Recent comment in the press and in the market on the Media World case has suggested that it could prejudice the ability of Australian companies to raise debt finance. It has been argued that damages claims by transferee shareholders may have equal ranking with unsecured debt claims.
However, the existing law is clear. Section 563A of the Corporations Act 2001
provides that the debt claims of members of a company, whether by dividends, profits or otherwise, are postponed to the claims of creditors (in the context of a liquidation).
The general principle that creditors rank ahead of shareholders in a winding up of a company remains unaffected, although the case does indirectly raise some interesting issues about the possibility of shareholders making claims in the capacity of ordinary creditors. However, the Australian position on these issues is no worse than, and probably better, for creditors and debt financing, than in the UK.
The court's decision is very specific: a subscribing shareholder with a claim against the company for damages arising from a misleading prospectus that induced the shareholder to subscribe for shares does not have status as a creditor of the company for the purpose of a voluntary administration of the company – a proceeding under Australian insolvency law that may or may not be followed by liquidation. This mirrors the position in a liquidation.
The press commentary arose in relation to the judge's non-binding comments about whether a transferee shareholder with a claim for damages arising from a misleading prospectus that induced the shareholder to purchase the shares on the open market is a creditor for voting purposes in an administration. Justice Finkelstein referred to a UK case that supports the proposition that a transferee with such a claim may rank as a creditor in winding up proceedings, even though still a member of the company. That proposition has not been tested in Australia. Media World
dealt with a company in voluntary administration. The case did not specifically address the issue of the ranking of external creditors and transferee shareholders with such a claim in a winding up.Media World: a summary
In Media World, subscriber shareholders (subscribers) claimed damages against Media World Communications Ltd (MWC) for misleading conduct of MWC in relation to the prospectus for the issue of the subscribers' shares. MWC was in voluntary administration.
Media World followed the reasoning in an old English case, Houldsworth
(1880), which provided that subscribers cannot, while retaining their shares, recover damages against a company on the basis of inducement to subscribe by fraud or misrepresentation. Houldsworth's case makes it clear that a member of a company may only bring such an action against a company after rescission of the contract of subscription and that such rescission is impossible after the commencement of the winding up of a company. Therefore, a subscriber may bring an action against a company as a creditor but only before winding up proceedings have commenced and after it has rescinded its contract of subscription.
In Media World
, the court decided that a subscriber with such a claim who has not rescinded his or her contract of subscription before commencement of the administration is barred from claiming as a creditor during an administration. The decision was based on s437F of the Corporations Act 2001
. That section provides that an alteration of status of members of a company that is made during its administration is void unless the court deems otherwise. The relevance of the issue for the administrators of Media World was that, if the shareholders were to be treated as creditors in the administration, they could vote in creditors' meetings and their views be taken into account when determining whether the company should enter into a deed of company arrangement or should be wound up. Non-binding comments in Media World
Justice Finkelstein was asked to address the hypothetical question of whether a shareholder who purchases shares of a company on the open market (a transferee) on the basis of an alleged misrepresentation by the company could, in bringing a claim for damages against the company for misrepresentation, have the status of a creditor of the company in the administration.
Justice Finkelstein stated that the reasoning in Houldsworth
's case did not easily fit the situation of a transferee shareholder. He referred approvingly to the UK House of Lords' case of Soden
(1997), which involved a court-approved scheme of arrangement for a company in administration under which the company's assets were to be distributed on the same basis as a winding up. Soden
was decided on the basis of specific UK legislation in the context of a winding up that a transferee might be able to make a claim in damages and rank as a creditor on the basis that the transferee's claim for misrepresentation relating to the share purchase is not of the same character as a claim of a subscriber and may not be barred in the same manner. However, the side observations made by Justice Finkelstein were brief and given without the benefit of opposing argument on the point.Other relevant issues in Media World
In relation to the question of transferees, ordinary creditors of a company can take comfort from the following:
- Media World was a decision handed down by a single judge and Justice Finkelstein's comments, though of some persuasive force, are not binding;
- there is currently no Australian authority that deals directly with the question of whether a transferee with such a claim would be a creditor in an administration or a winding up and whether the transferee's claim would be postponed to unsecured creditors' claims in a winding up; and
- it is clear, in a company liquidation, that shareholder claims that relate to the subscription are postponed to unsecured creditor claims.
In the Australian High Court case of Webb
(1993), which had similar facts to Media World
(but in the context of a liquidation), subscribers were precluded from rescinding their subscription contracts for the shares (and thus from being able to claim as creditors). In any event, their claims for damages for misleading conduct under s52 of the Trade Practices Act 1974
related directly to the subscribers' membership (they claimed as members) and therefore were liable to be postponed in accordance with the predecessor of s563A. There is an equivalent provision under UK legislation. Both provisions support the principle of maintenance of share capital, expressed simply, that members come last on a winding up, in each case protecting creditors from indirect reductions of capital. Webb did not have to consider any distinction between subscribers and transferees.Observations
It is worth noting that the position of ordinary creditors under UK law would seem to be worse than under Australian law (and better for claiming shareholders). Soden
gave a narrow reading to the equivalent of s563A. It expressly decided that transferees with a claim against the company for damages for misleading conduct that induced them to acquire shares, may rank with unsecured creditors in the English administration of a company and that their claims would not be regarded as rights given to members in their capacity as members. According to the House of Lords, what determined the particular capacity in which a member was claiming (ie as a member or creditor) was whether or not the claim of the member was founded on the statutory contract of membership. Lord Brown-Wilkinson emphasised this distinction when he said that the principle is not that 'members come last' but that the 'rights of members as members come last'.
In England, therefore, transferee shareholders do rank equally with creditors in relation to misrepresentation claims. In addition, one of the other barriers to shareholder claims has been removed by statute (see below). Soden
expressly left open the question of how subscribers would be treated in these circumstances.
The position in the UK is not assisted by the fact that the rule in Houldsworth
is, at least in part, overridden by s111A of the Companies Act 1985
(UK). The meaning of this section is still to be decided as a matter of UK law.
In the US, bankruptcy legislation appears to make it clear that both subscribers and transferees as classes of equity holder cannot, through securities fraud claims, bootstrap themselves up to the level of creditor on the insolvency of a company. However, the full extent of the statutory bar is not clear and equity holders still do attempt to claim as ordinary creditors in some insolvencies.
Needless to say, secured creditors need not be concerned by this decision.Crosbie, in the matter of Media World Communications Ltd (Administrator Appointed)  FCA 51
Following an earlier English case Oakes v Turquand (1867).
Section 74(2)(f) of the Insolvency Act 1986 (UK) states that: 'a sum due to any member of the company (in its character as member) by way of dividends, profits or otherwise is not deemed to be a debt of the company, payable to that member in a case of competition between himself and any other creditor not a member of the company.'
The statutory contract being the contract between the members and the company and the members as between themselves constituted by statute.
Section 111A of the Companies Act 1985 (UK) provides that: 'a person is not debarred from obtaining damages or other compensation from a company by reason only of his holding or having held shares in the company or any right to apply or subscribe for shares or to be included in the company's register in respect of the shares.'