Brash Holdings Ltd. (Administrator appointed) v Katile Pty. Ltd.

REASONS FOR JUDGMENT 1 Media World Communications Ltd (MWC) is a public company whose shares were listed on the Australian Stock Exchange. At some point the company's principal asset was thought to be the intellectual property rights to what has been described as "a unique technology for the representation of very large data sets, such as video, in a much more efficient format". Purportedly the technology enabled data to be encoded, compressed and decoded more effectively than current technology would allow. If true the technology was of value. In April 2004 MWC issued a prospectus in connection with an offer to raise a minimum of $4.6 million in additional capital to enable it to expand its operations and exploit the technology. The capital raising was successfully completed on 10 May 2004. Within a few months, however, the utility and effectiveness of the company's technology was questioned. An announcement to that effect was made to the ASX on 20 September. The share price immediately slumped. On 22 September 2004 the directors called in an administrator, fearing that the company was insolvent. According to Mr Crosbie, the administrator, MWC is insolvent having debts of at least $6.56 million and assets, principally cash at bank, of just over $1 million. 2 The second meeting of the creditors, at which a decision will be taken in relation to the future of MWC, is to be held on 11 February 2005. At the meeting one issue that the creditors must consider is whether the company should execute a deed of company arrangement. A deed is being proposed by Mr Clarke, the alleged inventor of the technology, whose company, Adam 12 Holdings Pty Ltd, is MWC's major shareholder. Mr Clarke's proposal is that he will procure a $5 million capital investment in MWC of which $3 million, together with any cash in excess of $1 million, will be applied in payment of the company's trade creditors in discharge of their claims. The company is then to be returned to the control of a new board. 3 The issue with which this application is concerned has come about in the following way. A number of persons who on the strength of the prospectus subscribed for and were allotted shares in MWC allege that the prospectus contained statements about the utility of the technology that were false and had they known the true position they would not have subscribed for the shares. Those shareholders (I will refer to them as subscribing shareholders) say that they have claims in damages against MWC which they wish to prove in the administration. The claims are founded in tort (deceit and negligence) and under statute, in particular s 9 of the Fair Trading Act 1999 (Vic), which proscribes false or misleading conduct, and s 12DA of the Australian Securities and Investments Commission Act 2001 (Cth), which proscribes misleading or deceptive conduct in relation to financial services which, according to the combined effect of the definitions in ss 12BAA and 12BAB, include an offer for shares. The subscribing shareholders might also rely on s 728 of the Corporations Act 2001 (Cth) which prohibits a person offering shares under a prospectus which is misleading or deceptive. The question which has been raised by the administrator in an application for directions under s 447D is whether the subscribing shareholders can be treated as creditors of MWC for the purposes of its administration. This question is not hypothetical. If the subscribing shareholders are entitled to be treated as creditors the administrator will admit them to proof for he believes they have just claims. In practical terms the consequence of treating subscribing shareholders as creditors is that they can vote at the second meeting of creditors and if it is resolved that the company should execute the proposed deed of company arrangement, they will be bound by that deed in their capacity as creditors. 4 The application was heard last Friday as a matter of urgency. The administrator needs an immediate answer to his question so he can advise creditors of the position well before next week's meeting. Fortunately I have had the weekend to consider the matter which, as it turns out, raises some difficult problems. I also had the benefit of helpful submissions from counsel. 5 The first thing that had to be done was to get the application on the right procedural track. As I said, the application was for directions under s 447D. This procedure is commonly employed by administrators who seek guidance from the court about problems which arise during the course of an administration. But it is not a provision which can be employed to resolve substantive rights of third parties: Re Lorenz's Settlement (1861) 3 Dr & Sm 401, 402 [62 ER 433, 434]. At a preliminary hearing before another judge, Mr Naidoo a subscribing shareholder, and Blackburn's Office Supplies Pty Ltd, a trade creditor, were given leave to be heard in the proceeding. This was done so the views of those who might be effected by the decision were before the court. When those parties filed outlines of argument it became apparent that the administrator had a substantial dispute on his hands. Further, not only would the relief that he seeks directly affect the substantive rights of subscribing shareholders, it would also affect the rights inter se of the subscribing shareholders and the company's trade creditors. And this on an application where none of the people who would be affected were parties, with the consequence that any direction given would not bind anyone and there may not be a right of appeal: Murdoch v Crawford [1986] VR 97, 99-100 and the cases therein cited. In those circumstances I said that I would not dispose of the application unless Mr Naidoo and Blackburn's Office Supplies (or other appropriate persons) were joined as parties and appropriate representative orders made. Only in this way would the court dispense "perfect justice", to adopt the language of the old Chancery Court. In the event joinder orders were made, together with the usual order for the costs of the representative parties. In addition I intend to grant relief in the form of a declaration, being the type of relief that should have been sought. Put differently, I will treat this application as one in which the administrator seeks a substantive remedy, as befits the case. 6 The next thing that must be done is to get the case on the correct legal track. The administrator, whose submissions were supported by Blackburn's Office Supplies, put the following case. For the purposes of Pt 5.3A a creditor is a person who has a debt or claim which, if the company were in liquidation, would be admitted to proof under s 553(1); but a person with a debt or claim which in a liquidation would be subordinated by s 563A (and it was said the subscribing shareholders were in this position) cannot be admitted to proof and is therefore not to be treated as a creditor. Section 553(1) relevantly provides that in a winding up "all debts payable by, and all claims against, the company (present or future, certain or contingent, ascertained or sounding only in damages)" are admissible to proof. Section 563A provides: "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". It was said that the decision in Brash Holdings Ltd. (Administrator appointed) v Katile Pty. Ltd. [1996] 1 VR 24 required acceptance of the submission. 7 One of the questions resolved by Brash Holdings is the meaning to be given to the word "creditor" when used in Pt 5.3A, where it has no defined meaning. The Appeal Division held ([1996] 1 VR 24, 32-33) that having regard to the objects of Pt 5.3A, the word should be given the meaning it has in the winding up provisions. As a result, a creditor for the purposes of the Part is a person who at the commencement of an administration has a debt or claim against the company which is "present or future, certain or contingent, ascertained or sounding only in damages". That is all that the Appeal Division decided. It did not decide that it is necessary to pick up, or incorporate, into Pt 5.3A a section such as s 563A. That section, along with other sections in Pt 5.6, Div 6, Sub-Div D, set out the priority in which claims must be satisfied in a winding up. It is a scheme of priorities which has no role to play in the case of a company in administration. The scheme may be applied to a company that is subject to a deed of company arrangement, but only if the scheme is adopted by the deed itself. In any event, as I will soon show, if applied to Pt 5.3A, s 563A could exclude from proof in the administration of a company a person who may be entitled to prove in the liquidation of that company. That in itself is a sufficient reason to reject the argument. 8 This is not to suggest that s 563A may not be of indirect assistance in determining who is a creditor for the purposes of Pt 5.3A. The winding up provisions of the Corporations Act, as well as other parts of the Act, distinguish between the rights (including the claims) of creditors and the rights (including the claims) of members. As I have shown, one instance of the distinction is in relation to claims made against the fund available for distribution in a winding up. There, claims made by members in that capacity are, speaking generally, subordinated to those made by creditors in that capacity. The reasons for this subordination are the twin privileges of incorporation and limited liability. That is, if a member's liability is limited then the capital which he subscribes, or agrees to subscribe, to the company must be available for creditors. The distinction between the rights of creditors and the rights of members is also to be observed under Pt 5.3A. For example, by s 444D(1) a deed of company arrangement binds all creditors of a company in relation to their claims and by s 444G(b) it also binds the company's members. They are bound as creditors and members in those capacities. 9 If the problem which confronts the administrator in this case had presented itself to a liquidator then, as Cotton LJ said in In re Addlestone Linoleum Company (1887) 37 Ch D 191, 204-205, two questions would arise. The first is whether the shareholders could prove at all for damages for the fraud and misrepresentation which induced them to become shareholders. The second, which would only arise if they are entitled to prove, is whether the shareholders' claims should be postponed to outside creditors. The first question is to be answered by reference to any applicable rule of law and the second (and only the second) is governed by s 563A. As I see it, the first question can arise under an administration (as it does in this case) but the second cannot. Part 5.3A is not concerned directly with the subordination of one class of claimant over another. If there is to be any subordination then, as I have said, that is a matter to be resolved by the creditors through a deed of company arrangement. I should indicate that the ability to subordinate claims is not unlimited. For instance, it is doubtful whether a deed can affect the claims of members qua members. 10 The question that I must answer is whether the subscribing shareholders have claims which they can bring against MWC. The answer to that question is very clear. The rule which was established in Houldsworth's case (Houldsworth v City of Glasgow Bank and Liquidators (1880) 5 App Cas 317) is that a person who has subscribed for shares in a company may not, while he retains those shares (that is, if he has not renounced the contract by which he acquired those shares), recover damages against the company on the ground that he was induced to subscribe for those shares by fraud or misrepresentation. In Webb Distributors (Aust) Pty. Ltd. v State of Victoria (1993) 179 CLR 15, the High Court held that this rule bars not only common law claims but also statutory causes of action unless of course the statute itself overrides the rule. 11 The precise basis for the rule is not altogether clear. The most important of the speeches in Houldsworth's caseare by Earl Cairns, LC and Lord Selborne. The Lord Chancellor said (at 325): "If he [the pursuer] succeeds in that action, this Ł4000 will be paid out of the assets and contributions of the company. But he has contracted, and his contract remains, that these assets and contributions shall be applied in payment of the debts and liabilities of the company, among which, as I have said, this Ł4000 could not be reckoned. The result is, he is making a claim which is inconsistent with the contract into which he has entered, and by which he wishes to abide; in other words, he is in substance, if not in form, taking the course which is described as approbating and reprobating, a course which is not allowed either in Scotch or English law." Lord Selborne said (at 329): "[I]t is impossible to separate the matter of the Pursuer's claim from his status as a corporator, unless that status can be put an end to by rescinding the contract which brought him into it. His complaint is, that by means of the fraud alleged he was induced to take upon himself the liabilities of a shareholder. The loss from which he seeks to be indemnified by damages is really neither more nor less than the whole aliquot share due from him in contribution of the whole debts and liabilities of the company; and if his claim is right in principle I fail to see how the remedy founded on that principle can stop short of going this length. But it is of the essence of the contract between the shareholders (as long as it remains unrescinded) that they should all contribute equally to the payment of all the company's debts and liabilities." 12 There can be no doubt that the rule in Houldsworth's case, which to a substantial extent has been repealed in the United Kingdom (see s 111A of the Companies Act 1985 (UK)), applies in Australia. In Webb Distributors (Aust) Pty Ltd v State of Victoria (1993) 179 CLR 15, 39McHugh J said that "[t]he rule is too deeply entrenched to be set aside by judicial decision." 13 It follows that the subscribing shareholders can only maintain a claim in damages against MWC based on fraud or misrepresentation if they have renounced their shareholding. In the case of a company which is in the process of being wound up the contact to acquire shares cannot be rescinded. This was established in Oakes v Turquand (1867) LR 2 HL 325. The basis for the decision is that upon a winding up the rights of creditors have intervened and cannot be defeated by members. In Tennent v The City of Glasgow Bank and Liquidators (1879) 4 App Cas 615, 622 Earl Cairns LC said that rescission may also be impossible if before liquidation the company has become insolvent and stopped payment of its debts; that is for all practical purposes has gone into liquidation. This proposition was accepted as correct by the High Court in Elder's Trustee and Executor Company Limited v Commonwealth Homes and Investment Co. Ltd. (1941) 65 CLR 603, 618-619. See also In re Lucks Limited [1928] VLR 466, 475 where Irvine CJ held that the principle would also apply when there was "a definite public declaration of insolvency" by the company, as when it has stopped paying its debts even though the business in fact has been kept open as a going concern. 14 In the case of a company in administration there is also a bar to the rescission of a contract for the subscription of shares, but this time the bar is statutory. Section 437F provides that a transfer of shares or an alteration in the status of members of a company that is made during its administration is void except so far as the court otherwise orders. It was not suggested that the rule in Houldsworth's case would not apply because the statutory bar is not absolute. Presumably the rule would apply until the court orders rescission. 15 The result is that subscribing shareholders who have not renounced their shareholding cannot bring an action against MWC based on any false statement in the prospectus and therefore cannot be treated as creditors of the company. But, dependent upon what happens in the future, it is possible that the statutory bar against rescission will disappear. For example, if the administration of MWC comes to an end and the company is returned to the control of its directors, s 437F will cease to have operation to it. In that event the right to rescind will revive unless in the meantime the subscribing shareholders have affirmed their respective contracts to acquire shares. It was not suggested that for this reason the subscribing shareholders should be treated as contingent creditors of MWC. 16 I should also say, lest it be thought that I have overlooked the point, that no argument was advanced in favour of the proposition that subscribing shareholders should be treated as contingent creditors because of the possibility that an order might be made under some other relevant statute, such as s 158 of the Fair Trading Act, that a subscribing shareholder's contract to acquire shares was wholly void. The possibility that such an order could be made might, I do not put it any higher than that, sidestep the rule in Houldsworth's case. In Webb Distributors (Aust) Pty Ltd v State of Victoria (1993) 179 CLR 15, 36-37 the High Court held that a rescission order could not be made under s 87 of the Trade Practices Act 1974 (Cth), a section which is indistinguishable from s 158. However, in a rather bold judgment by the Full Court in Tenji v Henneberry & Associates Pty Ltd (2000) 98 FCR 324, 330-331 it was suggested that this decision has been overtaken by legislative changes. Perhaps the view taken in this case (and it is a view which has much to commend it) is that if there is power to order rescission there is no real prospect of persuading a court to make the order, and for that reason the point was not worth raising. In any event, I suppose again the bar against proof would subsist until an order is made. 17 For the foregoing reasons I will grant a declaration that a member of MWC is not a creditor of that company for the purposes of Part 5.3A in respect of a claim for fraud or misrepresentation by the company which induced the member to subscribe for shares in the company. 18 The administrator also seeks directions regarding how he should deal with shareholders who might allege that the prospectus induced them to purchase shares in MWC on the open market and for that reason wish to prove as creditors. In effect, he invites me to extend the rule in Houldsworth's case to cover shareholders who acquired their shares by transfer. 19 There are reasons why I should not deal with this issue. First no member has come forward alleging that he is in that position. The second meeting of creditors is to be held in a few days time and if there were any such shareholders it is likely they would by now have made themselves known to the administrator. Accordingly the point raised by the administrator may be moot. Second, I have not had the benefit of argument in opposition to the case put by the administrator that these claims, if they exist, should not be admitted to proof. 20 Despite the need for caution, I am prepared to express my opinion on the matter (an opinion which will not be binding on transferee shareholders), substantially for the reason that I have formed the firm view that the position taken by the administrator is wrong and therefore I should give him guidance in case the point does arise. 21 Houldsworth itself was not concerned with a claim by a transferee shareholder, but a subscribing shareholder. Moreover, the reasoning in Houldsworth does not, so it seems to me, easily fit the situation of a transferee shareholder. The case was decided substantially on the basis that there is an inconsistency between a shareholder on the one hand retaining his shares and on the other seeking in effect to recover the amount which he subscribed for those shares. That is the "approbating" and "reprobating" which the Lord Chancellor said ought not be permitted. The taking of inconsistent positions is avoided if the shares are renounced, which is the point made in all the authorities: see by way of example In re Hull and County Bank (1880) 15 Ch D 507, 512-513. A transferee shareholder cannot, however, renounce his shareholding as against the company except in unusual circumstances, as is made clear in cases such as Peek v Gurney (1873) LR 6 HL 337, where it was held that rescission was possible only if the shareholder could establish a direct contract between himself and those responsible for the issue of the prospectus. See also Wallace & Young, Australian Company Law and Practice (1965) at 181. Thus, if the Houldsworth rule were extended to a transferee shareholder the result would be that as he cannot rescind his shareholding in the company he wishes to sue, he would forever be barred from pursuing a claim in damages against the company to vindicate his rights. That would be an intolerable situation and fortunately not one which I am required to create. 22 In any event the decision of the House of Lords in Soden v British & Commonwealth Holdings plc [1998] AC 298 is against the administrator. There it was held that a claim for damages by a defrauded transferee shareholder is not of the same character as a claim by a defrauded subscribing shareholder. The claim of the latter is in substance a claim for the return of his capital. The claim of a transferee shareholder is the same as any other civil claim a person may have against a company, and will not either directly or indirectly produce a reduction of capital. As Lord Browne-Wilkinson, who delivered the principal speech, said (at 326): "The general body of creditors are in exactly the same position as they would have been had the claim been wholly unrelated to shares in the company". I see no error in that reasoning. Indeed, I agree with it. 23 Finally I must deal with Mr Clark and Adam 12 Holdings. They were permitted to make submissions without being joined because Mr Clark is the proponent of the deed of company arrangement and his company is the major shareholder. They now ask for costs in line with those ordered in favour of the representative parties. This order is not opposed and in the circumstances should be made. I certify that the preceding twenty-three (23) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Finkelstein.