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US Investors in Australia Beware: New Advisory Report Supports the Sons of Gwalia Decision

January 29, 2009

We have previously reported on the infamous Sons of Gwalia decision in which the High (i.e. Supreme) Court of Australia concluded that a shareholder's claim against an Australian issuer for damages caused by defective disclosure practices should not be subordinated to the claims of legitimate unsecured creditors in insolvency proceedings. For our prior update on the Sons of Gwalia situation, including its drastic implications for creditor votes and our discussion of "lessons learned" for investing in Australian debt, click here.

Our prior update also reported that the Sons of Gwalia decision was so controversial that it drew numerous market commentaries and business editorials, resulting in the undertaking of a review by CAMAC (Corporations and Markets Advisory Committee, www.camac.gov.au). Specifically, CAMAC was asked "to consider whether the current position should be retained or changed to postpone [subordinate] claims by shareholders as aggrieved investors, and whether other changes should be made to ameliorate the consequences of either outcome.

"CAMAC's press release announcing the study on September 20, 2007 can be found here, and CAMAC's lengthy discussion paper concerning the issues, including a discussion of relevant law from other jurisdictions, can be found here.  Bracewell & Giuliani provided input through our Australian friends at Arnold Bloch Leibler, urging that the decision be overturned due to its poor policy and its negative effect on US investment in Australian debt securities. A copy of the submission can be found here.

At noon today in Canberra, CAMAC publicly issued its long-awaited report. For a copy of the 112-page report, click here. In short, CAMAC is recommending no change to the law. To quote from CAMAC's press release accompanying the report:

"While recognising that the decision has significant implications, including for providers of corporate debt finance as well as the conduct of external administrations, CAMAC has not recommended action to overturn its effect.

The empowerment of shareholders to hold a company to account in damages reflects a significant shift in regulation. It has in effect turned shareholders into potential unsecured creditors as well. The views of respondents to CAMAC’s earlier discussion paper were polarised on the question whether the current position should be maintained or changed.

The Committee as a whole is not persuaded of the need for change in the legal position. Any move to curtail the rights of recourse of aggrieved shareholders where a company is financially distressed could be seen as undermining legislative initiatives to provide shareholders with direct rights of action in respect of corporate misconduct."

While this is only a recommendation to the Australian Government and it is clear that the members of CAMAC were not unanimous in their views, our sources tell us that the Government is likely to accept the recommendation. We do not intend to go down without a fight, however, and we and ABL will now focus our lobbying efforts directly on the Australian Government, urging that a more pragmatic approach is required, particularly in these extraordinary times.

We repeat our comments from our prior update that the Sons of Gwalia decision should not prevent US investors from purchasing Australian debt securities or making loans to Australian corporates.  At the same time, we have been involved in other restructuring and insolvency situations since the Sons of Gwalia decision was issued and the shadow of pari passu shareholder claims has loomed large in each of those situations, repeatedly frustrating swift restructuring efforts. The concerns have been further heightened by the explosion of third-party funded litigation in Australia, in which litigating shareholders are indemnified by the funders against the costs of the litigation, including any award of the other side's litigation fees under Australia's "loser pays" system. In fact, the largest litigation funder in Australia, IMF (Australia) Ltd. (www.imf.com.au), is now a public company listed on the Australian Stock Exchange.

The timing of the CAMAC report is particularly critical given the flood of Australian private place note offerings that are currently being shown to US investors as Australian corporates are seeking to refinance their borrowings from foreign banks who are exiting their positions due to the credit crisis. This raises once again the question of whether US investors should increase their focus on higher pricing, tighter covenants, structural protections, and possibly even collateral security. While each situation will be different, of course, we can assure you that Australian banks who are still lending are also considering all of these issues and we encourage you to do the same. We would also be pleased to discuss with you our views of particular transactions and protections if you would find it helpful.