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Company directors to have more protection

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As noted in our December 2009 newsletter, the Federal Government has been considering a number of reforms to Australia’s corporate insolvency laws.

As part of this package of reforms, the Federal Minister for Financial Services, Chris Bowen, has recently announced that the government will introduce legislation to overturn the landmark High Court ruling of Sons of Gwalia v Margaretica. The proposed legislative changes aim to provide company directors with more protection and facilitate greater certainty for financiers in terms of lending risk, particularly where a company is struggling. The amendments are part of a package of reforms that will implement many of the recommendations made by the Corporations and Markets Advisory Committee (CAMAC) in its Issues in external administration report of 2008. Also underpinning the reforms is the Federal government’s policy to stimulate and to reduce the costs of funding to Australian companies.

Sons of Gwalia (“Gwalia”) v Margaretic: shareholders v creditors

In 2007, the High Court held that shareholders should be treated equally with creditors where a company becomes insolvent. The case involved an action by a small shareholder who acquired shares in Sons of Gwalia, a mining company, only 11 days before it was placed in voluntary administration. As Mr. Margaretic’s shares were rendered valueless, he sought to recover his losses (approx $26,300). He made a claim against Gwalia on the grounds that the directors failed to disclose to the market that the company could not continue as a going concern. Further, by reason of the non-disclosure, the company directors had engaged in misleading and deceptive conduct in contravention of section 52 of the Trade Practices Act 1974 (Cth).

The key question before the Court was whether a shareholder’s claim would rank equally with other creditors or should be postponed. Under the Corporations Act (s563A), a claim by a shareholder was subordinate to the claims of creditors. The Court found that shareholders should be treated as a creditor of Gwalia and that Mr Margaretic’s claim should rank equally with Gwalia’s other creditors.

The benefits of the proposed amendments

Since the High Court decision there has been much discussion about whether or not shareholders should be entitled to compete with creditors when a company is winding up. Insolvency administrators have faced claims from both creditors and shareholders, the company pool of assets has faced dilution and financiers have been less willing to provide new funding to distressed companies. It was also apparent to the government that in response to the Gwalia decision, directors were winding up companies prematurely rather than be faced with a ‘trading whilst insolvent’ charge from the Australian Securities and Investment Commission. As a result, the proposed legislation will see shareholder claims subordinated to the claims of creditors, although it is important to note that shareholders will still be able to pursue directors where the company is solvent and there has been a breach of continuous disclosure obligations.

The legislative amendments should promote greater certainty for companies with respect to their capital funding and financiers will have lower lending risks particularly where they are lending on an unsecured basis. Where a company is insolvent, the new legislation will allow for faster and more efficient winding up. The changes have been unanimously welcomed across the business and banking fraternity. MST will continue to provide details of further proposed amendments and their potential impact in forthcoming newsletters. Please contact a Corporate Advisory lawyer for further information

Author: Susan Reece Jones