Cadence Asset Management Pty Ltd v Concept Sports Limited

REASONS FOR JUDGMENT Introduction 1 The question in the present appeal is whether a subscriber for shares offered pursuant to a prospectus can recover from the company that issued the prospectus the loss suffered as a result of the subscription without the subscriber rescinding the contract to acquire the shares. The question is of some importance as a subscriber can no longer rescind the contract pursuant to which it acquired the shares if the shares have been sold by the subscriber, or if the company that issued the prospectus is in liquidation. 2 Section 729(1) of the Corporations Act 2001 (Cth) ('the Act') provides that 'a person' who suffers loss because an offer of securities in a prospectus contravenes s 728 of the Act may recover that loss from the person making the offer. In the usual course, that person will be the company issuing the prospectus. However, in Cadence Asset Management Pty Ltd v Concept Sports Limited [2005] FCA 1280 the primary judge decided that s 729(1) is subject to the rule in Houldsworth v City of Glasgow Bank (1880) 5 App Cas 317 ('Houldsworth'). The rule protects creditors as it maintains the capital of a company by preventing a shareholder, whether directly or indirectly, from receiving back any part of the shareholder's contribution to the capital of the company. 3 Applying the rule in Houldsworth, the primary judge concluded that a shareholder wishing to rely on s 729(1) of the Act to sue a company to recover loss suffered in its capacity as a shareholder must first rescind the contract to acquire the shares, which it can no longer do if the company is in liquidation or if the shares have been sold by the shareholder to a third party. Accordingly, the primary judge ordered that the claim for loss under s 729(1) made by the appellant be dismissed, because the appellant was a subscribing shareholder that had sold its shares and had not rescinded its contract to acquire the shares. The order was made on the basis of the pleading of the appellant's claim, made pursuant to s 729(1), against the company issuing the prospectus. The order was therefore an interlocutory order but the Full Court granted the appellant leave to appeal. Background 4 The first respondent ('Concept Sports') issued a prospectus offering 24 million shares at an issue price of $0.50 each. Pursuant to the offer contained in the prospectus, a company acting as trustee for the appellant subscribed for 100 000 shares in Concept Sports at $0.50 each. The shares were issued to the trustee on or about 7 June 2004. On 21 and 22 September 2004 the appellant sold the shares to a third party at an average price of 11.5 cents. 5 Subsequently, the appellant commenced a group proceeding under Pt IVA of the Federal Court of Australia Act 1976 (Cth) against Concept Sports and its directors. The appellant claims that it, and certain other shareholders in Concept Sports, suffered loss and damage as a result of contraventions of the Act in relation to the prospectus and seeks to recover that loss and damage pursuant to, inter alia, s 729(1) of the Act. 6 The primary judge determined, as a preliminary issue, that the rule in Houldsworth barred the claims of the appellant as it was suing in its capacity as a subscribing shareholder. This is because it is suing for the recovery of its loss (being, in substance, the price paid on subscription less the price received on the sale of the shares) but has not rescinded, and can no longer rescind, the contract by which the shares were acquired. His Honour appears to have proceeded on the basis that the appellant's beneficial interest in the shares was sufficient to make the rule in Houldsworth apply to it. In view of the conclusions we have reached, it is unnecessary for us to consider that aspect of his Honour's decision. 7 Forty one other persons, who also subscribed for shares in Concept Sports, are in the same position as the appellant. That is, having sold the shares for which they subscribed, they can no longer rescind the contract by which the shares were acquired. Accordingly, the claims made on their behalf as group members under s 729(1) will also fail if the statutory right of recovery is qualified by the rule in Houldsworth. 8 Although the primary judge's orders dismissed the appellant's claims under s 729(1) and s 1317HA of the Act the appellant does not seek to appeal in relation to the dismissal of its claim under s 1317HA. Accordingly, the issue on the appeal is whether the statutory entitlement of a shareholder to recover compensation under s 729(1) of the Act in respect of the prospectus issued by Concept Sports is qualified by the rule in Houldsworth. The rule in Houldsworth 9 The rule in Houldsworth was considered by the High Court in Webb Distributors (Aust) Pty Ltd & Ors v The State of Victoria & Anor (1993) 179 CLR 15 ('Webb'), which concerned claims which would ground an action in deceit or under s 52 of the Trade Practices Act 1974 (Cth) ('TPA') for unliquidated damages by shareholders who acquired their shares in certain building societies in reliance upon misleading and deceptive conduct by the societies. The liquidator of the societies sought directions in relation to two questions: (a) whether the unliquidated damages claimed by the shareholders against the societies were provable in the liquidation; and (b) whether the shareholders were precluded from prosecuting an action for damages against the building societies in relation to the acquisition of their shares. 10 Webb was an appeal against the decision of the Appeal Division of the Supreme Court of Victoria in State of Victoria v Hodgson & Ors [1992] 2 VR 613 ('Hodgson'). The Appeal Division found that the questions should be answered: (a) No; and (b) Yes. 11 In Webb, the High Court dismissed the appeal. In the majority judgment, Mason CJ, Deane, Dawson and Toohey JJ applied s 360(1) of the Companies (Victoria) Code ('the Companies Code') to the liquidation of the building societies. Section 360(1) provided that, on the winding up of a company, members are liable to contribute to the company's debt subject to certain qualifications, including: '(e) in the case of a company limited by shares, no contribution is required from a member exceeding the amount (if any) unpaid on the shares in respect of which he is liable as a present or past member; … (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.' 12 In Webb, the majority judgment made the following observations (at 33-35) in respect of s 360(1)(e) and (k), which are now substantially reflected in ss 516 and s 563A of the Act: 'Section 360 imposes an obligation on members to contribute to the payment of all the liabilities of a company on its liquidation. Paragraph (e) limits that obligation to the amount unpaid on the members' shares. Paragraph (k) subordinates sums due to a member in his or her capacity as a member to sums due to non-members. In In re Addlestone Linoleum Co some members sought leave to tender proofs on the winding up against the company for damages for breach of contract in relation to the issue of shares in respect of which they had become contributories. At first instance Kay J held that the sums claimed fell within s 38(7) of the Companies Act 1862, which is, in all material respects, identical to s 360(1)(k). Kay J said: "Now, unquestionably the applicants - retaining these shares and claiming damages because the shares are not exactly what they were represented to be - are making such claims in the character of members of the company, and the only question is whether such claims are for sums due `by way of dividends, profits, or otherwise'." His Lordship then went on to hold that that question should be answered in the affirmative because the applicants were seeking to recover a dividend in respect of the share capital which they were compelled to pay on the winding up. In practice, this would have meant recovery from the pockets of creditors of the share capital that they, as contributories, were liable to pay. The Court of Appeal dismissed an appeal from the decision of Kay J, principally by reference to the decision in Houldsworth. However, Lopes LJ agreed with the construction placed upon s 38(7) by Kay J. And Cotton LJ, with reference to the applicants, stated that "now they come here as shareholders, and in substance retain their shares, and seek to sue the company for breach of the contract under which they took them". In our view, s 360(1)(k) bears the same interpretation as that which Kay J held s 38(7) of the Companies Act 1862 to bear. In so far as it is relevant, the subsequent legislative history has supported this interpretation of s 360(1)(k). Section 563A of the Corporations Law appears under the heading "Priorities" and differs from s 360(1)(k) of the Code in that it draws more strongly on the language of priority. However, in relation to s 563A the explanatory memorandum to the Corporate Law Reform Bill 1992 asserts that the section was intended to have the same effect as the then current s 525, a provision virtually identical in its terms to s 360(1)(k). Paragraph (k) of s 360(1) will not prevent claims by members for damages flowing from a breach of a contract separate from the contract to subscribe for the shares. But, in the present case, the members seek to prove in the liquidation damages which amount to the purchase price of their shares, which is a sum directly related to their shareholding. Moreover, they sue as members, retaining the shares to which they were entitled by virtue of entry into the agreement and they seek to recover damages because the shares are not what they were represented to be. Accordingly, the claim falls within the area which s 360(1)(k) seeks to regulate: the protection of creditors by maintaining the capital of the company. In that regard it should be noted that s 360(1)(k) provides that a sum due to a member in his or her capacity as a member may be taken into account for the purposes of the final adjustment of the rights of contributories among themselves. To that extent the member with a claim against the company occupies a preferred position to other members.' (footnotes omitted) 13 Although the decision in Webb was based on s 360(1) of the Companies Code, the majority judgment considered the rule in Houldsworth, the basis for which was succinctly explained by Tadgell J (with whom Fullagar J and Gobbo J agreed) in Hodgson (at 627): 'In my opinion the principle of limited liability leads inevitably to the conclusion that a member at the commencement of the winding up of a company limited by shares cannot prove in the winding up for damages designed to indemnify him for loss sustained in subscribing share capital to the company. The member's only title to such damages would depend on his having sustained loss through a subscription of share capital. If he were to obtain indemnity from the company in respect of that loss he could not logically be regarded as having subscribed the share capital for the subscription of which the company had indemnified him.' 14 As we later explain, the majority judgment (at 33) rejected the appellant's challenge to the conclusion reached by Tadgell J. 15 In Sons of Gwalia Limited (Administrator Appointed) (ACN 008 994 287) v Margaretic [2005] FCA 1305 ('Sons of Gwalia'), Emmett J helpfully summarised the decision in Webb at [34]-[37]: '34. The High Court, by majority, dismissed the appeal from the decision of the Appeal Division of the Supreme Court of Victoria. It did so on the basis of what it considered to be well established principles based on English decisions of the 19th Century. In particular, two related streams of authority were relied upon. 35. The first line was regarded as establishing the principle that a company incorporated under the Companies Act 1862 (UK) had no power to purchase its own shares. The restriction in companies legislation on the power of limited companies to reduce the amount of their capital had the effect of prohibiting every transaction between a company and a shareholder, by means of which the money already paid to the company in respect of shares was returned to the shareholder, unless the Court had sanctioned the transaction as a return of capital. A company could not, by any expedient, arrange with its shareholders that they would not be liable for the amount unpaid on shares held by them. A shareholder in a limited liability company purchased immunity from liability beyond a certain limit on terms that there would be, and there would remain, a liability up to that limit (Webb's Case at 28, citing Trevor v Whitworth (1887) 12 App Cas 409 and Ooregum Gold Mining Co of India v Roper [1892] AC 125). 36. The second line established the principle that, once the winding up of a company had begun, a shareholder could not, on the ground of fraud, rescind a contract for the purchase of shares from the company, since innocent third parties had acquired rights that would be defeated by such a rescission. A shareholder could not rescind a purchase of shares induced by fraudulent misrepresentation, once the company from which the shares had been purchased had gone into liquidation, even though he might have been entitled to do so had the company been a going concern. In addition, the shareholder also lost any right to claim damages upon the liquidation. After a company is wound up, it ceases to exist, and rescission is impossible. Upon winding up, there are only creditors and contributories, and no company. The liabilities are no longer the liabilities of the company, except to the extent of the assets realised. They become liabilities of the contributories, being the persons who are shareholders at the time of the winding up, to the extent of the unpaid capital on their shares (Webb's Case at 28 to 30, citing Oakes v Turquand (1867) LR 2 HL 325, Tennent v City of Glasgow Bank (1879) 4 App Cas 615 and Houldsworth v City of Glasgow Bank (1880) 5 App Cas 317). 37. The majority in Webb's Case observed that the principle in Oakes v Turquand was not in issue and said that it was common ground in the appeal that the holder of shares ordinarily loses any right to [rescission] on winding up. That must be taken to be a reference to rescission of the contract between the holder of the shares and the company that issued them. However, the majority considered that the decision in Houldsworth also precluded any claim for damages against the company. The principle on which Houldsworth was decided was that a shareholder contracts to contribute a certain amount, which is to be applied in payment of the debts and liabilities of the company, and it is inconsistent with his position as a shareholder, while he remains such, to claim back any of that money: he must not directly or indirectly receive back any part of it (at 31, citing In re Addleston Linoleum Co (1887) 37 ChD 191).' 16 In Sons of Gwalia, Emmett J at [43] rejected the contention that Webb precludes a claim by a shareholder against the company even where the shareholder acquires the shares from a third party, rather than from the company. The reason for that conclusion was that s 563A (and its predecessor s 360(1)(k) of the Companies Code) only applies to a debt of the company to a shareholder, or a claim against the company by a shareholder, in the shareholder's capacity as a member of the company. That is not the situation when the shares are acquired by the shareholder from a third party. 17 A further aspect of the conclusion in Webb which prevented the claims of members of the societies from prevailing over the claims of creditors, was the rejection by the majority of the appellant's contention that its claims arose independently under the TPA and were therefore not fettered by s 360(1)(k) of the Companies Code. In the majority judgment, their Honours stated (at 37): 'Whether the actual decision in Houldsworth can stand against the provisions of the Trade Practices Act is a question which does not arise. … It was the appellant's contention that the Trade Practices Act provided its "own code of remedies, unfettered". The Trade Practices Act is unquestionably a piece of innovative legislation. But it is 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 a company.' McHugh J (at 40-42) dissented on this issue. 18 In summary, the rule in Houldsworth prevents a person who is a shareholder from claiming a debt, or making a claim, against the company in that person's capacity as a shareholder of the company if payment of the debt or claim will directly or indirectly recoup the money subscribed by the shareholder for the shares acquired by it. The rule was usually applied when the company in question was in liquidation. The rule received statutory recognition and, as we later explain, modification in s 360(1)(k) of the Companies Code and in that section's statutory successors, which include s 563A of the Act. It was also clear from the majority judgment in Webb that the longstanding rule, as embodied in its statutory form, is not able to be eliminated 'by a sidewind', such as ss 52, 82 and 87 of the TPA. 19 Although the primary judge applied the reasoning in Webb and Hodgson to the appellant's claims under s 729(1) of the Act, as was explained by the primary judge, the statutory regime under the Act differs in significant respects from the regime that applied in those cases. We will shortly turn to consider the present regime but the most significant change was the specific conferral in s 729(1) of a statutory cause of action in favour of shareholders, including subscribing shareholders, against a company that has failed to meet the Act's requirements in respect of a prospectus. The primary judge's decision 20 The primary judge considered the legislative history of s 729 starting with s 3 of the Directors Liability Act 1890, 53 & 54 Vict c 64 which provided that, subject to certain exceptions, every director, promoter and other person who authorised the issue of a prospectus should be liable to pay damages that a subscriber has suffered 'by reason of any untrue statement in the prospectus'. 21 His Honour then noted the legislative changes that occurred in the early 1990s that led to legislatures in Australia expanding the persons who could be held accountable for false statements in a prospectus to include the company issuing the prospectus. His Honour stated at [17]: '17. … Prior to 1991 the position in relation to prospectuses was covered by s 107 of the Companies Codes of the States. In all relevant respects s 107 was to the same effect as s 3 of the Directors Liability Act upon which it was based. In 1989 there was an unsuccessful attempt to expand the range of persons who could be held liable in damages for false statements in a prospectus. In that year the Commonwealth enacted a statute entitled the Corporations Act 1989 (Cth). By s 1006 of that Act, the persons who could be held accountable for false statements in a prospectus included not only, as in the past, the directors, promoters and those who had authorised the prospectus, but also those named in the prospectus as stockbrokers, sharebrokers or underwriters, auditors, bankers or solicitors, as well as the corporation itself. According to the Explanatory Memorandum to the Bill, the new provision "aim[ed] to make all persons involved in the preparation of a prospectus responsible for the prospectus" (at [2996]). However, many provisions in the Corporations Act were struck down for constitutional reasons: see New South Wales v Commonwealth (1990) 169 CLR 482. In due course the Act was replaced by the Corporations Law which came into operation on 1 January 1991. Section 1006 of the Corporations Law reproduced s 1006 of the Corporations Act. Section 729 of the current legislation is in similar terms.' 22 His Honour then said at [18]-[21]: '18. The question then comes down to this. Did the introduction of the company that issued the prospectus as a possible defendant to a claim for damages under s 729 overturn the rule in Houldsworth'scase? 19. There are factors pointing both ways. Those that point in favour of overturning Houldsworth'scase are these. First, the cause of action conferred by s 729 against the company is remedial in nature and should therefore be given broad effect. Second, s 729 is in terms unrestricted, and to impose a limitation (that is the limitation set by Houldsworth's case) would be inconsistent with the terms. Third, if the section has not overturned Houldsworth'scase, it would have a somewhat reduced scope. That is to say, if rescission is a necessary precondition to an action, a subscribing shareholder could only recover consequential or indirect damages in an action under s 729. 20. The factors that point the other way are these. First, Parliament could have but did not in terms overturn Houldsworth'scase. That is, Parliament could have but did not enact a provision similar to s 111A of the English Companies Act. Second, it is apparent that Parliament is aware of Houldsworth's case and its consequence and when it wishes to do so it will overturn its effect and do so in clear language. Here I have in mind s 737 of the Corporations Act which was introduced into the Corporations Law by the Corporate Law Economic Reform Program Act 1999(Cth). The purpose of the new section was to provide additional remedies for a contravention of s 724 (the predecessor to s 728). One additional remedy was "the right to return the securities and have their application money repaid". According to s 737(1) the right is available "even if the company that issued the securities is being wound up". The only purpose for including these words is to reverse the combined effect of Houldsworth's case and Oakes v Turquand namely that there can be no rescission after a winding up. Third, a similar argument made in relation to the operation of s 52 of the Trade Practices Act 1974 (Cth), a "fundamental piece of remedial and protectionist legislation" (so described by McHugh J inWebb Distributors (Aust) Pty Ltd v State of Victoria(1993) 179 CLR 15, 41) was rejected by the Full Court of the Supreme Court of Victoria in State ofVictoria v Hodgson [1992] 2 VR 613. Justice Tadgell who delivered the leading judgment stated (at 631) that: "To hold otherwise would be to regard the Trade Practices Act as intending to overturn by implication a cardinal tenet of limited liability which has prevailed for 130 years. It would be surprising indeed if the Trade Practices Act had that intention or effect". Fourth, if the submission were accepted it would produce an anomalous situation. I mentioned earlier that the rule in Houldsworth'scase has been given statutory effect when a company is in liquidation. If s 729 has overturned Houldsworth'scase, it could only have done so for an action against a company that is not in liquidation. Section 563A, which would preclude proof of claims when the company is being wound up, remains in place: Webb Distributors (Aust) Pty Ltd v State of Victoria(1993) 179 CLR 15. It would require a good reason indeed to impute to Parliament an intention to overturn Houldsworth'scase when the company is a going concern but not when it is being wound up. 21. It seems to me that the reasons for denying the plaintiff the relief that it seeks are to be preferred. Moreover, to hold otherwise would conflict with State of Victoria v Hodgson, a decision of an appellate court which I am required to follow. In any event, State of Victoria v Hodgson is correct, in my opinion.' The Corporations Act 23 Consideration of the applicability of the rule in Houldsworth to the appellant's claim under s 729 must commence with the terms of the Act. 24 Section 140 of the Act provides for a company's constitution to have effect as a contract between the company and each member as well as between a member and each other member. 25 The successors to ss 360(1)(e) and (k) of the Companies Code are to be found in ss 516 and 563A respectively. The sections are in Pt 5.6 of the Act, which applies to the winding up of a company. 26 Section 516 relevantly provides: '… if the company is a company limited by shares, a member need not contribute more than the amount (if any) unpaid on the shares in respect of which the member is liable as a present or past member.' 27 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.' 28 Ch 6D of the Act (ss 700-742) contains a highly prescriptive scheme in respect of the disclosures that are, and are not, to be made in respect of the corporate fundraising governed by the chapter. Section 703 ensures that there can be no contracting out of the requirements of the chapter. 29 Sections 704 to 725 provide for the circumstances in which the disclosures required by Ch 6D are to be made and also set out the requirements that are to be met in respect of those disclosures. Part 6D.3 sets out the prohibitions, liabilities and remedies in respect of corporate fundraising governed by Ch 6D. The provisions that create the statutory right to compensation that are relevant for present purposes are ss 728(1) and 729: 'Misleading or deceptive statements, omissions and new matters 728(1) A person must not offer securities under a disclosure document if there is: (a) a misleading or deceptive statement in: (i) the disclosure document; or (ii) any application form that accompanies the disclosure document; or (iii) any document that contains the offer if the offer is not in the disclosure document or the application form; or (b) an omission from the disclosure document of material required by section 710 , 711, 712, 713, 714 or 715; or (c) a new circumstance that: (i) has arisen since the disclosure document was lodged; and (ii) would have been required by section 710, 711, 712, 713, 714 or 715 to be included in the disclosure document if it had arisen before the disclosure document was lodged. Right to recover for loss of damage resulting from contravention 729. Right to compensation (1) A person who suffers loss or damage because an offer of securities under a disclosure document contravenes subsection 728(1) may recover the amount of the loss or damage from a person referred to in the following table if the loss or damage is one that the table makes the person liable for. This is so even if the person did not commit, and was not involved in, the contravention. People liable on disclosure document [operative]