CHAPTER 3
KEY ISSUES
Introduction
3.1
The submissions received can be divided into those that discussed the
policy approach of the Bill, and those who were supportive of the Bill but
raised concerns regarding drafting issues. In particular, the submission from
the Law Council of Australia, Corporations Committee (LCA) raised a number of
drafting concerns with the Bill. At the public hearing on
26 October 2010, the Committee requested that The Treasury provide a
response to these drafting concerns.
Approach of the Bill
3.2
As previously noted by the CAMAC report[1],
there are divergent views regarding the appropriate status of shareholder
claims against insolvent companies. These opposing views were reflected in the submissions
and evidence received by the committee. The key issues and concerns raised
during the inquiry include:
-
the appropriateness of aggrieved shareholder creditors ranking
equally with unsecured creditors in an insolvency process;
- the impact of the Sons of Gwalia case on access to credit for
Australian companies;
-
the effect of allowing aggrieved shareholders claims on external
administrations; and
- the issue of investor protection.
Aggrieved shareholder claims and
unsecured creditors
3.3
Chartered Secretaries Australia (CSA) were broadly supportive of the
Bill, noting that it 'merely restores the position, well understood by the
market, creditors and shareholders, as to priorities of payment in the event of
insolvency'.[2]
Principally, CSA was concerned that the approach in the Sons of Gwalia case
could negatively affect the rights of creditors. During the insolvency process,
creditors may have the choice to vote on whether a company should end
administration and resume trading, enter into a deed of company arrangement (a
binding arrangement between a company and its creditors governing how the affairs
of the company will be dealt with) or should be wound up. CSA stated that, if
aggrieved shareholders had the same right to vote at a creditors' meeting, they
could 'decisively influence administration outcomes'.[3]
3.4
In this context, the EM notes that in most liquidations, unsecured
creditors receive, at best, a small percentage of the funds they are owed. It
describes a scenario where 'there could be 5000 aggrieved shareholders...[and] their
votes could significantly affect the efficacy of the liquidation and reduce the
returns for other creditors'.[4]
3.5
The relative positions of shareholders and unsecured creditors were
contrasted in several submissions. For example, the Australian Financial
Markets Association (AFMA) argued that unsecured creditors should be
differentiated from shareholders because:
....unlike shareholders, they do not take an investment risk
on the company; rather they provide their goods and services on commercial
terms with credit as part of that business arrangement.[5]
3.6
Similarly, Mr Robert McKenzie of the LCA stated:
Ordinary unsecured creditors like trade creditors are not in
the same position as shareholders. Shareholders take risks in order to get
capital appreciation and dividends paid out of profits. Unsecured creditors do
not get that opportunity.[6]
3.7
CSA highlighted the importance of maintaining the distinction between
debt and equity in a limited liability company. CSA's view was that
shareholders should absorb the risk of insolvency as part of the risks they
take in acquiring shares and that, until the Sons of Gwalia case, creditors
expected to have priority over shareholders in having access to the company's
equity base during an insolvency process. Further, while shareholders risk
losing their equity investment, they also benefit from the distribution of any
dividends and any capital gains from their shareholding. In contrast, creditors
can only recover the principal owed to them (as well as interest in some cases).[7]
3.8
This position was not accepted by IMF Australia, which quoted the High
Court judgement in the Sons of Gwalia case to support its position. In that
case, then Chief Justice Gleeson stated that what determined the case was that
the respondent's claim was not founded in his rights as a shareholder but the
obligations that arose by virtue of the company's conduct.[8]
IMF Australia did not agree that shareholders should 'assume the risk of that
they will be lied to when making investment decisions as part of the trade off
for gaining a share of any potential profit or capital gain'. Further:
Shareholders, as with all other beneficiaries of the [market
protection regime], should be able to expect the companies with whom they deal
to comply with their statutory obligations and invest freely in and allocate
capital within, the market on that basis.[9]
3.9
It was also noted that many creditors have options to protect their
interests if a company becomes insolvent. Recoveries and Litigation Support (RLS)
noted that banks concerned about loans to companies have the option to secure
those loans and should not be preferred over aggrieved shareholders.[10]
Similarly, IMF Australia disputed the position in the EM that 'as the
shareholder group...is best able to manage the risk of management misconduct,
shareholders as a group should bear the cost of failing to manage this risk'.[11]
3.10
IMF Australia noted that, in the modern equity market, shareholders
remain outside of the relevant company and have little influence on its
operation, or insight into its performance. IMF Australia contrasted the
position of shareholders with that of trade creditors and unsecured finance
creditors 'who are typically much closer to the company' and banks who 'are always
in close contact with company management' and can access the company's records
to assess the risk of their loans. While the above groups have options to
protect themselves from company insolvency, 'only investors in the shares of
the company are unable to take steps to secure their position at the time they
enter into their transaction with the company'.[12]
Access to credit
3.11
A key rationale for the Bill was the effect of the Sons of Gwalia case
on access to credit and debt financing for Australian companies. As the EM
stated:
The effect of Sons of Gwalia v Margaretic is to shift
losses suffered by shareholders, due to misleading conduct or non disclosure,
from shareholders to unsecured creditors.
By reducing the likely return to unsecured lenders in the event
of insolvency, the decision is likely to increase credit spreads for unsecured
debt and to adversely affect the availability of credit, particularly in
respect of distressed companies and companies where there have been concerns
regarding corporate disclosure.[13]
3.12
The Australia Financial Markets Association (AFMA) supported this
position, noting that its members were 'of the firm view that the practical
effects of the High Court's decision...on lending behaviour are harmful and
warrant a change to the law'.[14]
AFMA argued that, while the Sons of Gwalia decision was expected to only affect
a few cases, it has broader relevance 'because lenders are unable to determine
which cases it will ultimately apply at the time credit is given'. Since the
natural reaction of lenders in these circumstances is to increase the cost of
credit, tighten credit conditions or reduce the amount of unsecured credit made
available, this has 'undesirable consequences for Australian companies seeking
to finance their businesses through debt issues'.[15]
3.13
While AFMA acknowledged that it was not possible to provide data to
measure the precise effect of the Sons of Gwalia decision, it had received
'consistent and broad based feedback from member firms reporting the harmful
effect of the decision on the price and availability of unsecured lending in
recent years'.[16]
3.14
AFMA noted the significance of overseas finance for Australian
companies, highlighting that foreign investors hold 79 per cent of bonds issued
by Australian non-financial companies. It argued that the Sons of Gwalia case
had disadvantaged Australian companies seeking funding in international debt
markets, especially in the United States:
Investors in this market are accustomed under US law to all
shareholders, whether aggrieved or not, being subordinated to secured and unsecured
creditors. Consequent to the Sons of Gwalia decision, some US corporate bond
market investors have a markedly reduced appetite for unsecured Australian
debt.[17]
3.15
AFMA also informed the Committee that its members expected that
reversing the effect of the Sons of Gwalia case 'will increase the availability
and lower the cost of unsecured debt finance for Australian companies...[and]
assist development of the corporate bond market in Australia by providing greater
certainty and lowering the risk associated with unsecured corporate debt'.[18]
3.16
CSA was also deeply concerned that the decision in the Sons of Gwalia
case would affect opportunities for Australian companies to obtain debt finance
or credit in the United States, which would ultimately disadvantage Australian
shareholders.[19]
In particular:
Potential lenders to any Australian company will be
confronted with higher risk on unsecured debts (a lower recovery rate in the
case of company failure) than before. Consequently, CSA is of the opinion that
interest rates charged on unsecured debt will increase to compensate for the increased
risk.[20]
3.17
In contrast, IMF Australia considered it a 'remarkable fact' that the
Bill was undergoing parliamentary scrutiny 'without any evidence of the cost or
availability of debt being affected by the Sons of Gwalia decision having been
made public'. It noted that the experience in the United Kingdom, which does
not discriminate between shareholder claims and other unsecured creditors
'suggests the effect is negligible, if existent at all'.[21]
IMF Australia contended:
In Australia, there has been no evidence that the Sons of
Gwalia decision resulted in any increase in credit margins or difficulty for
Australian companies to raise debt finance.[22]
3.18
IMF Australia also argued that, to make a reasoned decision on the Bill,
Parliament would need evidence in respect of a number of factors, including
'the nature and extent of any increased costs of, and access to, debt financing
caused by the Sons of Gwalia decision'.[23]
Effect on external administrations
3.19
The EM to the Bill states that the Sons of Gwalia decision 'has had a
negative effect on costs and delays in the conduct of some external
administrations, and consequentially a diminution of returns to creditors'. It
notes:
Costs and delays arise due to the complexities introduced
into external administration in respect of identifying which parties are
creditors and the quantification of their claims for the purpose of providing
access to information, determining voting rights and making distributions of
funds.[24]
3.20
However, Recoveries and Litigation Support (RLS) supported the position
established by the Sons of Gwalia case. It suggested that unsecured creditors
and admitted shareholder creditors had received significant funds through the
administration process in the Sons of Gwalia case (21 cents in the dollar).[25]
This presumably also indicates that payments for creditors had not been diluted
through the claims of aggrieved shareholders.
3.21
RLS noted that, contrary to an argument made in the CAMAC report, Shareholder
claims against insolvent companies, the issue of complexities in
determining shareholder claims had not been evident in the Sons of Gwalia case:
The established and successful Gwalia administrators'
processes and documentation can be used as an example to establish a regime to
deal with aggrieved shareholders claims in other failed companies which have
fraudulently misled or deceived their investors.[26]
3.22
IMF Australia also did not accept the argument in the EM. It argued that
only a few insolvency administrations each year will be affected and distinguished
the Sons of Gwalia example where the administrator dealt with 8000 shareholder
compensation claims within about a year:
Not many cases will be as complicated as the Sons of Gwalia
administration. The position adopted by the administrators of that company,
from personal experience, is such that administrative complexity can no longer
be used as an argument in favour of the Bill.[27]
3.23
However, the Insolvency Practitioners Association noted it had previously
made submissions to government explaining the negative impact on insolvency
administrations of the decision in Sons of Gwalia. It pointed to a recent
Federal Court decision that 'illustrates the difficulties for a liquidator in
managing large shareholder claims based on a company's alleged
misrepresentations, and the need for the court to intervene using existing law
in order to facilitate the progress of administrations'.[28]
3.24
CSA also perceived the potential for uncertainty for administrators in
adjudicating the claims of aggrieved shareholders and the risk of substantial
delay for creditors. The approach in the Sons of Gwalia case could divide the
rights of shareholders, creating uncertainty and allowing recent shareholders
to make a claim due to inadequate disclosure by the company, while longer term
shareholders may have no claim. CSA was also concerned that shareholders could
claim equal rights with creditors without having to prove their claim, potentially
leading to speculative claims.[29]
3.25
Mr Robert McKenzie of the LCA commented that a majority of its members
supported a change in the law to restore the position in respect of shareholder
claims prior to the Sons of Gwalia case. He stated:
The reason for this prevailing view is that dealing with
shareholders claims causes delays, increased complexity, increased costs and
increased court involvement, all of which prejudice the financial returns for
other unsecured creditor claims. Dealing with the shareholder claims and other
unsecured creditors equally is therefore contrary to the efficient and
cost-effective administration of an insolvency regime in our submission. More
of the assets are lost in administration costs rather than being returned to
creditors as dividends. [30]
Investor protection
3.26
The EM notes that, if shareholder claims are not subordinated, the
burden of meeting compensation claims falls on unsecured creditors instead of
those who are responsible for or who benefited from the misconduct of the
company. The situation created by the Sons of Gwalia decision, 'does not,
therefore, create any incentive for those who are responsible for misconduct
(or who take advantage of misconduct) to adopt alternative behaviour'.[31]
3.27
IMF Australia disagreed with this assertion:
This argument...falsely assumes that directors of listed
companies contemplating breaching the Market Protection Regime are only
deterred from doing so because their company or themselves may have to pay
compensation if they breach the legislation and are caught. IMF submits that
the primary deterrent effect of the Market Protection Regime is the negative
effect on the directors' reputations that would arise on being publicly
identified as the cause of the companies' legislative breach. The compensation
is usually covered by insurance, but the directors' reputations would be
permanently harmed.[32]
3.28
IMF Australia noted that the whole foundation of the market protection
regime 'rests on companies being able to be held accountable for breaches'. It argued
that subordinating defrauded shareholders from claiming damages against a
company 'would be to eschew the purpose for which the Market Protection Regime
was designed'.[33]
Specifically:
A direct consequence of the passage of the Bill will be to
make unviable the enforcement of the Market Protection Regime... [It] will
become commercially unviable to enforce against companies with net unsecured
assets of less than about $50 million (that is "Small to Medium Cap
Companies") unless it is known to the victims of the contravention at the
commencement of proceedings that the company has insurance that will materially
respond.[34]
Drafting concerns
3.29
A number of submissions were broadly supportive of the approach adopted
by the Bill but also pointed to areas where there could be greater clarity in
the proposed legislation. Some submissions suggested a range of amendments to circumvent
possible unintended consequences for the operation of other sections of the
Corporations Act.
General issues
Debts and claims
3.30
The Insolvency Practitioners Association (IPA) highlighted that the
wording in proposed new section 563A 'does not accord with section 553 of the
Corporations Act [dealing with debts or claims that are provable in a winding
up] which refers to "debts payable" (not owed) by the company, and to
"all claims against" the company'.[35]
3.31
The IPA also contrasted the wording in subsection 563B(2) that 'payment
of the interest is to be postponed until all other debts and claims in
the winding up have been satisfied' with that in proposed new section 563A
which only refers to claims.[36]
As the IPA explained:
If there is a judgment debt obtained against the company by a
person arising from the person buying, holding, selling or otherwise dealing in
shares in the company, that debt may not be subordinated...This is because a
debt is different from a mere claim. In that case, the shareholder who was
misled, and who has a judgment for the loss suffered, would be able to prove in
the insolvency of the company along with all other creditors....The question
would then arise if that shareholder creditor has recovered its judgment debt
from the company before its formal insolvency - should that creditor then be entitled
to retain it, or should the law provide that the insolvency practitioner has a
right of recovery of the amount paid to the shareholder by the company?...The
proposed provisions do not directly deal with these issues and they are left
unclear.[37]
3.32
The LCA also suggested that proposed new subsection 563A(1) should refer
to 'all other debts owed by or claims made against' a company to make it
consistent with other provisions within Subdivision D of the Corporations Act
and proposed new subsection 563A(2). Similarly this could apply to the
proposed new section 600H which could be changed to 'a person whose debt or
claim against the company'.[38]
3.33
In response the Treasury noted that, while it may improve consistency
with other provisions of the Corporations Act, the inclusion of 'debts' in
addition to claims in proposed subsection 563A(1) is unnecessary as '[c]laims
made against a company will include all debts owed by the company'.[39]
3.34
The Treasury later provided additional information to the committee,
stating that, in relation to this matter, the amendments proposed by the LCA
'would not undermine the intended policy underlying clause 2 in the Bill'.[40]
Return of capital
3.35
In addition, the LCA noted that current section 563A subordinates 'debts'
owed to members to all 'debts owed to or claims made by persons otherwise
than as a member of the company'.[41]
It argued that 'qualification has been lost in the wording of the proposed
s563A and leaves an unintended lacuna whereby a 'subordinate claim' is arguably
subordinated to all other claims (including those by members for a return of
capital).[42]
At the public hearing, Mr McKenzie commented:
...there are different types of claims: where shareholders
are involved; where a dividend has been declared; and where there is misleading
and deceptive conduct—or for a return of capital. Obviously we do not want the
return of capital to be caught in this; it never has been and should not be.
So, effectively, what we are asking there is just to make sure that that is the
situation by essentially clarifying what sorts of claims to rank above the
subordinated claims.[43]
3.36
The LCA recommended that this section be made clearer by being amended
to read:
The payment of a subordinate claim made against a company is
to be postponed until all other debts or claims admissible to proof
against the company under s553 are satisfied.[44]
3.37
However, according to The Treasury, the status quo is maintained in
respect of the ranking of claims for return of capital:
It is our view that subsection 563A(2) definition is broad
enough to cover claims for return of capital. Such claims are therefore
necessarily excluded from "other claims" in subsection 563A(1).
It should be noted that the effect of section 563A is to rank
certain claims below non-subordinated claims. It does not override any other
rules regarding the ranking of subordinated claims amongst themselves. It will
therefore not have the effect of making return of capital claims rank equally
with, say, unpaid dividend claims.[45]
3.38
Nonetheless, The Treasury appeared to alter its position, indicating in
further information provided to the committee that it did not oppose the LCA's
suggested amendments above. It stated:
...the suggested amendments provide that the claims referred
are only those that are admissible to proof and that such amendments would
maintain the intended policy underlying clause 2 in the Bill. In view of this,
Treasury does not oppose these LCA proposed amendments. [46]
'A person'
3.39
The LCA also suggested that proposed new paragraph 563A(2)(b) may be too
widely drafted, and could refer to a claim by a person against the company
arising from another person dealing in the shares. For greater certainty, the
section could be amended to read 'any other claims by a person that
arises from that person' buying, holding, selling or otherwise dealing
in shares in the company.[47]
3.40
The Treasury conceded that there was possible ambiguity due to the
inclusion in the text of 'a person' in proposed new paragraph 563A(2)(b) and informed
the committee that it would examine whether the paragraph as drafted will give
effect to the government's intent:
Treasury will examine whether the paragraph as stated will
give effect to the Government's policy intention. We note that any possible
ambiguity could be addressed by the simple removal of the offending words.[48]
3.41
The Treasury later provided additional information to the committee,
stating that, in relation to this matter, it does not oppose the removal of 'a
person' from paragraph 563A(2)(b).[49]
Nominees and custodians
3.42
Allens Arthur Robinson (AAR) commented that the broad language in
proposed new paragraph 563A(2)(b) was necessary:
...because most equity investors do not become
"members" directly; they are not entered on the register, but hold
beneficial ownership through nominees and custodians, who are entered on the register...[F]urther,
many equity investors invest through warrants and other rights with respect to
shares.
3.43
However, AAR argued that the wording used in the Bill does not
adequately cover this issue because it only deals with holding and dealing in
the shares themselves, rather than interests in shares and rights with respect to
shares. AAR's suggested approach was to redraft proposed new paragraph 563A(2)(b)
to read:
(b) any other claim that arises from a person buying,
holding, selling or otherwise dealing in, or with respect to, shares in the
company or interests in, or rights with respect to, shares (issued or unissued)
in the company, including rights against any person to acquire or dispose of
shares or interests in shares in the company.[50]
3.44
In response, The Treasury noted that the Bill:
...reflects the intention that subordination will not extend
to claims arising from dealings in non-shareholder equity interests, e.g.
transactions in derivatives. Such claims were not understood to be subordinated
by section 563A prior to the Sons of Gwalia decision.[51]
3.45
The Treasury also drew attention to the CAMAC report which recommended
that, if the government chose to 'reverse' the effect of the Sons of Gwalia
decision, 'subordination of claims arising from shareholder interests should
not extend to claims arising from other kinds of equity interests'. Further:
In the case of nominees or custodians, claims arising from
their buying, selling, holding or dealing in shares will be subordinated by the
provision. The provision does not require the buying etc of shares to have been
carried out by the person making the claim.[52]
Definition of 'external
administration'
3.46
The LCA highlighted the use of the term 'external administration' in
proposed section 600H, noting that this term is not defined in the Corporations
Act. The LCA submitted that the wording of the proposed section should be
clarified to indicate:
(a)
if proposed paragraph 600H(a) is to apply to schemes of arrangement
under Part 5.1 of the Corporations Act; and
(b)
the ambit of the term 'external administration' in proposed paragraph
600H(b) (ie. whether it is confined to the forms of external administration in
section 600H(a)).[53]
3.47
Specifically, the LCA suggested that the words 'during the external
administration of the company' in proposed paragraph 600H(b) be replaced with
'while the company is an externally administered body corporate'. Such an
amendment would make use of an existing defined term in the Corporations Act.[54]
3.48
The Treasury outlined the various uses of the term 'external
administration' in the Corporations Act. In particular, it commented that
Chapter 5 of the Corporations Act is headed 'External Administration' and, with
one specialised exception, all kinds of corporate insolvency proceedings are
included in that Chapter. In its view, the term 'external administration' would
'be read in line with the intended policy underlying the Bill and in accordance
with the ordinary meaning of the term as all kinds of corporate insolvency
administration under the Corporations Act'.[55]
3.49
However, The Treasury later provided additional information to the
committee:
Treasury notes that a definition of external administration
could be inserted into section 600H to address the LCA's concerns. If
appropriate, the definition could be accompanied by explicit references to
processes to which the provision is intended to apply. This would address the
LCA's concerns and still give effect to the underlying policy behind the Bill.[56]
Statutory interest claims
3.50
The LCA also drew attention to the need for clarity regarding the
ranking of statutory interest on claims pursuant to subsection 563B(1) which
provides for interest to be added on to debts or claims paid by a liquidator in
the winding up of a company. Subsection 563B(2) provides that payments of
interest on these debts and claims are postponed until all other debts and
claims in the winding up have been satisfied, other than debts owed to members
of the company.[57]
The LCA noted that this is difficult to interpret consistently with proposed new
section 563A and, accordingly, raises a number of questions for consideration.[58]
3.51
At the public hearing, Ms Barbara Gordon of the LCA elaborated:
[D]o we want our Sons of Gwalia claims to be paid out before
any of the other creditors are paid interest on their debts? That is one
question. If the answer to that is no, then what will happen is that the
existing creditors will get their 100 cents in the dollar. They will then get
interest on those debts. Then the Sons of Gwalia type claims and the other
existing claims for dividends et cetera which fall within the definition of 'subordinate
claim' would then presumably be payable, and we would be guessing—and that is
all we are doing at the moment—from the draft of the legislation that interest
should then be payable in relation to those claims once both paragraphs (a) and
(b) have been paid. But this is a question that needs consideration, some sort
of decision needs to be made and then the legislation needs to be tweaked to
amend section 563B to reflect the outcome of that consideration.[59]
3.52
The response from The Treasury to
these concerns noted that the existing rule was that claims covered by the
current section 563A are ranked after payment of non-subordinated claims and
after payment of interest on those non-subordinated claims. The Treasury
maintained that the Bill was not intended to alter this approach and that this
was not an issue that had been raised during the CAMAC examination or exposure
draft consultation. However, The Treasury acknowledged the potential problem
highlighted by the LCA:
The LCA supplementary submission does highlight a possible
issue regarding whether the current cross referencing in section 563B will be
read as referring to all subordinated claims (as intended) in subsection 563A(2)
or only to paragraph 563A(2)(a) claims...Treasury will examine whether the
paragraph as stated will give effect to the Government's policy intention.[60]
3.53
The Treasury later provided additional information to the committee on
this matter:
To address the LCA's concern, section 563B could be amended
to clarify that interest on non-subordinated claims will rank above all
subordinated claims under the proposed section 536A. Treasury does not oppose
these LCA amendments.[61]
Schemes of arrangement
3.54
Where a company may become insolvent (or already is insolvent), there
are several forms of external administration available so that control of the
company's affairs is taken from the company's directors and put into external
hands. These include voluntary administration, receivership, creditors' schemes
of arrangement and winding up.[62]
3.55
A creditors' scheme of arrangement is one form of external
administration of a company in financial difficulty. Under a creditors' scheme
of arrangement, a company may restructure its debts through a compromise of
creditors' claims to avoid liquidation. A scheme binds creditors only if it is
approved by a majority of creditors and must also be approved by the court.[63]
The Treasury explained further to the committee:
Section 411 [of the Corporations Act] provides that a
creditors' scheme of arrangement is binding on a class of creditors only if a majority
by number and more than 75% by value of creditors in that class vote for the
scheme. There are separate requirements for votes by members (in that capacity)
in a members' scheme of arrangement.
Approval by the Court is also required before a scheme can
bind a class of creditors or members. This provides protection against abusive
schemes.[64]
3.56
The creditors' scheme of arrangement option has not been commonly used since
the voluntary administration procedure is regarded as being subject to less formality,
delay, expense and greater flexibility of outcome.[65]
Nonetheless, the LCA argued 'there may be a resurgence in popularity of
creditors' schemes of arrangement in the wake of recent court decisions'[66]
and 'schemes of arrangement [might] regain popularity in the context of claims
against the company where creditors will also have claims against third parties
arising out of the same circumstances'.[67]
3.57
The LCA also noted that the postponement of claims by proposed new section
563A 'is confined to the context of winding up' a company, meaning that the
Bill does not adequately address situations where there is an attempt to
formally reconstruct an insolvent company through a scheme of arrangement
process. In particular, an insolvent company will be unable to use a scheme of
arrangement to achieve an effective compromise with creditors and shareholders
with 'subordinate claims' as these claims will survive any reconstruction of
the company.[68]
3.58
Ms Barbara Gordon explained further:
With this legislation clause 600H(b) deprives [subordinated
creditors] of their right to vote...The problem with a scheme of company
arrangement, however, is that a scheme will only bind a class of creditor who
has voted in relation to the scheme....The legislation as it is proposed
effects a postponement of the subordinate claims; it does not extinguish
them...That is the reason for the problem. You cannot reconstruct a company and
come out clean on the other end if these subordinated claims survive the
reconstruction, so there needs to be some mechanism for binding these claimants
to the reconstruction...[69]
3.59
The LCA suggested that the most efficient solution to accommodate the
scheme of arrangement process is to amend proposed new paragraph 600H(b) (which
restricts the capacity of creditors with subordinate claims to vote when the
company is in external administration) to clearly not apply in the context of
schemes of arrangement. Alternatively, part of the Corporations Act dealing
with the administration of creditors' compromises could be amended to
extinguish the subordinate claims where 'the return to those creditors will be
less than complete satisfaction of their debts and claims'.[70]
3.60
The LCA summarised their concerns about the effect of the Bill on
creditors' schemes of arrangements as: (a) the lack of clarity regarding the
application of proposed paragraph 600H(b) on meetings convened for approving a
scheme of arrangement; (b) that proposed new paragraph 600H(b) may have no
application if a scheme is proposed by creditors or the company itself (as the
proposed section is restricted to 'during' external administration); and (c)
the lack of clarity regarding whether a company subject to a scheme of
arrangement is in 'external administration' for the purposes of 600H(b).[71]
3.61
In relation to proposed new section 600H, the Insolvency Practitioners
Association also noted a number of drafting issues. These were as follows:
- proposed new section 600H refers to 'person whose claim against a
company is postponed', but it is the payment not the claim which is postponed;
- proposed new section 600H should be included in the list of
sections allowing electronic communications in section 600G; and
- proposed new section 600H allows a person to apply to a court for
the right to vote, but the law should allow representative applications on
behalf of groups of shareholders.[72]
3.62
In its response to the issues raised by the LCA, The Treasury initially commented
that schemes of arrangement involving shareholder compensation would be
expected to occur 'very rarely', that is:
In recent years, there have been nil to four insolvency
related schemes of arrangement per year. Overwhelmingly, reorganisations occur
through the non-court based process afforded by voluntary administrations. In
recent years, there have been approximately 1500 to 2100 voluntary
administrations per year.[73]
3.63
However, The Treasury clarified its view on the effect of the Bill with
respect to schemes of arrangement, outlining two possible scenarios. In the
first, the court grants subordinated shareholder compensation claimants leave
to vote (for example where the court determines it is appropriate they should
vote, in light of factors such as whether they have a financial interest in the
company) and they are bound if the class of creditors collectively votes 'yes'.
In the second, the court does not grant subordinated shareholder compensation
claimants leave to vote and consequently the scheme cannot bind them.[74]
3.64
The Treasury noted this second scenario will mean subordinated
shareholder compensation claimants 'will effectively remain free to frustrate
deals in relation to matters in which they may have no demonstrated interest
(or to use their ability to frustrate deals to extract from other stakeholders
a financial interest which they would not otherwise be entitled to)'. Therefore:
Treasury is examining whether, in respect of any schemes of
arrangement that might arise in respect of companies subject to shareholder
compensation claims, the Bill is effective in achieving its policy objectives.[75]
3.65
The Treasury later provided additional information to the committee,
noting it had undertaken further discussions with the LCA regarding its
concerns:
It is Treasury's understanding that the LCA's concerns may be
addressed by amendments that would have the effect of providing that a Part 5.1
compromise or arrangement would be binding on creditors with subordinated claims
who had not been given leave to vote, despite the fact that a meeting of that
class of creditors had not been ordered by the Court under section 411(1).
Treasury does not oppose these LCA proposed amendments.[76]
Subsidiaries
3.66
Allens Arthur Robinson (AAR) suggested that the Bill should also
subordinate claims against subsidiaries to ensure that claims by shareholders
are not picked up by class order deeds of cross guarantees issued by the
company and its subsidiaries. The result would be that shareholders have claims
against subsidiaries which rank equally with creditors of those subsidiaries.[77]
3.67
In response to this issue, The Treasury stated 'that where a shareholder
made a claim against a subsidiary and the subsidiary then sought contribution
or indemnity from a parent company, the later claim is not considered to have
been subordinated under the current section 563A'. It also noted that the Bill
does not purport to alter the status quo in respect of this issue.[78]
Application provision and
commencement
3.68
Several submissions raised concerns regarding which claims the Bill
would apply to and the commencement of the Bill. AAR's submission noted that
Item 4 of Schedule 1 of the Bill provides that proposed section 563A 'applies
to a claim that arises after this Schedule commences'. AAR was concerned that
this would mean that claims which 'arise' prior to the Schedule's commencement would
continue to enjoy the priority afforded to them according to the principles in
the Sons of Gwalia case. Since proposed new section 563A is an amendment to a
provision of the Corporations Act which operates in relation to external
administrations, AAR argued it was therefore appropriate that the provision
operate by reference to the commencement of the relevant external administration
and not when the relevant claims arose. AAR submitted that the wording should
be amended to:
(1) Section 563A of the Corporations Act 2001, as amended by
this Schedule, applies to a claim made against a company if the external
administration of the company commences after this Schedule commences.[79]
3.69
AAR commented that, as it stood, the benefits of the Bill would be
delayed for a considerable period, 'possibly until all shareholder claims which
arose prior to the enactment of the Bill are statute-barred'.[80]
AAR also stated that the current proposed transition provision could result in
situations where 'aggrieved shareholders making claims within the same external
administration will be subject to different priority regimes depending on
whether their claims arose prior or subsequent to the commencement of the
Bill'.[81]
3.70
The Insolvency Practitioners Association considered that section 553
'adopts clearer wording which should be used in the application provision'.[82]
Subsection 553 (1) provides:
...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.
3.71
Australian Financial Markets Association also expressed concern about
any delay in the commencement date of the Bill:
...if the legislation was to be substantively amended or its
passage delayed for an extended period...[this] could harm Australia's standing
as an investment location, especially amongst international investors who are
anticipating enactment of the legislation.[83]
3.72
The EM states that the Bill does not have retrospective effect.[84]
The Treasury responded that the Bill applies to claims arising after
commencement and noted that this reflects an 'underlying policy decision that
the Bill should not reduce the value of existing property rights of some
claimants with a corresponding increase in the value of property rights of
other claimants'. The Treasury further advised the committee:
Legal advice has been obtained that indicates that doing so
without providing adequate compensation to the persons whose property rights
are adversely affected may amount to a constitutionally impermissible acquisition
of property.[85]
Conclusion
3.73
The committee acknowledges that the proposed measures in the Bill
comprise an important amendment to a complex area of corporate regulation. This
is intended to implement the government's policy of reversing the effect of the
High Court's decision in the Sons of Gwalia case.
3.74
The committee recognises that conflicting viewpoints exist in relation
to the issue of ranking aggrieved shareholders claimants during a corporate
insolvency process. The committee agrees with the approach in the Bill and the
position that these claims should not rank equally with unsecured creditors and
trade creditors. As noted in a number of submissions, the Bill restores the
commonly understood position which existed prior to the Sons of Gwalia case.
3.75
The committee acknowledges the statement made by IMF Australia that further
inquiries should be undertaken regarding the effect of the Sons of Gwalia case
on access to credit for Australian companies.[86]
While the committee agrees this data would be useful in considering the Bill,
it agrees with the Australian Financial Markets Association that:
...it is not possible to provide data to measure the precise
effect of the Sons of Gwalia decision and related government decisions, given
the nature of the response by lenders, the impact of the global financial
crisis and the range of other factors that impact the level and terms of
unsecured lending.[87]
3.76
It is unfortunate that some of the drafting issues identified in this
inquiry were not previously raised during the exposure draft consultation and
resolved prior to the introduction of the Bill into Parliament. However, the
committee appreciates the efforts of submitters and witnesses, in particular
the Corporations Committee of the Law Council of Australia, for raising
potential issues with the drafting of the Bill. The committee also acknowledges
The Treasury for promptly responding to these drafting concerns, once they were
drawn to its attention.
3.77
The Treasury has indicated that it does not oppose the amendments to the
Bill proposed by the Law Council of Australia which are highlighted above. Consequently
the committee considers that these proposed amendments should be incorporated
before the Bill is passed into law. Since the sections of the Corporations Act
dealing with corporate insolvency 'are interpreted closely by the courts',[88]
it would be unfortunate if consequential amendments were required to address
any unintended consequences caused by drafting concerns in the Bill.
Recommendation 1
3.78 The committee recommends that, subject to the drafting
matters raised by the Law Council of Australia during this inquiry being
addressed, the Senate pass the Bill.
These drafting matters are:
- the inclusion of 'debts', as well as 'claims' in relevant
proposed new sections to ensure the consistent use of terminology in the
Corporations Act;
- the amendment of proposed new subsection 563A(1) to clarify the
types of claims which rank above subordinated claims;
- the amendment of proposed new paragraph 563A(2)(b) to clarify
that a claim by a person against a company must arise from that person's
involvement in dealing in the relevant company's shares;
- the amendment of current section 563B of the Corporations Act to
clarify that statutory interest on non-subordinated claims will rank above
subordinated claims under proposed section 563A;
-
the insertion of a definition of the term 'external
administration' in proposed new section 600H; and
- amendments to ensure that the Bill does not disturb the effective
operation of creditors' schemes of arrangement.
Senator Trish Crossin
Chair
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