High Court allows use of compulsory examination powers to investigate class actions

What you need to know

• The High Court by majority (3-2) has adopted a broad interpretation of the purposes for which former shareholders can use the mandatory examination power under s 596A of the Corporations Act when a company is in external administration.
• The power enables "eligible applicants" to examine an officer or former officer of a corporation under oath about the corporation's affairs. The court may also require the person to produce documents under s 597(9).
• The powers were historically considered "extraordinary powers" and "of an inquisitorial kind", to be exercised for the purpose of a winding up, to enable a liquidator to ascertain what had been done with the assets of the company.
• The majority decided that in light of changes made to the legislation, the purposes for which the power can be used when a company is in external administration have become much broader.
• The decision opens the way for directors and officers of a failed company to be examined under oath by shareholders investigating class actions, even if the liquidators do not intend to pursue claims against them.

The securities class action landscape

The risk of class action liability poses a major concern for public companies and their boards of directors, particularly in relation to market disclosure. Securities class actions are a key feature of the legal landscape in Australia. In this type of case shareholders claim they were misled about the value of the company when they bought shares. Shareholders typically rely on alleged breaches of continuous disclosure rules and prohibitions against misleading or deceptive conduct.

In recent years a series of law reform inquiries has considered whether changes are required to the class action regime. Further, in response to the uncertainty produced by the COVID-19 pandemic, the federal government introduced a new "fault" element, potentially making it harder for claimants to bring securities class actions. These changes have since been made permanent.

For third party litigation funders and plaintiff law firms, it can be difficult to decide whether to commence class action proceedings. The information needed to assess the merits of a claim may not all be available on the public record. Deciding whether to commence court proceedings may be particularly difficult where the company fails. This raises the question, what investigative powers can class action proponents exploit to assess the merits of a claim?

The High Court's decision in Arrium adopts a broad interpretation of existing compulsory examination powers, opening the way to existing insolvency law powers being used to investigate potential securities class action claims.

The collapse of Arrium and the compulsory examination application

Arrium was an ASX listed steel and iron ore producer. In late 2014 Arrium raised $754 million in capital. The export price of iron ore declined. The company announced it would suspend or close a mine. In early 2015 Arrium acknowledged its mining operations were worth $1,335 million less.

Arrium entered voluntary administration in 2016. Some shareholders wanted to investigate Arrium's disclosures to the market about the state of its business prior to the capital raising. The shareholders wrote to ASIC in 2018 seeking "eligible applicant" status under the Corporations Act to obtain examination and production orders. The company entered into liquidation in 2019.

In 2019 the shareholders obtained examination orders against a former director of Arrium under s 596A of the Corporations Act, and orders for production against Arrium, Arrium's auditors and Arrium's advisers on the capital raising under s 597(9).

The shareholders initially said that they were investigating a derivative action in the name of the company. However it was later acknowledged that the predominant purpose of the shareholders was to investigate a potential class action by shareholders against the company's former directors and auditors. The shareholders also acknowledged that they were not creditors of Arrium. The investigation did not concern a claim against Arrium and did not relate to matters that were for the potential benefit of Arrium.

Arrium's challenge to the examination orders in the Supreme Court of NSW was dismissed at first instance. On appeal, the NSW Court of Appeal considered that the examination orders should not have been made because they were sought for a private purpose for the benefit of a limited group of shareholders.

The purpose of the s 569A compulsory examination power is broader than its historical predecessors

Courts have long had the power to summon officers of a company for examination when the company is being wound up, to compel them to give information about the affairs of the company. However, traditionally the courts have limited the purposes for which this power can be used. The courts have held it to be an abuse of the court's process to use the power for an improper purpose.

In Arrium the High Court by majority, allowing an appeal from the NSW Court of Appeal,held that it was not an abuse of process to use the compulsory examination power under s 596A of the Corporations Act for the purpose of investigating a potential class action irrespective of whether it is in the interests of the corporation.*

Section 596A is wider than predecessor examination powers. It is not limited, as the NSW Court of Appeal had suggested, to examinations for the purpose of benefitting the corporation, creditors or contributories.

In the joint majority judgment, Edelman and Steward JJ held that the purpose of s 596A is to address the enforcement of the law concerning a corporation in external administration and its officers in public dealings. In the present case, the shareholders' intended investigation of a potential class action concerned the public dealings of the corporation and its officers. Accordingly, the examination was not outside of the scope of s 596A. According to their Honours, it would only be an abuse of process if the purpose of the eligible applicant would contradict or stultify the public interest in the external administration of the company.

Justice Gageler, also in the majority, preferred not to map out the legitimate purposes of s 596A. However, his Honour held that obtaining information for potential proceedings against officers and other persons in connection with the examinable affairs of the company was not an illegitimate purpose, irrespective of there being no benefit to Arrium or its creditors.

In a joint minority (dissenting) judgment, Kiefel CJ and Keane J, considered that in accordance with long standing authority in relation to earlier versions of the provision, the purpose of s 596A was confined to facilitating investigations for the benefit of the company, its creditors or contributories as a whole. Their Honours would have dismissed the appeal and upheld the decision of the NSW Court of Appeal.

Implications of the High Court's decision

The Arrium decision necessarily increases class action risk for directors, officers and third parties where a company is placed into external administration. The need for boards to develop and implement market disclosure risk management policies and processes is underscored by the prospect that directors and officers may be subjected to compulsory examination on behalf of shareholders, regardless of what the company's liquidators might think.

However the High Court's decision in Arrium should be kept in perspective. The compulsory examination power in respect of companies in external administration is not unqualified. Before it can be exercised, shareholders still require ASIC approval as "eligible applicants". The court also retains its express and inherent powers to oversee and supervise compulsory examinations, including ensuring questions are directed to the examinable affairs of the corporations. The court is unlikely to allow shareholders to re-examine matters already properly examined by the company's liquidators.

*Ashurst acted for the second respondent.

Authors: John Pavlakis, Partner; Andrew Westcott, Expertise Counsel; and Reuben Heim, Lawyer.