheld the original decision.

The appellants were granted leave to appeal to the High Court. The Court found that Margaretic had a claim that could be proved and then looked at where that claim ranked.

The decision was based on an interpretation of section 563A of the Corporations Act, which says:

Payment of a debt owed by a company to a person in the person’s capacity as a member (shareholder) of the company, whether by way of dividends, profits or otherwise, is to be postponed until all debts owed to or claims made by persons otherwise than as members of the company have been satisfied.

While Margaretic was a “member” of the company, the Court said the key issue was whether the assumed liability of the company to Margaretic was a liability to him in his capacity as a member. The majority held that it was not.

Reflecting the majority view, Chief Justice Gleeson said:

What determines the present case is that the claim made by the respondent is not founded upon any rights he obtained or any obligations he incurred by virtue of his membership of the first appellant (Sons of Gwalia). He does not seek to recover any paid-up capital, or to avoid any liability to make a contribution to the company’s capital.

His claim would be no different if he had ceased to be a member at the time it was made, or if his name had never been entered on the register of members. The respondent’s membership of the company was not definitive of the capacity in which he made his claim. The obligations he sought to enforce arose, by virtue of the first appellant’s conduct, under one or more of the statutes mentioned in the earlier description of the respondent’s claim.

The impact of the decision is that section 563A of the Corporations Act no longer embodies a general principle that in an insolvency shareholders come last.

Peter Fray

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