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Can A Company Provide Financial Assistance To A Person To Acquire Shares In The Company?

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By Benjamin Caddaye, Law Clerk and Alicia Hill, Principal, MST Lawyers

The High Court of Australia in Connective Services Pty Ltd v Slea Pty Ltd [2019] HCA 33 was concerned with two shareholders who used their combined voting power to initiate proceedings in the name of a group of companies against a third shareholder who proposed to sell his interest, in contravention of a pre-emptive rights provision of the companies’ constitution. In upholding the Court of Appeal’s decision to dismiss the proceeding against the third shareholder, the High Court illustrated the circumstances in which financial assistance by a company to a shareholder will be prohibited by section 260A of the Corporations Act 2001 (Cth).

Background

The Connective Services group of companies were incorporated in 2003 to conduct a mortgage aggregation business, and described themselves as ‘Australia’s leading mortgage aggregator’. The shareholders in the Connective Services companies are Slea Pty Ltd (Slea) (holding 33.33% of the shares), Millsave Holdings Pty Ltd (Millsave) (holding 50% of the Shares) and Mr Haron (holding the remaining 16.67% of the shares). The Constitution of each of the Connectives Services companies includes a pre-emptive rights provision which required a shareholder who wishes to sell their interest to first offer their shares to a current shareholder in proportion to their existing interest before they could sell the shares to a third party.

In 2009, Mr Tsialtas (the sole shareholder of Slea) entered into an agreement with Minerva Financial Pty Ltd (Minerva) to sell his interest in Slea. In 2010, a second agreement, the ‘Accommodation Agreement’ was entered into between Slea and Minerva. However, it was not until August 2016 when Millsave and Mr Haron used their majority voting power in the Connective Services companies to institute proceedings against Slea and Minerva, claiming that the 2009 Agreement and the Accommodation Agreement breached the pre-emptive rights provisions of the Companies’ constitution.

In October 2016, Slea and Minerva applied to have the proceedings against them dismissed or stayed. The basis of this application was that by applying for an injunction under s 1324 of the Corporations Act to restrain the Agreements, the Connective Services companies were in breach of s 260A(1) of the Act which contained an implied prohibition against financial assistance to shareholders to acquire shares.

At first instance, Almond J found in favour of Connective Services, dismissing the Application. However, on appeal, the Court of Appeal found in favour of Slea and Minerva, dismissing the proceedings. Connective Services consequently appealed to the High Court.

Prohibition Against Financial Assistance

The High Court outlined the history of the prohibition against financial assistance, tracing its introduction back to the UK’s Company Law Amendment Committee headed by Lord Greene in 1929. The Greene Committee had recommended that companies should be prohibited from directly or indirectly providing any financial assistance in connection with the purchase of their own shares by third parties. This was soon adopted in Australia’s state-based companies legislation in 1931 and has existed in various forms ever since.

The current provision, s 260A of the Corporations Act was introduced in 1998 and states that a company may financially assist a person to acquire shares in the company, only if the assistance does not materially prejudice the interest of the company, its shareholders, or the company’s ability to pay its creditors.

Because the provision is expressed in positive terms, the prohibition against assistance is considered to be implied, as assistance is only prohibited where relevant material prejudice exists. The High Court expressed the requirements imposed by s 260A as being in three parts. First, there had to be financial assistance. Secondly, that financial assistance must have been to acquire shares or units of shares. Thirdly, as a result of that assistance, there must have been material prejudice to the company, its shareholders, or its ability to pay its creditors.

The first requirement was easily satisfied in the eyes of the High Court, given the broad characterisation of financial assistance. The High Court stated that any action by a Company could be deemed as financial assistance if it eases the financial burden that would be involved in the process of acquisition, or if it improves the person’s net balance of financial advantage. There was no requirement in the legislation that a transaction exist between the company and the third party acquiring shares for it to deemed financial assistance.

To meet the second requirement there must also be a sufficient connection between the financial assistance and the acquisition of the shares in the company. The High Court was clear in the broad connotations of ‘acquisition’, stating that it did not require an acquisition to actually take place, and includes conduct that is in connection with the process of an acquisition. Therefore, the Court was of the view that by initiating proceedings to enforce a pre-emptive rights provision, the company was providing financial assistance by relieving Millsave and Mr Haron of the financial burden of enforcing their rights. That assistance was clearly in connection with the acquisition of shares in Connective Services, as that would be the effect of the pre-emptive rights if enforced.

The final question for the High Court was whether the financial assistance carried with it the requisite material prejudice for it to be prohibited by s 260A(1). This required a comparison of the position of the company before the giving of the assistance with the position afterwards to see whether the company, its shareholders or its ability to pay its creditors was worse off.  The Court noted that answering this question was not assisted by the introduction of further concepts which required further explanation. The Court also noted that under s 1324(1B), the onus was on the Connective Services to disprove the assumption that there was material prejudice as a result of the financial assistance. The Court considered the evidence of Slea that the pre-emptive rights proceeding was going to cost between $525,000 and $755,000, and those costs would not be entirely recoverable if the companies were successful. Therefore, Slea’s equity may be reduced by the cost of the proceeding which equated to a sufficient material prejudice to invoke the implied prohibition of s 260A, and Connective companies had not discharged the onus of proving that there was, in fact, no material prejudice

In dismissing the appeal the High Court noted that this action was one that was commonly brought by individual shareholders, as the Company’s constitution is deemed under 140(1) of the Corporations Act to have effect as a contract between each member of the company and between the members of the company and the company itself. Therefore, it was a proceeding more appropriately initiated by Millsave and Mr Haron themselves, without financial assistance from the Connective Services companies.

Points To Note

The Connective Services case is a reminder of the prohibition against a company providing any ‘financial assistance’ to a third party in connection with the acquisition of the company’s shares, where that assistance results in the material prejudice to the company, its shareholders or the ability to pay creditors. While Millsave and Mr Heron may have considered using the company’s resources to be financially advantageous, their choice resulted in an adverse costs order against the companies and a rebuke from the High Court for not initiating proceedings in their own names.

In practice, it will be difficult for a company to prove to a court’s satisfaction that financial assistance to acquire shares will not disadvantage it, shareholders or creditors and this will need to be the critical factor to consider before deciding whether to provide financial assistance.

If you have any questions about this article or the issues raised in it, please feel free to contact Alicia Hill of MST Lawyers’  Dispute Resolution and Litigation team by email or phone +61 8540 0200.