Statutory Debt Subordination: An Appraisal of the North American Experience

Abstract

The High Court of Australia recently found that statutory subordination laws in Australia did not embody a principle of members come last. The decision in Sons of Gwalia raised questions about whether the current law represents a sound policy outcome, and specifically drew attention to competing models in the US and Canada. The government has now referred this question to the Corporations and Markets Advisory Committee to consider law reform.

The purpose of this article is to examine the policy and legal position of the subordination of shareholder claims during insolvency in the United States and Canada and to examine what lessons may be learnt from that experience. A critical appraisal of the North American jurisprudence on the subordination of shareholder claims for damages arising out of misrepresentation inducing the acquisition or retention of shares may be of assistance in resolving the current difficulties experienced in Australian insolvency law. The authors argue that the US position of blanket subordination should not be adopted in Australia, and propose a different model of limited subordination that will encourage confidence in the equity markets without undermining creditor protections.

Keywords: subordination, shareholders, securities fraud, class actions, bankruptcy, misrepresentation, equity cushion

JEL Classification: K22