TGIF 6 December 2019: Proper Purpose – shareholders allowed to examine former director to determine prospects of potential class action

This week’s TGIF considers the latest decision in Arrium and the recent refusal by the Supreme Court of New South Wales to set aside, on Arrium’s application, a summons for examination to a former director. 

What happened?

On 15 May 2019, a Registrar issued a summons for examination and orders for production to a former director of Arrium following an application by two shareholders of the company.   The shareholders had been authorised as eligible applicants by the ASIC the previous year.

Arrium subsequently challenged the Registrar’s decision and the application was listed before the Court to consider the question of whether the summons should be issued afresh.

Relevant background

The proposed examinee was a director of Arrium until 2015, chairman of its governance committee and a member of the audit & compliance committee.  The plaintiff shareholders (being the applicants for the summons) had sought the order for his examination to investigate whether claims should be brought against:

• company officers for misrepresentations or failing to adequately inform the market in relation to a 2014 capital raising; and
• an audit firm for misleading or deceptive conduct and negligence.

The deed administrators for Arrium had informally interviewed the proposed examinee but he had not been subject to formal examination under s 596A.  Further, the 2014 capital raising had not been considered in detail during any of the prior examinations conducted by the deed administrators as they had formed the view that its circumstances were unlikely to give rise to a cause of action which would benefit Arrium or its creditors.

The plaintiffs’ disclosed purpose of the examinations was to investigate the potential for claims to be made on behalf of creditors or shareholders in Arrium.  Details of the proposed claims had been made available on a website for potential participants in a potential class action.

Arrium contended the statutory purpose of s 596A was to facilitate external administrations and not to allow prospects of a shareholder class action to be investigated. That was argued to be an improper purpose such that the summons should be set aside.    

The competing submissions

The thrust of Arrium’s argument was that the plaintiffs’ purpose was a wholly private purpose, the proposed action would not benefit Arrium or its creditors and, if successful, a recovery could be detrimental to creditors given any shareholder class action could deplete the amount of insurance cover available to former directors in respect of separate insolvent trading claims brought by the liquidators.

In response, the plaintiffs submitted that:

• the potential identification of unlawful conduct attendant on the management affairs of the company was a legitimate purpose of examination and was in the public interest;
• it was wrong to focus on the potential outcome of the examinations rather than their purpose; and
• the examinations could expose actionable claims by Arrium from events which had not been substantially investigated.

The Decision

The relief sought by Arrium was refused and the Court was not satisfied it had discharged the ‘heavy’ onus of establishing examination of the former director would be an abuse of process.  

Critical to his Honour’s view was that the former director had not been previously examined and that information likely to be produced on the plaintiffs’ examination may advance the interests of Arrium - and its creditors - by providing additional relevant information to support further causes of action by Arrium or, to the extent it didn’t, otherwise validate and support the liquidators’ decision not to pursue claims arising out of the 2014 capital raising and instead focus on insolvent trading recoveries.

The Court expressly noted this determination had been reached with “considerable hesitation”.

Comment

This is a significant decision for both insolvency practitioners and those who operate in the class action space.  Whilst the onus to set aside an examination summons is demanding, it was vigorously argued the threshold had been met in this case where the evidence made clear what the plaintiffs’ stated purpose was.  Part of Arrium’s challenge to the examination order was that the advantage the plaintiff shareholders may obtain is not one which should be obtained by the exercise of the examination power and their claim would compete with the claims brought by the liquidators for the benefit of all creditors.  

Notwithstanding this, the fact the matters subject of the proposed examination had not been previously tested – in detail – during prior examinations and the possibility they could lead to additional information being gathered that may benefit Arrium, even simply by confirming the liquidators’ assessment not to pursue such matters, proved crucial.