Connective Services Pty Ltd recently tested the scope of the prohibition in s260A of the Corporations Act 2001 (Cth) (the Act) in the High Court, and lost. That section stops a company giving financial assistance to assist a person acquire the company’s shares. The case illustrates how broadly this prohibition can apply. Connective was not making a loan or giving security in relation to the acquisition of its shares, it was trying to stop one of its shareholders selling their shares in breach of the first right of refusal provisions in its constitution.
The prohibition against giving financial assistance
The prohibition against giving financial assistance has its footings in the case law and legislation of the United Kingdom. The Company Law Amendment Committee recommendation that a company should be prohibited from directly or indirectly providing any financial assistance in connection with the purchase of its own shares by a third party was adopted in the Companies Act 1929 (UK). It didn’t matter whether such assistance is provided in the form of loan, guarantee, provision of security or otherwise.
Australia followed suit in 1932 and introduced similar legislation in each state’s Companies Act. The rule was modernised in 1998 to include a material prejudice test and its current form is in s260A Corporations Act 2001 (Cth). Section 260A of the Act is expressed in permissive terms and provides a company may ONLY financially assist a person acquire its shares (or its holding company’s shares) if giving the assistance:
- does not materially prejudice the interests of the company, its shareholders or the company’s ability to pay its creditors; or
- is approved by its shareholders; or
- falls within one of the narrow exceptions to this rule.
It is an offence under the Act to be involved in a contravention of the rule against a company providing financial assistance in relation to the acquisition of its shares. The maximum penalty for being involved in the breach is five years in jail. Monetary penalties can also apply.
Connective Services Pty Ltd recently asked the High Court to over-rule a decision that the litigation it brought against its shareholder Slea Pty Ltd breached the rule.
Connective companies are a leading Australian Mortgage Aggregator. The shareholders of the Connective companies were Slea Pty Ltd (holding one third of the shares), Millsave Holdings Pty Ltd (holding half of the shares) and Mr Haron (who held one sixth of the shares).
The constitutions of each Connective company contained identical pre-emptive clauses (pre-emptive rights provision). The pre-emptive rights provisions prevented shareholders from selling or transferring shares without first offering those shares to the existing shareholders. However, in 2009, Mr Tsialtas, the sole director and shareholder of Slea Pty Ltd (Slea), decided to sell the entirety of his shares to Minerva Financial Group Pty Ltd (Minerva).
The Connective companies claimed the 2009 Agreement and a subsequent Accommodation Agreement breached the pre-emptive rights provisions of their constitutions. Connective sought orders to compel Slea to offer his shares to Millsave and Haron.
Slea and Minerva subsequently sought to have Connective’s claim dismissed or stayed on the basis the action was in contravention of the implied prohibition against financial assistance in s260A(1) of the Corporations Act, and won on appeal. Connective then appealed the decision to the High Court.
The High Court
The High Court dismissed Connective’s appeal.
By commencing proceedings to have Slea offer its shares for sale to its remaining shareholders, Connective had provided financial assistance in relation to an acquisition of its shares and that action was to Slea’s detriment. In effect, the majority shareholders should have brought the action rather than Connective.
- had incurred costs (provided financial assistance) trying to enforce the pre-emptive rights in favour of the other shareholders – Slea had estimated the cost of the pre-emptive rights proceedings to be $525,000 to $725,000 in addition to any potential adverse costs orders; and
- had not obtained shareholder approval required under s260B Corporations Act.
It was for Connective to satisfy the Court that bringing proceedings at its own expense, does not materially prejudice the interests of the company, or its shareholders or its company’s ability to pay its creditors, as implied in s260A. The Court held Connective failed to discharge this onus.
This case highlights the breadth of the implied prohibition against a company providing financial assistance for the purchase of its own shares where there is determinant to either the company, the shareholders or its creditors.