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Shareholder and other equity holder loans – are yours in writing?

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By Davide Cavalleri, Special Counsel, MST Lawyers

In acting for shareholders in private companies, we often have to deal with loans and other financial accommodation made available by the shareholders to their company. 

Usually, these loans have been outstanding for long periods, and their balances fluctuate over time.  Fluctuations may result from the shareholder/lender:

  • injecting cash funds into the company over time;
  • paying costs and expenses which are properly attributable to the company without immediate reimbursement to the shareholder; or
  • receiving funds from the company which cannot or are not characterised in a specific way (for example, as remuneration for working in the company or as a dividend).

The fluctuations are reflected in movements in shareholders’ loan accounts, which will appear in the periodic financial statements of the company.

The same can be said of loans made by other equity holders to their respective entities, such as a unit holder to a unit trust.

Shareholder loans generally do not give rise to any problems, until a dispute or other tension develops between shareholders, or a shareholder wants to exit the company, dies or becomes incapacitated.  Frequently, the loans have not been properly documented, or even documented at all, creating uncertainty for all parties and unfortunately, in some instances, leading to costly disputes.

We therefore recommend that all private companies and trusts with outstanding loans from shareholders review those loan arrangements, ensuring that the shareholders/unit holders and the company/trustee are in agreement as to the terms and conditions governing the loans, and that the agreed terms and conditions are set out in a legally binding document, such as a loan agreement.  The matters such an agreement should deal with include:

  • the period over which the loan needs to be repaid;
  • any early repayment events, such as a shareholder selling their shares or dying;
  • whether interest is payable and, if so, the rate and the frequency of payment of interest;
  • whether the loan is to be subordinated or of limited recourse;
  • whether the loan is to convert to shares or other equity in certain circumstances; and
  • whether the loan is to be secured over any or all of the company’s assets.

If a loan is secured or guaranteed by a third party, additional documents may be necessary, such as a deed of guarantee or a security document.  Loans to company groups may require a cross-guarantee by some or all group companies to ensure all relevant group companies are responsible for paying all loans made to the group.

If the loan is secured over the company’s assets, depending on the nature of those assets, the security arrangement may need to be registered on the Commonwealth personal property securities register or as a mortgage on a land titles registry to ensure the arrangement will be fully enforceable.  If the company has existing secured creditors, such as a bank, their consent may be needed to the company giving security for shareholder loans.  The secured creditors may, as a condition of their consent, require the company and the shareholders/lenders to enter into a deed of priority.

Loans from shareholders, and any related security arrangement, when entered into as part of any transaction involving an acquisition of shares in the company or in the company’s holding company, may need to comply with special procedures set out in the Corporations Act 2001 (Cth) concerning companies financially assisting the acquisition of shares to ensure that the company’s directors, and anyone else involved in the transaction will not contravene the financial assistance provisions of the Act.

We can assist clients with documenting shareholder and other equity holder loan arrangements and providing related advice, as well as attending to the preparation of security documents for those loans and the registration of any related security.  We recommend that, as part of that process, lenders/shareholders and borrowers/companies seek advice from a tax professional as to the tax treatment, from both the lender’s and borrower’s perspective, of shareholder loans.

If you need advice or assistance in relation to shareholder or other equity holder loans, please contact Davide Cavalleri or our experienced Corporate Advisory team on (03) 8540 0200.