Category: Fundraising (Chapter 6D)

What are some of the key issues relating to securities held by an account provider on behalf of several investors in a single account?

The single account in this case is called an “omnibus account”.

In practice, client assets are typically held through an omnibus account in the name of the custodian or its nominee, rather than in individual accounts for each underlying client.

“Omnibus” accounts

An “omnibus” account is an account opened in the name of an account provider, the securities credited to which belong to several clients of the account provider. Typically the account provider will be obliged to maintain accounts on his own books recording the interests of these clients in respect of the securities credited to the account in the account-provider’s name. Omnibus accounts may contain a mixture of the account provider’s own and clients’ assets. This type of account is not permitted in some countries such as Lithuania, Finland, to name but a few.

 “Nominee” accounts

A “nominee” account is typically distinguished from an omnibus account by two features.

• While a nominee may open an account for the purpose of holding several clients’ securities, this is not necessarily so. Often a nominee acts for a single client, for example an omnibus account provider (who acts for many clients). Single-client nominee accounts are common when a global account provider, being foreign, is not permitted by the membership rules applicable to the local CSD to participate directly in the CS.
• A nominee’s duties and discretions will usually be much narrower than those of other account providers. An omnibus account provider will commonly be granted discretionary powers by its client, whereas a nominee is likely to be permitted only to do such acts as are strictly necessary to maintain the client’s holding of securities.

Providers of both nominee and omnibus accounts are likely to know (although it is not always mandatory under the applicable legal system for them to know) that their account-holder is acting as nominee or holding a pool of securities for many investors.

Legal reasons for omnibus accounts

In practice, a combination of tradition and operational and legal reasons rather than ease of settlement of transfers are likely to dictate the use of omnibus accounts. Practice has become entrenched, so that where omnibus accounts are common, the law has tended to support their existence. The following legal factors may be relevant in particular countries:

• In countries where local investors are obliged to hold their securities directly in the CSD/issuer the need for omnibus accounts only arises in respect of foreign investors who already use a global account provider to hold their securities.
• In countries where the person who is registered at CSD/issuer level is regarded as the owner of the securities, to the exclusion (in most circumstances) of other claimants, there may be obstacles to recognition of custodial arrangements. The operational set-up is likely to have been created historically in a way which does not envisage that a CSD participant would need multiple accounts. In order to operate a separate account for each investor, the account provider would have to persuade the higher-tier intermediary to operate multiple accounts for the account provider, and pay (or charge investors for) the additional fees associated with many accounts. Instead, it may be simpler to establish an omnibus account.
• Even in countries where omnibus accounts are common (where direct holdings are not compulsory and indirect holdings are standard practice), there may be operational influences on account structures. A higher-tier intermediary may be unwilling to agree to a single-investor-per-account holding pattern, for example because the higher-tier intermediary is constrained by systems limitations on scaling up to the degree implied by each of its account provider clients having multiple accounts. Another factor is the need to have separate identifiers for each account. Where an omnibus account is used, the task of allocating securities received to buyers is carried out by the account provider. A settlement system may (but may not) be able to supply the account provider with identifiers to facilitate the allocation of securities received to the sub-accounts maintained by the account provider for its clients. Where a stock exchange operates a straight-through processing system linked into the relevant CSD, the choice of account structure may be affected by the amount of detail that the various systems can support.

In any of these cases, the technical and operational systems will have grown up domestically in a manner which suits the local legal arrangements, and may be difficult to adapt wholesale. Rather, individual market participants have developed ad-hoc arrangements to cope with local market expectations.

Advantages of omnibus accounts

The following advantages of using omnibus accounts can be stated:

• Cost. Only one account is needed for many investors. This should reduce fees associated with (a) maintaining the account and (b) transfers, where credit and debit entries offset and the settlement processing technique permits internalised (or net) settlement.
• Voting and corporate actions. Provided that an account provider can gather in the voting instructions for the collectively held securities (and contrary voting is permitted – see below) the volume of voting instructions required to be processed by the issuer will be significantly reduced. Likewise, for other corporate actions, the account provider will be responsible for processing the instructions and entitlements for all the investors under its account, thereby reducing the burden on the issuer.
• Internalised settlement. Investors could “settle” across the books of an account provider instead of using the CSD. If each investor’s holding is held in a separate account with an upper-tier intermediary, “internalised settlement” is impossible, since an account provider acting as lower-tier intermediary needs to process a transfer from a selling investor client to a buying investor client by means of external instructions to the upper-tier intermediary. By contrast, if an omnibus account is used, and the ordinary processing algorithms permit, an account provider would not need to issue any external instructions to settle such a transfer. Internalised settlement could reduce the cost of transfers and improve service levels (eg by offering “transfer finality” at an earlier moment than if settlement occurs at a higher tier intermediary).
• Reduced burden for issuers. Issuers do not need to deal directly with large numbers of investors where they are required legally only to recognise the persons who hold directly from them. This shifts the burden of dealing directly with investors to the account providers. Account providers may be freer to negotiate the level of service provided to their account holders, whereas issuers will generally be required to treat all holders alike.

Disadvantages of omnibus accounts

The following disadvantages may arise with regard to the use of omnibus accounts:

• Effect of permanent shortfalls. Assuming it cannot be made good by the account provider, a permanent shortfall on an omnibus account is bound to cause loss to some investors; the question arises how the loss should be borne. The answer to this question may range from “all investors lose any claim to anything held by the account provider”⁹through to “rateable loss-sharing”. More complex solutions are theoretically possible, including forensic accounting to identify precisely “whose” securities were lost¹⁰. This is a highly practical question, as the insolvency of an account provider is likely to be strongly correlated with accounting deficiencies and the existence of shortfalls. In some countries a clear and simple statutory solution is provided.
• Forced borrowing. Shortfalls are likely to arise routinely and without malpractice by the account provider, as a result of operational error (which could be error on the part of some other person). Provided that the account provider (a) is required by regulatory rules to conduct reconciliations and to take action to remove imbalances, and (b) is not insolvent, the difficulties of permanent shortfalls (discussed above) should not arise.
• However, while a temporary imbalance remains, the consequence of a shortfall may be that the investors entitled to what remains will to some degree be making securities loans to any investor who wishes to dispose of the whole of its holding. Lending may be beyond the capacity of some investors and would in many cases require the consent of the lender. Regulatory rules typically require account providers to explain to investors that their securities may be utilized to satisfy other investors’ instructions.
• Distance between issuer and investor. Where an omnibus account is used, the structure necessarily implies that securities are held indirectly. The issuer knows that the registered holder is not the investor, but not who the investors are. Corporate communications are made more difficult. Some countries have established rules which empower issuers to stay in touch with investors where an omnibus account is used. Distance between issuers and investors also engenders delay: by the time an investor at the end of a chain of intermediaries receives notice of a vote or other corporate action, it may be very close to the last practical moment for action or even too late.
• Corporate actions. If securities are consolidated or rights issues relate to holdings of specific numbers of securities (eg a 2-for-5 issue) the account provider will typically receive replacement or additional assets which do not divide perfectly among the investors in precisely the ratio in which the investors held the original securities. Some rounding and cash-settlement of differences is necessary, which may affect investors differentially. The outcome for many investors is likely to be different¹³ (though not necessarily worse) from that if their securities were held in accounts segregated at the higher-tier intermediary. Investors typically confer discretion on account providers to handle this kind of situation.
• Conflicting votes. Where an account provider holds securities for many investors, some may wish to vote in favour of a particular matter and others may wish to vote against. In theory there may be a risk in theory that the relevant legal system does not permit a single investor to vote contrarily: part of his vote for, and part against.
• No title. If the relevant legal system does not recognise the omnibus account as a valid
  form of co-ownership, there is in theory a risk that the investor has no property rights at all if the account provider pools his securities with those of other investors.¹⁵
• The disadvantages listed above are likely to be more acute where the legal or regulatory system has not developed a clear code to cater for omnibus accounts. These difficulties may be aggravated in a cross-border context where the legal solutions chosen in different countries are different, or where one of the countries involved does not “recognise” omnibus accounts.

Authorities on whether pre-contractual statements are promissory or representational

A statement may be on a matter of importance upon which the representee was intended to and did rely without being promissory: J J Savage & Sons Pty Ltd v Blakney [1970] HCA 6; (1970) 119 CLR 435. In that case, the vendor of a boat and engine, in the course of pre-contractual negotiations, provided his estimate of the speed the boat would reach if powered by a particular engine. The High Court described the statement as an expression of opinion as the result “of approximate calculation based on probability” which tended against the inference of a promise that the boat would in fact achieve the nominated speed. Statements of opinion on future matters are less likely to be found to be promissory even if they induce entry into a contract.

In J J Savage & Sons Pty Ltd v Blakney [1970] HCA 6; (1970) 119 CLR 435, the High Court considered whether a statement made in the course of negotiations for the construction of a motor boat was promissory or representational. During the negotiations the plaintiff requested the defendant’s manager to place in writing his views upon various engines that might be used in the boat. The defendant set out in a letter details in relation to three types of engines and made recommendations in favour of one engine, of which the “estimated speed” was stated to be 15 miles per hour. The plaintiff ordered a boat with the engine recommended by the defendant. A written contract was executed in which no reference was made to the capacity of the boat to attain any particular speed. The boat supplied to the plaintiff was not capable of a speed in excess of 12 miles per hour. The plaintiff sued the defendant for breach of warranty, alleging that the representation in relation to “estimated speed” was a condition or warranty of the contract, alternatively that it was a collateral warranty to the contract. The Full Court of the Supreme Court of Victoria held that the representation was a collateral warranty by the defendant that the boat would attain a speed of approximately 15 miles per hour. An appeal to the High Court was allowed. Barwick CJ, Kitto, Menzies, Owen and Walsh JJ said, at 442 – 443:

“The Full Court seems to have thought it sufficient in order to establish a collateral warranty that without the statement as to the estimated speed the contract of purchase would never have been made. But that circumstance is, in our opinion, in itself insufficient to support the conclusion that a warranty was given. So much can be said of an innocent representation inducing a contract. The question is whether there was a promise by the appellant that the boat would in fact attain the stated speed if powered by the stipulated engine, the entry into the contract to purchase the boat providing the consideration to make the promise effective. The expression in De Lassalle v. Guildford [1901] 2 KB 215, at p 222 that without the statement the contract in that case would not have been made does not, in our opinion, provide an alternative and independent ground on which a collateral warranty can be established. Such a fact is but a step in some circumstances towards the only conclusion which will support a collateral warranty, namely, that the statement so relied on was promissory and not merely representational.

When the letter which we have quoted was written, the negotiations for the construction and delivery of the boat were incomplete. On receipt of the letter there were three courses open to the respondent. He could have required the attainment of the speed to be inserted in the specification as a condition of the contract; or he could have sought from the appellant a promise – however expressed, whether as an assurance, guarantee, promise or otherwise – that the boat would attain the speed as a prerequisite to his ordering the boat; or he could be content to form his own judgment as to the suitable power unit for the boat relying upon the opinion of the appellant of whose reputation and experience in the relevant field he had, as the trial judge found, a high regard. Only the second course would give rise to a collateral warranty.”

Whether a statement (be it of fact, intention or opinion) is promissory, is determined objectively by reference to the whole of the relevant circumstances: Hospital Products Ltd v United States Surgical Corporation [1984] HCA 64; (1984) 156 CLR 41. Gibbs CJ said in that case (at 61 – 62):

“If the parties did not intend that there should be contractual liability in respect of the accuracy of the representation, it will not create contractual obligations. In the present case [the respondent], who made his statements fraudulently, had, of course, no intention that they should amount to contractual undertakings, but he could not rely on his secret thoughts to escape liability, if his representations were reasonably considered by the persons to whom they were made as intended to be contractual promises, and if those persons intended to accept them as such. The intention of the parties is to be ascertained objectively; it ‘can only be deduced from the totality of the evidence’: Heilbut, Symons & Co. v. Buckleton [1912] UKHL 2; [1913] A.C. 30, at p. 51.”

If an intelligent bystander would reasonably infer that a contractual promise was intended, that would suffice even though neither party in fact had it in mind: Hornal v Neuberger Products Limited [1957] 1 QB 247 at 256 per Denning LJ.

Whether a statement is promissory or representational depends upon the intention of the parties, and their intention is to be ascertained objectively from the totality of the evidence. See Hospital Products Ltd v United States Surgical Corporation [1984] HCA 64; (1984) 156 CLR 41, at 61 – 62. The distinction between a representation on the one hand and a promise on the other is, however, fine, and the distinction is difficult to apply. See Ross v Allis-Chalmers Australia Pty Ltd (1981) 55 ALJR 8, at 11 – 12.

In Hyundai Elevator Co Ltd v Liftronic Pty Ltd, unreported; CA SCt of NSW; Mahoney, Priestley and Handley JJA; 9 December 1994, Priestley JA said, at 19:

“… the question whether the words used were promissory over and above being representational is to be decided objectively. The subjective intentions of the parties, if they could be known, would not be conclusive. If both had in fact had it in mind that the statements were promissory, then it is very likely that this understanding would have been manifested so that a reasonably intelligent bystander would have recognised that a binding promise was being offered; but, if there were no outward manifestation of the internal understanding it would be for the court to decide from whatever communications had passed between the parties whether or not the statements were promissory: cf Taylor v Johnson [1983] HCA 5; (1983) 151 CLR 422 at 428 – 429.”

In Australian National Nominees Pty Ltd v GPC No 11 Pty Ltd [2004] NSWSC 773 the plaintiffs lent money to the first or second defendant in response to invitations to the public, contained in information memoranda, to lend money to those defendants. The loans were to be secured by promissory notes. The plaintiffs contended that the terms embodied in the information memoranda were terms of the contracts of loan evidenced by the promissory notes. Einstein J held that the terms of the information memoranda were merely representational. His Honour was unable to discern from the information memoranda an objective intention that the words upon which the plaintiffs relied were promissory in character.

In Gates v The City Mutual Life Assurance Society Limited (1986) 160 CLR 1, the statement in issue was of an intention in relation to a future matter. The statement was to the effect “that the total disability benefit under the provisions [the insurer’s agent] was recommending for inclusion in his existing and new policy would be payable to [the appellant] if he suffered an injury or illness which left him physically incapable of carrying on his occupation as a self-employed builder”. Gibbs CJ said (at 5):

“The question whether the statements constituted a collateral contract depends on the intention of the parties … In the present case the statements were not promissory in form –– they purported to be descriptive or explanatory of one of the terms of the formal written contracts into which the parties proposed to enter. I find it impossible to say that either of the parties actually intended that the statements should constitute a term of the contracts between them or … that an objective inference can be drawn that they did so intend. The statements were representations and nothing more.”

In Emu Brewery Mezzanine Ltd (In Liq) v Australian Securities and Investments Commission [2006] WASCA 105 BUSS JA at [90] said:

In my opinion, the statements in the Information Memorandum relied on by the respondent were not intended, objectively, to have contractual force. Some of the statements are imprecise and lack detail, and others are merely explanatory or descriptive. The absence of precision and detail is more consistent with the statements as a whole being intended, objectively, to be representations. No doubt, the sole or dominant purpose of the statements was to induce potential investors to invest in the promissory note issue. However, even if the investors were induced to invest in reliance on the statements, that circumstance would not, in itself, be sufficient to support a conclusion that the statements were intended, objectively, to be promissory. In my opinion, the statements were not, either individually or collectively, the subject matter of an assurance. They conveyed representations, but did not constitute enforceable promises.

Chapter 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.

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.

When ss 728 and 729 were recast into their present form by the Corporate Law Economic Reform Program Act 1999 (Cth), par 8.1 of the Explanatory Memorandum accompanying the bill stated that a purpose of the sections was as follows:

‘to ensure that issuers continue to provide full disclosure in the associated prospectus, issuers will be liable to investors in relation to the prospectus.’

Securities are broadly defined in s 92 of the Act.

A ‘disclosure document’ for an offer of securities is defined in s 9 as including, inter alia, a ‘prospectus for the offer’.

Sections 731, 732 and 733 set out a number of the defences, such as due diligence, lack of knowledge and reasonable reliance, that are available in respect of contraventions of s 728 and claims under s 729.

Sections 737 and 738 establish a limited right to return securities and to recover the money paid.

Sections 741 and 742 provide for exemptions from, and modifications to, Ch 6D by the Australian Securities and Investments Commission or by regulations.

Several features of the statutory scheme in respect of disclosure documents, which include prospectuses, should be noted.

Section 729(1) of the Corporations Act 2001 (Cth) 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.

CORPORATIONS ACT 2001 – SECT 729

Right to recover for loss or damage resulting from contravention

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 persondid not commit, and was not involved in, the contravention.

Note:          Item 2– director includes a shadow director (see section 9).

(2)  A person who acquires securities as a result of an offer that was accompanied by a profile statement is taken to have acquired the securities in reliance on both the profile statement and the prospectus for the offer.

(3)  An action under subsection (1) may begin at any time within 6 years after the day on which the cause of action arose.

(4)  This Part does not affect any liability that a person has under any other law.

Note:          Conduct that contravenes subsection 728(1) is expressly excluded from the operation of section 1041H.

Helpfully explained by Merkel, Weinberg and Kenny JJ

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.

Cadence Asset Management Pty Ltd v Concept Sports Limited [2005] FCAFC 265; see [9] to 019]

The question in the appeal was 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.

The rule in Houldsworth was considered by the High Court in Webb Distributors (Aust) Pty Ltd & Ors v The State of Victoria & Anor [1993] HCA 61; (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.

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] VicRp 89;[1992] 2 VR 613 (‘Hodgson’). The Appeal Division found that the questions should be answered:

(a) No; and
(b) Yes.

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.’

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 Lawappears 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)

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.’

The majority judgment (at 33) rejected the appellant’s challenge to the conclusion reached by Tadgell J.

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 19^th 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).’

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.

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.

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.

The CONCLUSION in the appeal.

We have concluded that the question we posed at the commencement of these reasons is to be answered in the affirmative. In other words, under s 729(1) of the Act, a subscribing shareholder can recover from the company issuing a prospectus the loss suffered as a result of the subscription without rescinding the contract to acquire the shares. However, by reason of s 563A of the Act, if the company is in liquidation the subscriber’s right to be paid the loss is postponed until the claims of persons made otherwise than as members have been satisfied.