A recent High Court decision Sons of Gwalia Ltd v Margaretic  HCA 1 has established by a majority that shareholders rank equally with other unsecured creditors in a voluntary administration.
At first blush, the decision has an immediate appeal. On 18 April 2004, Magaretic purchased 20,000 shares in Sons of Gwalia Ltd, a publicly listed gold mining company, at a cost of $26,200. 11 days later, on 29 August 2004, voluntary administrators were appointed to the company. At the time Magaretic bought the shares in the company, they were worthless. Magaretic claimed that Sons of Gwalia breached the stock exchange listing rules by failing to tell the Australian Stock Exchange that its gold reserves were insufficient to meet its gold delivery contracts, and that it could not continue as a going concern. Accordingly he brought a claim for misleading and deceptive conduct pursuant to the Trade Practices Act, the Corporations Act and the ASIC Act. He seeks compensation for the amount he spent on the valueless shares). Many other shareholders have similar claims.The High Court has decided that Magaretic is indeed a creditor, and that his claim ranks equally with other unsecured creditors.
Section 563A of the Corporations Act essentially provides that payment of a debt to a person in his or her capacity as a shareholder (whether dividends, profits or otherwise, will be postponed to any other claims of any other creditors. The practical effect of this is that claims by shareholders rank last – they can only get the money (if any) which is left over after all the other secured and unsecured creditors have taken their slices of the asset pie. A majority of the High Court decided that Magaretic’s claim could not be described as arising from his capacity as a shareholder (Calllinan J dissented). Strictly speaking, Margaretic’s claim arose before he became a shareholder at all, for that was when the misleading and deceptive conduct occurred. Section 563A of the Corporations Act can be contrasted with §510(b) of the United States Bankruptcy Code which specifically subrogates a shareholders claim “for damages arising from the purchase or sale of such a security”.
The practical effect of the decision is that Magaretic and all the other shareholders with claims for misleading and deceptive conduct will now be able to claim with all the other unsecured creditors (trade creditors, employees and lenders). This will substantially enhance the shareholders’ chance of recovery, but it will also reduce the amount available for distribution to other creditors. In this instance, there are apparently many other shareholders with claims for misleading and deceptive conduct. An administrator will find it difficult to ascertain which shareholders’ claims have validity, and the amount of damages to which they are entitled. This will significantly increase the length of voluntary administrations. Further such claims are not included as listed liabilities when a potential lender tries to ascertain whether it should lend money to or invest in a company. Mark Korda has noted that this may make some US companies wary of investing in Australian companies.
Although one’s immediate sympathies lie with Magaretic, who bought worthless shares eleven days before the administration, investment on the share market is a risky business. The broader practical implications of the decision may be to make the administration of insolvent companies much more difficult and costly, and result in less money for all creditors. Already, according to the administrator of car-part manufacturer Ion, payouts to creditors will be delayed by a year by the decision in Margaretic.