Claims by shareholders in an insolvency statutory reversal of Sons of Gwalia

Insolvency practitioners and litigators should note the recent amendments to section 563A of the Corporations Act. The Corporations Amendment (Sons of Gwalia) Act 2010 (Sons of Gwalia Act) came into effect on 18 December 2010, legislating to ensure that all claims by shareholders of an insolvent company are subordinated to those of other creditors.

A brief history

We have previously reported on the High Court’s decision in Sons of Gwalia Ltd v Margaretic (2007) 231 CLR 160. The High Court in a 6-1 majority held that section 563A, as it was then worded, did not subordinate certain claims by shareholders below those of other creditors in an external administration.

The High Court’s decision caused much consternation and triggered a wave of shareholder class actions. The federal parliament referred a number of issues arising out of the decision for consideration by the Corporations and Markets Advisory Committee (CAMAC).

We have also previously reported on the December 2008 CAMAC report, which made recommendations in respect of many issues (not just the Sons of Gwalia decision). However, in respect of Sons of Gwalia, CAMAC ultimately felt that the effects of the High Court’s decision were positive as it provided shareholders with “direct rights of action in respect of corporate misconduct”. Accordingly, CAMAC recommended that the government maintain the status quo that had been established by the High Court’s decision.

In January 2010, the government indicated its intention to introduce corporate insolvency law reforms that largely adopted the recommendations of CAMAC, but not in respect of the Sons of Gwalia decision.

What does the Sons of Gwalia Act do?

The Sons of Gwalia Act reverses the effect of the High Court’s decision in an insolvency context. It does so by amending section 563A of the Corporations Act to expressly provide 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 is important to note that the subordination of a debt under section 563A does not extinguish the debt, thus a shareholder may still claim rights as a creditor. However, the Sons of Gwalia Act also inserts a new section 600H which removes the right of persons bringing claims regarding shareholdings to vote as creditors in a voluntary administration or winding up, unless they receive permission from the court.

Section 563A will only apply prospectively to claims by shareholders arising after 18 December 2010.

The Explanatory Memoranda for the Sons of Gwalia Act indicates that the government considered that amending section 563A would:

• facilitate the provision of credit to companies by reducing costs and risks associated with the provision of credit;
• reduce administration costs and delays; and
• increase the efficiency of the economy by promoting the expeditious and cost-effective reallocation of assets.

It noted the recommendations of the CAMAC report, but stated that arguments in favour of investors rights to claim in an insolvency were “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.”