Houldsworth: an obsolete piece in the legislative puzzle.

• Author: Nehme, Marina
• Position: Australia

Contents I. Introduction II. Brief Analysis of the Main Arguments in Houldsworth III The Impact of Houldsworth on Australian Law IV. Conclusion I. Introduction

Modern Australian companies operate within a complex matrix of legislation, common law, business norms and policy considerations. The existing regulatory regime is difficult to navigate, given the interplay between the Corporations Act 2001 (Cth) ('Corporations Act') and other relevant legislation, such as the Trade Practices Act 1974 (Cth) ('Trade Practices Act') and the Australian Securities and Investments Commission Act 2001 (Cth) ('ASIC Act). In addition, corporate regulators need to consider common law rules that may clarify or complicate an already intricate legislative system. one of these rules was developed by the House of Lords in Houldsworth v City of Glasgow Bank and Liquidators ('Houldsworth'). (1) In 1880, the Court in Houldsworth held that a member of a company could not claim damages for fraudulent misrepresentation against a company in the process of liquidation. (2) The Court further held that there was no right to rescission of the share subscription contract on the basis of fraudulent misrepresentation once the company went into liquidation, as this event renders restitution impossible. (3)

To some extent, the Houldsworth rule is still entrenched within the current corporate regime, despite there being difficulties in accommodating its principle within our system. Partly, this is because the rule in the case was developed when the concept of modern business corporations was in its infancy. For instance, when Houldsworth was decided, concepts such as a company's having a separate legal entity to its members, the acceptance and development of limited liability companies as the norm, (4) and the recognition that companies are legal entities with full legal capacity, (5) had not yet evolved.

In the 21st century, corporations have acquired legal maturity and are readily perceived and treated as legal persons with full legal capacity. This can be illustrated by s 124 of the Corporations Act, which states that 'a company has the legal capacity and powers of an individual both in and outside this jurisdiction. A company also has all the powers of a body corporate'. This necessarily raises the question as to whether Houldsworth is the missing 'piece' that helps rationalise the legislative corporate puzzle, (6) or alternatively, are we trying to complete such a puzzle using the wrong piece altogether.

This article will briefly critically examine the reasoning behind the Houldsworth rule. The application and effect of this rule will then be assessed within the context of s 563A and Chapter 6D of the Corporations Act, together with the implications of the case on s 52 of the Trade Practices Act and s 12DA of the ASIC Act. An argument will be developed that this 19th century case is antiquated and serves only to complicate and confuse the application of the statutory regime. Accordingly, the principle in the case should be abolished by legislative intervention. It is only through parliamentary action that the real or illusory application of the Houldsworth rule can be erased once and for all from the corporate landscape.

2. Brief Analysis of the Main Arguments in Houldsworth

   The City of Glasgow Bank was an unlimited liability company, which was established in 1839.7 The bank rapidly expanded. By 1857, it had 88 branches in scotland and, one year later, it had acquired the status of the third largest branch network of any British Bank. (8) Consequently, the City of Glasgow Bank was considered as one of the most respectable banks of its time. The Times, for instance, noted that

   among the various joint-stock banks which are established in scotland, none occupied a more favourable place in the estimation of the public than did the city of glasgow ... it was regarded as the safest source of investment to be met with. (9) In February 1877, Arthur Houldsworth purchased shares worth 4,000 [pounds sterling] from the City of Glasgow Bank. This purchase was induced by the company directors' representations that the bank was solvent. The directors even provided Houldsworth's agent access to the company's financial reports. However, sometime later, it became apparent that these financial reports were incorrect. In October 1878, the City of Glasgow Bank issued the following telegram: 'Bank has stopped payments. Close your doors at once and pay nothing whatever'. (10) These fateful words indicated the collapse of one of the most reliable and trustworthy banks of that era. The collapse of this unlimited liability company negatively impacted upon many of its investors. For instance, of the 1819 shareholders of the bank, only 254 remained solvent after the bank's liquidation. (11)

   When the City of Glasgow Bank became insolvent, Houldsworth, as a contributor, was required to financially contribute to help cover the company's debts. In December 1878, he took action against the liquidator to recover damages from the company. The damages claimed equated to the money he had paid for the stock, the money he had already contributed towards the company's debts and any future payments he would be called upon to pay. Houldsworth claimed that he was induced to buy the stock because of the fraudulent misrepresentations made to him by the company's officers. Earl Cairns, Lord Selborne, Lord Hatherley and Lord Blackburn unanimously rejected Houldsworth's claim for damages against the company because he had not renounced his shares. (12) Consequently, he was denied compensation for any losses caused by the fraudulent misrepresentations, which allegedly had induced his share subscription.

   On a number of occasions in the judgment, the learned judges stated that no 'case has been cited in which such a remedy as that sought by the Appellant in the present case has been allowed to take effect by any Court either in Scotland or in England'. (13) The question raised was whether such a claim for damages should be rejected because no other case could be cited to support the claim or alternatively because no previous case had considered this particular matter. To answer this question, their Lordships relied heavily on the judgement in Addie v The Western Bank of Scotland ('Addie'). (14) Their Lordships considered the facts of Addie to be similar to those in Houldsworth. However, unlike Houldsworth, when Addie subscribed for his shares, the entity was an unincorporated company. It should be noted that the House of Lords in Houldsworth considered this difference insignificant. (15)

   The main arguments relied upon by the House of Lords in Houldsworth were the following: (16)

   * It is difficult to distinguish between a company and its members. Given this, if members are permitted to take action against the company, this then implies that members are in fact suing themselves. This argument was particularly relevant, as the City of Glasgow Bank was an unlimited liability company. (17)

   * An action for damages for fraudulent misrepresentation cannot be brought by a member against the company. The directors, on the other hand, may be personally liable. (18)

   * Damages in deceit against the company are not an option, while members retain their shares. This would be contrary to the implied contract that exists between members. To claim damages from the company, members must rescind their shares. This is needed to stop the shareholder from approbating and reprobating at the same time. (19)

   In 1957, Professor Gower noted that Houldsworth was 'an anomaly'. (20) Consequently, he attempted to rationalise the decision by noting that one possible justification for the case 'depends on the recognition of share capital as a guarantee fund for creditors.' (21) Even though Re Addlestone Linoleum Company (22) and Webb Distributors (Aust) Pty Ltd v Victoria ('Webb') (23) used this argument to justify the Houldsworth rule, the judges in Houldsworth do not appear to have relied on the principle of capital maintenance, as the basis for their judgement. For this reason, this article will not consider this argument in its analyses of the case.

   1. Difficulty of distinguishing between a shareholder and the company

      In Houldsworth, Lord Hatherley observed that

      the Appellant is trying to reconcile two inconsistent positions, namely, that of shareholder and that of creditor of the whole body of shareholders including himself. (24) Similarly, Lord Selbourne observed that

      it is impossible to separate the matter of the pursuer's claim from his status as a corporator, unless the status can be put an end to by rescinding the contract which brought him into it. (25) The argument that was proposed was that the company and its members are one and the same and that there is no separate legal entity that exists between them. Members cannot sue the company as creditors because if they do, they are ultimately taking action against themselves, especially where the company is insolvent. (26) This argument may be acceptable within the context of an unlimited liability company. However, the Houldsworth rule has not been confined to unlimited liability companies, but has also been considered and applied to limited liability companies. (27)

      This position adopted by Houldsworth of blurring the distinction between companies and their members was no longer acceptable by the end of the 19th century, mainly because of the landmark decision in Salomon v Salomon & Co Ltd ('Salomon's Case'). (28) This case changed the way companies were viewed and became the authority for the principle that a company, once incorporated, became a separate legal entity. (29) Lord MacNaghten stated:

      The Company is at law a different person altogether from the subscribers to the memorandum; and, though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the...