On 31 January 2007, in an important Australian decision that may have ramifications for Hong Kong (Sons of Gwalia Ltd v Margaretic [2007] HCA 1), the High Court of Australia, the equivalent of Hong Kong's Court of Final Appeal, held that shareholders with claims for damages against an insolvent company founded on the company's misleading conduct are entitled to prove their claims in competition with the general body of creditors. If the Hong Kong courts adopt a similar approach, this will have potentially very significant ramifications for insolvency practitioners in the conduct of liquidations, for the bond and structured lending markets, distressed debt traders and for anyone concerned in evaluating the credit risk of a company.

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The decision focussed on an Australian statutory provision that, in a winding-up, has the effect of subordinating debts owed to shareholders in their "capacity as a member of the company" in favour of ordinary creditors. In Hong Kong, there is a similar provision in the Companies Ordinance which provides that in a winding-up, debts owed to a member of a company "in his character of a member" will not be treated as a debt of the company in competition with ordinary creditors.

Sons of Gwalia, a mining company listed on the Australian Stock Exchange ("ASX"), was placed under insolvency administration in August 2004. Shortly prior to this the respondent, Mr Margaretic, purchased shares in the company through the ASX. As a result of the company's insolvency, the shares were acknowledged to have nil value. Mr Margaretic lodged a proof with the administrator claiming damages for the loss suffered on the basis that the company had in breach of a statutory obligation failed to keep the market informed of important information regarding its financial capacity and prospects.

The lower courts upheld Mr Margaretic's proof and given the significance of the issue at stake, the administrators appealed to the High Court. Six of the seven judges held that (in broad terms) Mr Margaretic's claim was not one in his "capacity as a member" as his claim was not founded on rights he obtained or any obligations he incurred by virtue of his membership of the company: his claim was based on statutory provisions which conferred a right of action on anyone affected by the misleading conduct, not just a shareholder.

The Court's reasoning was along similar lines to that of an earlier House of Lords decision in Soden v British & Commonwealth Holdings Plc [1998] AC 298. In their decision, the Australian High Court went further than the decision of the House of Lords in Soden, which was confined to the claims of transferee shareholders, extending the decision to include shareholders who obtained shares by subscription and, in so doing, disapproved an earlier, 19th century, House of Lords decision in Houldsworth v City of Glasgow Bank.

For Hong Kong insolvency practitioners, this case may have significant implications for the conduct of their administrations as the reasoning adopted in both Sons of Gwalia and Soden may find favour with the Hong Kong courts. Based on the Australian experience since the first instance decision in Sons of Gwalia in 2005, these may include:

  • The need to evaluate a large number of proofs lodged by shareholders seeking to rank equally with ordinary creditors. This would likely involve difficult quantifications of the loss suffered by shareholders claiming to have been misled into subscribing, buying or retaining shares in the company.

  • Attempts to extend the use of representative proceedings (or "class actions") to establish claims by shareholders against the company.

  • The increased involvement of sophisticated and well resourced professional litigation funders to promote and organise the lodging of proofs against the company by shareholders. (In relation to professional litigation funders, there has been an important recent decision of the High Court of Australia in Campbells Cash & Carry Pty Ltd v Fostif Pty Ltd (2006) 229 ALR 58 - please contact us for further details).

Equally, for financiers, this decision may affect the risk profile of borrowers, especially of those companies that are listed on the stock exchange. Mezzanine debt providers, for example, might now have to take into account the possibility of being subordinated not only to the general body of creditors, but also to a large body of the ordinary shareholders of the company. Closer to insolvency, distressed debt traders may likewise need to factor into their calculations the possibility of returns being diluted by shareholder claims.

For further information, please contact:

Name: Richard M. Tollan
Position: Partner
Phone: +852 2843 4551
Fax: +852 2103 5197