Implications of the Sons of Gwalia Decision
LAW COUNCIL OF AUSTRALIA
BUSINESS LAW SECTION Corporations Workshop
20-22 July 2007
Glenelg, South Australia
"Implications of the Sons of Gwalia Decision"
A commentary on the paper by Konrad de Kerloy
Commentator: The Hon Justice Robert Austin, Supreme Court of New South Wales
Introduction
My comment on Mr de Kerloy's paper will focus on the question of scope of the High Court's decision in Sons of Gwalia. The ideas I shall put forward are presented more fully in the most recent update to Ford's Principles of Corporations Law, especially at [24.501]-[24.510].
To understand the scope and significance of the High Court's decision, it is necessary to proceed step by step, by considering:
- the principle of maintenance of capital;
- the rule in Houldsworth's case; and then
- statutory deferral of shareholder claims in liquidation.
The principle of maintenance of capital
The principle of maintenance of capital was one of the three foundational principles of 19th-century British and Australian company law. The other two were the concept of limited liability and the idea that a company had power to act only if the power was conferred upon it by its memorandum of association. The third principle, the doctrine of ultra vires, was abrogated by legislation that reflected an important change of policy. But the other two principles, maintenance of capital and limited liability, have been retained, although both of them have been substantially qualified by statutory reforms.
In the Sons of Gwalia case, Gummow and Hayne JJ made the point that there is no common law of companies: the company is a statutory creature and the principles governing it must be derived from statute. The 19th century principles conformed to these propositions. Though the principles were given wide application, each of them was derived from the express provisions of, or by necessary implication from, the terms of the companies legislation.
In the case of maintenance of capital, the statutory reforms now offer simple procedures for share buybacks and reductions of capital. But those statutory provisions reinforce the general principle, because they assume that in the absence of facultative provisions, a reduction of capital or a share buyback would be contrary to the companies legislation and therefore invalid. Thus, s 256B permits the company to reduce its share capital "in a way that is not otherwise authorised by law" in certain circumstances.
The principle of maintenance of capital extends to transactions that have the indirect effect of returning paid-up capital to members. That was made clear, in Australia, in Australasian Oil Exploration Ltd v Lachberg (1958) 101 CLR 119 and Davis Investments Pty Ltd v Commissioner of Stamp Duties (NSW) (1958) 100 CLR 392. The breadth of the implications of that proposition has been demonstrated in later cases (for example, Jenkins v Harbour View Courts Ltd [1966] NZLR 1; Re Archaean Gold NL (1997) 23 ACSR 143; see Ford [24.360]). Where a transaction constitutes an indirect return of capital to members, not authorised by any provisions of the Corporations Act, the transaction is invalid by application of the maintenance of capital principle. That is why, when Jenkins v Harbour View Courts made it evident that the principle of maintenance of capital would affect the administration of residential home unit companies in a fashion thought to be undesirable in terms of policy, it was necessary to amend the legislation (see now s 258B).
If a subscriber for shares recovers damages from the company for actionable misrepresentations or misleading and deceptive conduct in connection with the offering of the shares for subscription, the damages will normally be measured by the difference between the subscription price and the value of the shares. If the shares are worthless, the shareholder's damages are equivalent to the subscription price (subject to claims for consequential loss or, in the Trade Practices Act context, loss of opportunity). If a shareholder is permitted to recover the subscription price for the shares, while remaining a shareholder, the recovery of damages has the effect, indirectly, of a return of capital. The principle of maintenance of capital appears, therefore, to be an obstacle to a successful action by the shareholder, unless there is a statutory provision that expressly or by necessary implication overrides the application of the general principle. As noted below, it is arguable that ss 553A and 563A have this effect when the company is in liquidation; and that certain statutory causes of action have like effect whether or not the company is in liquidation.
Sometimes judges have described the principle of maintenance of capital by using imprecise language, which appears to reflect a lack of understanding of financial accounting. They refer to paid-up capital as a "fund", as if it were represented by an identifiable asset or assets, to be preserved for the protection of creditors, who are said to rely on the preservation of that fund when deciding to extend credit to the company (for example, Trevor v Whitworth (1887) 12 App Cas 409, per Lord Herschell at 414; in the same case Lord Watson said (at 423-4) that persons who deal with the company "are entitled to assume that no part of the capital which has been paid into the coffers of the company has subsequently been paid out, except in the legitimate course of its business").
In the discussion in Ford's Principles of Corporations Law, we refer to the idea that paid-up capital is a physical fund as "the supposed capital fund principle". If it were the true basis of the law of maintenance of capital, the supposed principle would suggest that the law of maintenance of capital is engaged in much broader circumstances that have been thought to be the case: for example, a payment of damages to a purchaser of shares would be just as capable of diminishing the "fund" of paid-up capital, to the detriment of creditors, as would the payment of damages to a subscriber.
There are at least three difficulties with the supposed capital fund principle:
(1) the idea that paid-up capital is a "fund" physically preserved in the "coffers" of the company for the protection of creditors does not reflect the way modern corporations manage their assets or account for paid-up capital, as Callinan J (dissenting) clearly explained in Sons of Gwalia at [250];
(2) the supposed capital fund principle suggests that creditors are entitled to be protected against any diminution of the "fund" other than by ordinary trading, whether the diminution is by return of capital to members or by payment to some third party;
(3) the supposed capital fund principle would be an ineffective instrument of creditor protection, because in modern commercial conditions credit risk is assessed by reference to such matters as cash flow, liquidity, assets and liabilities, shareholder support and credit history, and the question whether paid-up capital has been preserved does not, as such, play a part in the assessment.
An important aspect of the High Court's decision in Sons of Gwalia is the recognition by Gleeson CJ (at [5]) and Gummow J (at [84]-[85]) of the defects in the supposed capital fund principle. Each of their Honours gave voice to one or more of the above three criticisms. Those criticisms are strongly expressed and seem to have the effect that the supposed capital fund principle has been excoriated once and for all (at least in Australia).
In Ford, it is suggested that a more accurate formulation of the principle of maintenance of capital ties the principle to the concept of limited liability. In Ooregum Gold Mining Co of India Ltd v Roper [1892] AC 125 at 145, Lord Macnaghten, citing Buckley on the Companies Acts, said that "the dominant and cardinal principle of these Acts is that the investors shall purchase immunity from liability beyond a certain limit, on the terms that there shall be and remain a liability up to that limit". This characterises the principle of maintenance of capital as a principle relating to members, which does not depend upon the idea that paid-up capital is a physical fund.
Once the proper basis for the principle of maintenance of capital is understood, the force of the policy underlying it can be assessed. Like the other 19th century principles of company law, time has shown that the principle of maintenance of capital is not to be applied with absolute rigour and without exception. It is generally unfair to allow subscribing shareholders to have the benefit of limited liability if they are relieved of their obligation to provide the paid-up capital that they have undertaken to provide when applying for the shares, or the capital is returned to them. But the legislature has decided that this is not an unfair outcome where, for example, the conditions for a reduction of capital or share buyback are satisfied. In the present context, there is a real question whether the indirect reduction of capital that occurs when a subscriber recovers damages from the company, equivalent to the subscription price, is always so unfair that recovery should be prohibited - especially where the subscriber can show that the company has engaged in fraudulent misrepresentation and there are issues of investor confidence and market integrity at stake.
The rule in Houldsworth's case
It is easy enough to give a textbook formulation of the rule in Houldsworth's case. The formulation we give in Ford [24.501] is this:
"a subscriber for shares in a company cannot, while remaining a member of the company, recover damages from the company in that capacity for misrepresentation in connection with the subscription."
It is said that the subscriber's proper remedy is to take proceedings in equity for rescission of the contract of allotment, in which the company will be required to make restitution in integrum by returning the subscription money. But rescission is not available in certain cases, including when the company has gone into liquidation (see Ford at [24.503], noting the discussion of Gummow J's observations on rescission in Sons of Gwalia at [59]). As McHugh J observed, dissenting, in the Webb Distributors case ((1993) 179 CLR 15 at 39), the rule is a source of injustice where the company is in liquidation, because the defrauded shareholder can neither rescind nor obtain damages.
The principle underlying the so-called rule has been said to be "famously elusive" (Sons of Gwalia at [14], per Gleeson CJ) and "of legendary impenetrability" (by counsel in submissions at first instance in Soden v British & Commonwealth Holdings plc [1995] BCC 531; see BCC at 537 per Robert Walker J). The Houldsworth case gave rise to a celebrated debate between Professors Gower and Hornby: (1956) 19 Mod LR 54; 61; and 185.
A careful reading of the speeches in the House of Lords discloses two rationales for the rule, one of which is now incorrect while the other supports a very narrow principle. One rationale is that the fraudulent conduct which induced the appellant to subscribe for shares should not be attributed to all of the shareholders (treating them as if they were partners) except one, namely the appellant ((1880) 5 App Cas 317 at 329 per Lord Selborne). In Sons of Gwalia Gummow J, taking up a theme advanced by Prof Gower, criticised this reasoning on the grounds that it failed to recognise the separate entity of the corporation (at [63], [69]-[70]), and that it has been superseded by later authority (e.g. New South Wales v Lepore (2003) 212 CLR 511).
The second line of reasoning discernible in the speeches in the House of Lords is that there is said to be an inherent inconsistency between the claimant's position as a member, liable as such to contribute to meet a shortfall in liquidation up to the limit of his or her liability, and the claimant's position as a creditor, seeking under the contract of allotment to recover at the expense of the body of shareholders including the claimant (Houldsworth, at 333 per Lord Hatheley). A member, it is said, should not be permitted to "approbate and reprobate" by maintaining his or her position as member while at the same time recouping in substance the whole or part of the subscription money (Earl Cairns LC at 325). Again the partnership analogy is called in aid, for a partner who is a creditor of a bankrupt firm cannot prove in competition with the firm's external creditors, because that would diminish the partnership assets available to meet the claims of the creditors of the firm, who are also the creditors of each partner.
There are several problems with this reasoning. In Sons of Gwalia Gleeson CJ criticised it on the ground that it misuses the partnership analogy (at [3]-[4]). Professor Hornby endeavoured to support the reasoning, but his analysis seems to depend crucially on the idea that on the facts of Houldsworth, the shareholders of the company had unlimited liability to pay calls. Where the company is an unlimited liability company (or a company with substantial unpaid calls), and there are insufficient assets to meet a damages claim made by a subscriber, allowing the damages claim would lead to a kind of infinite regression of "interlacing claims" (Houldsworth at 333 per Lord Hatheley), in which recoverable damages would rise when the call was made, forcing the company to make another call to meet the additional liability, thereby giving rise to a further increase in recoverable damages, and so on: "something akin to perpetual motion would be involved for the merry carousel would go round till the end of time, the aggrieved shareholder being eventually obliged to pay call after call to meet his own claim in damages" (Re Dividend Fund Inc (in liq) [1974] VR 451 at 454 per Anderson J).
In Ford [24.501], it is submitted that no similar "inconsistency" arises in the case of a limited liability company where all shares are fully paid. To the extent that Houldsworth is based on the "inconsistency" analysis, it is strongly arguable that the case should be confined to unlimited liability companies or companies with substantial unpaid calls, in circumstances where there are insufficient assets to meet the damages claim.
If, then, neither of the lines of reasoning actually advanced in the House of Lords to achieve the outcome in Houldsworth would support the rule as formulated, does it follow that the rule is without any foundation in principle? No, because later cases have supplied a rationale that their Lordships did not themselves advance. For example, in Re Addlestone Linoleum Co (1887) 37 ChD at 191 Lindley LJ said (at 205-6) that Houldsworth was authority for the principle that "a shareholder contracts to contribute a certain amount to be applied in payment of the debts and liabilities of the company, and that it is inconsistent with his position as a shareholder, while he remains as such, to claim back any of that money - he must not directly or indirectly received back any part of it". That is an orthodox statement of the principle of maintenance of capital, not corrupted by the supposed capital fund principle. The idea that Houldsworth's case is supported by the principle of maintenance of capital was taken up by Prof Gower, and eventually was recognised in the High Court of Australia. In the Webb Distributors case the majority (Mason CJ, Deane, Dawson and Toohey JJ, (1993) 179 CLR 15 at 33) concluded that Houldsworth supported the proposition that a shareholder may not, directly or indirectly, receive back any part of his or her contribution to the capital of the company, subject to statutory exceptions. Again, that is an orthodox statement of the principle of maintenance of capital. The same idea was reflected in the House of Lords in Soden v British & Commonwealth Holdings plc [1998] AC 298 at 326, and then in Sons of Gwalia (at [5] and [20] per Gleeson CJ; and at [83]-[86] per Gummow J).
On this approach, now well supported by authority, the rule in Houldsworth's case is an application of the principle of maintenance of capital in a case where the payment of damages by a company to its subscribing shareholder would constitute, indirectly, a return of capital not authorised by the statute. If the claimant for damages is not a shareholder, there is no obstacle to recovery, and so a subscriber claimant is required to rescind the contract of allotment as a pre-requisite to recovery. If the claimant for damages is a purchaser of shares, there is likewise no obstacle to recovery (at least, no obstacle under the rule - statutory liquidation provisions are considered below): the claimant's damages will reflect the purchase price paid for the shares to a third party, rather than any subscription of capital to the company. If the supposed capital fund principle were correct, the analysis in the case of a purchaser may be different, but for the reasons stated, that so-called principle has been rejected.
To summarise to this point: case law shows that the principle of maintenance of capital has an application to prevent a shareholder, while remaining as such, from recovering damages from his or her company for actionable misrepresentation measured by reference to the subscription price paid for the shares. That is the rule in Houldsworth's case. Note that the rule is expressed to be about misrepresentations actionable at common law. We have yet to consider whether various statutory causes of action, such as those under the Trade Practices Act or the Corporations Act, expressly or impliedly exclude the rule. Note also that the rule prohibits the shareholder from maintaining the cause of action; it does not merely postpone the claim to the claims of creditors. In Houldsworth's case itself, Earl Cairns LC rejected a submission that the appellant's claim for damages was viable but in the company's liquidation it was to be deferred in priority to the claims of external creditors (at 323).
Statutory deferral of shareholder claims in liquidation
If the company is in liquidation, the following provisions are relevant to an assessment of whether a shareholder may maintain a claim for damages, and if so, whether the claim is to be postponed to claims by external creditors:
"553(1) Subject to this Division, in every winding up, all debts payable by, and all claims against, the company (present or future, certain or contingent, ascertained or sounding only in damages), being debts or claims the circumstances giving rise to which occurred before the relevant date, are admissible to proof against the company."
"553A 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 not admissible to proof against the company unless the person has paid to the company or the liquidator all amounts that the person is liable to pay as a member of the company."
"563A 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."
A claim by a shareholder who has subscribed for or purchased shares in reliance upon misrepresentations by the company is admissible to proof against the company by force of s 553(1), if it is a valid claim. The predecessor of what is now s 553(1) was introduced in 1992, and it changed the law as to the admissibility of proofs of claim. Until then, statutory company law applied the law of bankruptcy to determine what debts and liabilities of a company were provable in its winding up, with the result that claims in the nature of unliquidated damages were not provable unless they arose by reason of contract, promise or breach of trust (Sons of Gwalia at [159] per Hayne J). By no stretch of the imagination can s 553(1) be read as overruling the rule in Houldsworth's case so as to validate subscriber claims, but if they are validated by some other provisions, then s 553(1) permits the claimant to prove.
Sections 553A and 563A apply only to a "debt" and do not expressly refer to a claim against the company. But it appears from the judgment of Hayne J (and by implication from the judgments of Gleeson CJ and Gummow J), that a claim for damages by a subscriber for or purchaser of shares falls within the description of "debt owed by a company" for the purposes of those two provisions (Sons of Gwalia at [166], [193]).
In its terms, s 553A assumes that a claim made by a person in the capacity of member for recovery of a "debt owed by" the company, "whether by way of dividends, profits or otherwise", will be admissible to proof once that person has paid all amounts payable by him or her as a member to the company. Section 563A appears on its face to refer to that same category of claim, and says that the meeting of the claim (that is, payment of the "debt") is to be postponed until all debts owing to or claims made by persons other than as members of the company have been satisfied. Once again, the section assumes that the category of claims that it identifies are valid claims, but it postpones payment of those claims. Should these provisions be construed as having abrogated the rule in Houldsworth's case with respect to a company in liquidation, so as to permit the subscriber's claim (as well as the purchaser's claim, to which the rule in Houldsworth's case does not apply) to be maintained for the purposes of proof of claim?
Section 563A was not always in its present form. Its predecessor in the Companies Code and in all previous manifestations in Australian legislation said this:
"360(1) On a company being wound up, every present and past member is liable to contribute to the property of the company to an amount sufficient for payment of its debts and liabilities and the costs, charges and expenses of the winding up and for the adjustment of the rights of the contributories among themselves, subject to the following qualifications: …
(k) a sum due to a member in his capacity as a member by way of dividends, profits or otherwise shall not be treated as a debt of the company payable to that member in a case of competition between himself and any other creditor who is not a member, but any such sum may be taken into account for the purpose of the final adjustment of the rights of the contributories among themselves."
In the Webb Distributors case, the majority in the High Court took the view that s 360(1)(k) amounted to a statutory recognition of the rule in Houldsworth's case, rather than the abrogation of the rule. They saw s 360(1)(k) as precluding a shareholder's claim for damages for misrepresentation in relation to the issue of shares (CLR at 34-5), not merely as a provision about priority of claims. Further, they held that the rule in Houldsworth's case, as recognised by s 360(1)(k), defeated not only common law claims in deceit but also claims made under the Trade Practices Act, because the Trade Practices Act was not to be seen as eliminating, by a side-wind, "the detailed provisions established for more than a hundred years to govern the winding up of the company" (CLR at 37). McHugh J, dissenting, criticised Houldsworth's case as misconceived and a source of injustice but he said that the rule in Houldsworth was "too deeply entrenched to be set aside by judicial decision", and that it had been applied on hundreds of occasions in the winding up of companies in Australia, and that the companies legislation had been enacted on the basis that it was an entrenched rule of company law (CLR at 39). But in his dissenting opinion, the rule could not prevail against the manifest width of the provisions of the Trade Practices Act, which should not be subject to an implied limitation in their application to companies in liquidation.
The United Kingdom legislation has, and has always had, a provision indistinguishable from s 360(1)(k) of the Companies Code (see, initially, Companies Act 1862 (UK) s 38(7); now Insolvency Act 1986 (UK), s 74(1)(f)). If the reasoning in Webb Distributors were to be applied in the UK, subscriber claims for damages for misrepresentation inducing the subscription would be unavailable against a company in liquidation because of the rule in Houldsworth's case, reinforced by the section. But there is another relevant provision in the UK, initially s 111A of the Companies Act 1985 (UK) and now Companies Act 2006 (UK), s 665. According to that provision, a person is not debarred from obtaining compensation from a company by reason only of holding or having held shares. That provision appears to reverse the effect of the rule in Houldsworth's case, whether or not the company is in liquidation.
In Soden's case, a purchaser of shares claimed damages against a company in liquidation for negligent misrepresentation inducing the share purchase. The issue was whether that claim was to be postponed to the claims of external creditors under the UK equivalent of s 360(1)(k). In contrast with the Webb Distributors case, there was no issue as to whether the claim could be maintained at all, presumably for two reasons: properly analysed, the rule in Houldsworth's case applies only to prevent a subscriber claim, not a purchaser claim; and in any event, the rule in Houldsworth's case had been abrogated by s 111A of the Companies Act 1985 (UK). The House of Lords held, for reasons considered below, that the purchaser's claim was not maintained in the character of member and consequently it could be admitted to proof in competition with external creditors.
Soden's case does not help us to decide whether the current Australian provisions abrogate the rule in Houldsworth's case. When the High Court came to consider Sons of Gwalia, there was still a live issue as to whether the statutory insolvency provisions (ss 553A and 563A) impliedly exclude the rule.
That issue need not have been decided in Sons of Gwalia. The High Court might have said that the rule in Houldsworth's case, even if it were preserved under the Corporations Act in respect of a company in liquidation, would have no application to a purchaser claim as opposed to a subscriber claim, for reasons to do with the proper analysis of the foundation of the rule in the principle of maintenance of capital. There are elements of such reasoning, especially in the judgment of Hayne J, who said (at [190]);
"Maintenance of capital may be relevant to a shareholder's entitlement to recover from the company amounts that the shareholder subscribes as capital, but it has no direct relevance to the recovery from a company of damages for loss occasioned by the making of a contract to acquire existing shares in the company from a third party."
However, all members of the majority in Sons of Gwalia appear to have based their reasoning primarily on the construction of the statutory provisions. Hayne J noted that s 553A assumes that the member's debt can be admitted to proof (at [163]) and emphasised that s 563A, in contrast with its predecessors, is expressed to be about the postponement of shareholders' claims, with the result that if the claim falls within the statutory description, it is admissible to proof though it is postponed to the claims of external creditors (at [193]-[197]). Gleeson CJ criticised the majority in Webb Distributors for finding that the rule in Houldsworth's case had received statutory recognition, given that the statute had been enacted (initially in 1862) before the House of Lords delivered its decision (in 1880); and in any case, he said that the section expressly contemplated that the claimant could prove after other claims were satisfied (at [14], [15], [26]). Gummow J discussed the rule in Houldsworth's case at length, reaching the conclusion that the rule does not prevent shareholder damages claims in the external administration of a company under liquidation provisions of the Corporations Act (at [84]-[96]).
In light of Sons of Gwalia, the correct conclusions seem to be that:
(i) purchaser claims are available against a company in liquidation, both because the rule in Houldsworth's case has no application and because such claims are impliedly recognised by ss 553A and 563A;
(ii) subscriber claims are available against a company in liquidation because, although the rule in Houldsworth's case would prevent them from being maintained, its application to a company in liquidation is excluded by ss 553A and 563A;
(iii) semble, although ss 553A and 563A exhibit a legislative intention wholly to exclude the rule in Houldsworth's case from the administration of winding up, s 563A does not necessarily postpone shareholder claims in every case, the question being whether the claim is brought by a person in his or her capacity as member of the company by way of dividends profits or otherwise.
Three questions about the viability of shareholder claims after Sons of Gwalia remain to be addressed:
- When is a claim postponed under s 563A?
- Are claims available when the company is not in liquidation?
- Are statutory claims available to shareholders?
Postponement under s 563A (see Ford [24.506])
A claim is not automatically postponed in a liquidation merely because the claimant happens to be a member. The question is whether, in the words of s 563A, the claim is for "a debt owed by [the] company to [the] person in the person's capacity as a member of the company, whether by way of dividends, profits or otherwise".
In Sons of Gwalia, Hayne J said that these words require a connection to be shown between the company's alleged obligation and the claimant's membership, and the connection must have its ultimate foundation in the Corporations Act (at [202]).
Thus:
(1) where a holder of partly paid shares makes an interest-bearing advance to the company in anticipation of later calls, interest payable by the company to the shareholder under the arrangement is not owed to the shareholder in the capacity of member (Hayne J at [195]): the claimant had no obligation to advance the money to the company in the capacity of member and has no entitlement to receive the interest as a member, and therefore the right to receive interest is not a right which attaches to membership (at [197]);
(2) a claim for damages by a former member, suffered when the company forfeited his shares without giving notice as required by its constitution, has been held not to be a sum due to the member in his capacity as member (Hayne J at [198]): it is a claim for damages payable under the statutory contract by reason of the claimant having been deprived of the rights of membership by an irregular act on the part of the company;
(3) where a company enters into an employment contract with an employee, under which it undertakes that if the employment is terminated it will find a purchaser for the shares issued to the employee when the employment commenced, and the company fails to discharge its obligation, the employee's claim for damages is not a claim for an amount due in his capacity as member (Gleeson CJ at [29]; Hayne J at [199]);
(4) where a company's managing director was obliged by the company's constitution to be a shareholder, his action for arrears of salary and for breach of his contract of employment was held not to be a claim made by him in the character of member (Gleeson CJ at [29]).
In Soden's case, the House of Lords linked the statutory wording (not quite identical with s 563A) with the concept of rights conferred by the statutory contract under the UK equivalent of s 140 of the Corporations Act. But Hayne J did not adopt the same test, saying that there may be cases where a claim to enforce a right conferred by the statutory contract is not a claim made in the capacity of member for the purposes of s 563A (at [204]-[205]). Specifically, where money is paid to create the relationship of member, by subscription for shares, the company's obligation to pay damages for fraudulent misrepresentation inducing the subscription is not an obligation whose foundation can be found in the statutory contract (at [205]).
On this reasoning, there appears to be a difference between a claim made in the capacity of member, and a statutory claim made by a member, if the statute confers a cause of action, not on a member as such, but on any person who has suffered loss or is a person aggrieved (see, for example, the causes of action created by ss 175(2), 283F, 729, 1041I, 1022B, 1317HA, 1317J(3A), 1325(2)). But an application for relief under the oppression provisions of the Corporations Act may be made, under the statute, by a member (and certain others) and therefore it seems that a member seeking a compensation order under the oppression provisions will (at least normally) be suing in the capacity of member, and the claim will be postponed under s 563A if the company goes into liquidation.
Shareholder claims when the company is not in liquidation (Ford [24.508])
The analysis presented so far leads to the conclusions that
- the rule in Houldsworth's case applies to subscriber claims (but not purchaser claims) where it is not abrogated by statute;
- ss 553A and 563A abrogate the rule where the company is in liquidation.
In cases where ss 553A and 563A do not apply, a subscriber's claim is precluded by the rule, but it is open to the subscriber to take proceedings for rescission, in which restitution in integrum will be ordered if rescission is granted. But the availability of rescission depends upon a number of considerations, including whether third party rights have intervened. Since the courts have held that third party rights intervene when winding up commences (Ford [24.503]), they may well hold that third party rights intervene and preclude rescission where voluntary administrators are appointed under Part 5.3A, or where the company is subject to a deed of company arrangement.
If rescission is not available, the application of the rule in Houldsworth's case will deprive the subscriber of any remedy for misrepresentation inducing the subscription, at least so long as the voluntary administration continues. Presumably if the result of the voluntary administration is to return the company to its directors, the third party rights created by Part 5.3A will be dissolved and the right to rescind and seek restitution in integrum will spring back into life. If the company passes into liquidation or administration under a deed of company arrangement, the right to rescind will remain suppressed.
In Re Media World Communications Pty Ltd (2005) 52 ACSR 342 it was held that the rule in Houldsworth's case precluded subscribers who complained about false statements in a prospectus from claiming damages against the company in voluntary administration, and consequently the claimants were not entitled vote at a meeting of creditors to consider a proposed deed of company arrangement. With respect, that decision appears to be a correct application of the law, which has not been affected by the Sons of Gwalia decision (see the fuller analysis in Ford [24.508]).
Where the company is in administration under a deed of company arrangement, the question is whether anything in the arrangement is inconsistent with the application, to subscriber claims, of the rule in Houldsworth's case. In the Sons of Gwalia case, the deed of company arrangement contained a provision causing s 563A to apply to the admission of proofs of claim and their ranking for payment. Section 444D(1) says that a deed of company arrangement binds all creditors of the company, so far as concerns claims arising on or before the date specified in the deed. Consistently with the High Court's view that Mr Margaretic's purchaser claim was a "debt" for the purposes of s 563A, the Court appears to have assumed that the claimant was a "creditor" bound by the terms of the deed. However, the Court held that the purchaser's claim was not postponed under the imported s 563A, because it was not a claim made in the capacity of member of the company.
If there is a deed of company arrangement but it does not import s 563A, then it appears that the rule in Houldsworth's case will prevent subscriber claims though it will not prevent purchaser claims.
Where the company is not in liquidation and not subject to voluntary administration or a deed of company arrangement, the rule in Houldsworth's case will prevent subscriber claims but not purchaser claims, although subscribers may be able to rescind and recover the subscription price by way of restitution in integrum.
All of this is subject to a qualification. Certain statutory damages claims are regarded as overriding the rule in Houldsworth's case, with the result that a subscriber may claim statutory damages without having to rescind the contract of allotment.
Statutory claims (Ford [4.509])
Since the rule in Houldsworth's case arises by implication from the provisions of companies legislation dealing with share capital and limited liability, it can be abrogated or amended by the Corporations Act or another Commonwealth statute. The High Court in Sons of Gwalia held that the rule has been made inapplicable by ss 553A and 563A when the company is in liquidation or otherwise subject to those statutory provisions. The first question to be addressed is whether a subscriber can maintain a statutory cause of action against the company when it is not subject to the statutory liquidation provisions, on the basis that the statute creating the cause of action overrides the rule. An associated question is whether the statutory cause of action overrides the postponement of priority in s 563A in a case where the company is subject to the statutory liquidation provisions.
There are many statutory causes of action that might be invoked by a subscriber for shares. But two sets of provisions are worthy of special note: first, the statutory provisions creating causes of action for damages for misleading or deceptive conduct under the Trade Practices Act, the Corporations Act and the ASIC Act; and secondly, the provisions of the Corporations Act which confer a statutory cause of action where a company has issued a false or misleading prospectus.
As to the misleading and deceptive conduct provisions, in Webb Distributors the High Court held by majority that a subscriber's claim was precluded by the rule in Houldsworth's case, reinforced by the statutory provision that preceded s 563A, and that the provisions of the Trade Practices Act did not override the company liquidation regime so established. The High Court's decision in Sons of Gwalia has the effect that a claim for damages for misleading or deceptive conduct under one of the legislative regimes may be made against a company in liquidation by a purchaser of shares who has relied on the company's misleading statement, without impediment from or postponement under any provision of the Corporations Act. That decision was reached upon the construction of s 553A and 563A rather than on anything in the Trade Practices Act or its equivalents. But Gummow J took the view (at [95]) that the remedial provisions of the Corporations Act itself (such as s 1325(2), and presumably also s 1041I) did override the liquidation provisions so that the claim was not to be postponed.
On that view, a subscriber's claim for damages may be maintained against the company in liquidation, because Houldsworth's case has been abrogated by ss 553A and 563A, but:
- to the extent that the claim is based on the common law of deceit or the like, the claim may be postponed under s 563A (depending upon whether the claim is in the person's capacity as a member by way of dividends profits or otherwise), while
- to the extent that it is a claim invoking a statutory cause of action for misleading and deceptive conduct, the claim is not postponed.
The reasoning of Gummow J implies that even if the company is not in liquidation or otherwise subject to the statutory liquidation provisions, the statutory cause of action for misleading and deceptive conduct is not limited by the rule in Houldsworth's case, which it impliedly overrides. The result is that if a subscriber invokes a statutory cause of action, the claim may be pursued without rescission.
As to the statutory right of compensation in respect of a defective prospectus, under s 729(1) of the Corporations Act, in Cadence Asset Management Pty Ltd v Concept Sports Ltd (2005) 56 ACSR 309 the Full Federal Court held, in a case where the company was not in liquidation, that the rule in Houldsworth's case does not qualify the availability of the statutory right of compensation. The court took the view that the statutory provisions contain a clear statement of the ingredients of entitlement to compensation and the defences to a claim for compensation, and are not to be qualified by reference to the Houldsworth rule (at [46]). Further, there is an express statutory right for the subscriber to return securities and obtain repayment if the company becomes aware of the misleading statement in the disclosure document after it has been issued, covering some of the ground that the Houldsworth rule would have covered if it had applied.
Although some parts of the judgment in Cadence Asset Management appear to be at odds with the High Court's decision in Sons of Gwalia, the reasoning outlined above is consistent with the High Court's decision, and therefore remains good law. Consequently Houldsworth's case does not apply so as to require that a claimant under s 729(1) against a company not subject to the statutory liquidation provisions must rescind before making the claim.
Concluding observations
There are many important aspects of the question of statutory law reform that is currently before the Corporations and Markets Advisory Committee. The main issues, concerning the appropriate legislative policy to be adopted in order to balance the claims of unsecured creditors and shareholders in an external administration, are touched upon in Mr de Kerloy's paper, but I have not addressed them here. Some suggestions for reform have been made in Ford [24.510].
Another suggestion for reform emerges from the matters raised in this commentary. The effect of the Sons of Gwalia case is to compound the technicality of what was already an extremely technical and unsatisfactory part of the law. As has been explained, the rule in Houldsworth's case takes its justification from the policy that underlies the principle of maintenance of capital. But the policy basis for the principle of maintenance of capital is not so strong as to trump every other consideration. That is demonstrated by the fact that reductions of capital and share buybacks, and certain other forms of return of capital, are expressly permitted by the Corporations Act. Other policy considerations drive consumer and investor protection legislation, and need to be placed in the balance. Additionally, it must be borne in mind that the law in this area often has to be administered, day to day, by insolvency practitioners rather than senior counsel. They should not be left in a position where they find it necessary to obtain legal advice whenever shareholder claims are made, regardless of the size of the company that is subject to administration. In other words, there is a very strong case for simplification.
Weighing up the policy considerations that underlie the principle of maintenance of capital, against questions of investor protection and the need for legal simplicity, it seems to me that a useful step forward would be to abrogate the rule in Houldsworth's case root and branch, by adopting a provision based on s 111A of the UK Companies Act of 1985. The mere fact that the claimant is a shareholder should not stand in the way of the claim, but if (for example) a subscriber provides capital to a company on the basis that it will be returned through a bogus damages claim, there is more to the case than the mere fact that the claimant is a shareholder and the law should intervene. Clearing away the Houldsworth rule would more effectively expose for consideration the main policy issue, which is whether shareholder claims should be postponed to other creditor claims in an external administration.
|
|
