The decision of the High Court of Australia in Sons of Gwalia Ltd v Luka Margaretic sent shockwaves through the business community when the judgment was handed down on 31 January 2007.
By a 6-1 majority (Callinan J dissenting), the Court held in favour of Mr Margaretic (“Margaretic”) and as a consequence the claims of more than 800 shareholders will now rank equally with the claims of general creditors.
It is submitted that the decision was not a reversal of widely held principles but instead the result of a purposive interpretation of the relevant provisions in the Corporations Act 2001 (“Act”) and a thorough examination of the case law. Creditors and insolvency practitioners may take some comfort in the Court’s view that Parliament could easily rectify the current position by amending section 563A of the Act. Justice Kirby argued that if it was Parliament’s intention that the payment of each and every debt owed by a company to a shareholder of the company is postponed until all other debts are paid, Parliament would have legislated to this effect.
Margaretic’s claim arose from his purchase of 20,000 ordinary shares in Sons of Gwalia Ltd (“the Company”) on 18 August 2004. On 29 August 2004 the company appointed administrators and Margaretic’s shares were worthless.
Margaretic claimed that the Company breached its continuous disclosure obligations under the Act, or alternatively engaged in misleading and deceptive conduct. He sought compensation from the company being the difference between the cost of his shares and their value (nil). The Company entered into a deed of company arrangement and a deed fund was established to meet subsequent claims upon the company in the event it was wound up.
Litigation commenced with the Deed Administrators’ application to the Federal Court for a declaration that Margaretic was ineligible to prove a debt and therefore his claim was subservient to the claims of creditors. ING – a creditor of the Company – joined in support of then Company. Margaretic cross-claimed seeking a declaration that he was a creditor of the Company and entitled to the same rights as other creditors. The Federal Court and the Full Federal Court found in favour of Margaretic. The Company and ING were granted special leave to appeal to the High Court of Australia.
The key issue was the interpretation of section 563A of the Act and whether this provision operated to exclude Margaretic from seeking compensation from the company. Section 563A provides:
Payment of a debt owed by a company to a person in the person’s capacity as a member 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.
The section operates to postpone the payment of member’s (eg shareholder’s) debts until other debts and claims are satisfied. Margaretic maintained that his claim for compensation was not made in his “capacity as a member of the company” and therefore his claim should not be subservient to the claims of unsecured creditors generally.
The High Court dismissed the appeal. Consequently, Margaretic could prove in the pool of creditors and the return to the body of unsecured creditors was reduced.
Where to from here?
If a member can make a claim against the company and successfully argue that such a claim is not made in his or her capacity as a member of the company, examples of which are that the company breached its continuous disclosure obligations to members or alternatively, engaged in misleading and deceptive conduct, they will be able to prove their claim and receive a share of the asset pool alongside creditors.
In the absence of an amendment to section 563A of the Act, creditors will potentially receive less from the pool of company assets as certain claims by members will be of equal standing.
In short, watch this space……..