Unreasonable director-related transaction? Director issuing shares to self
By Alicia Hill, Principal and Aidan Chu, Law Clerk
On 29 April 2022, Justice Anastassiou of the Federal Court of Australia delivered his judgement for the case of Aviation 3030 Pty Ltd (in liq) v Lao  FCA 458 (Aviation 3030).
Aviation 3030 dealt with the determination of whether the grant of shares by a director to himself constituted an unreasonable director-related transaction pursuant to section 588FDA Corporations Act 2001 (Cth)(Act).
In Aviation 3030, section 588FDA operated to restrict the rights of directors conferred upon them by an Option Agreement to purchase shares. In determining whether a transaction is ‘reasonable’, the court considers the benefits and detriments that the transaction has to the company.
Aviation 3030 had a maximum of 240 million shares it could issue to raise capital to acquire and develop land in Point Cook, Victoria.
The land was sold for a substantial commercial profit, rendering the proportion of shares held by shareholders as vital.
The land acquisition was a joint venture between Mr Hakly Lao, the First Defendant and director of Aviation 3030 (Mr Lao), his business associates and family – colloquially referred to as ‘The Founding Shareholders’.
Shareholders who had made investments but were not the Founding Shareholders were defined as ‘Early Investors’ to distinguish theme from Founding Shareholders.
As part of the capital raising process, the Founding Shareholders were entitled to exercise an Option Agreement, allowing them to purchase 76 million shares for $76,000, costing $0.001 per share.
On 17 March 2016 the Board of Aviation 3030, which Mr Lao sat on, approved the issue of two lots of 76 million shares as per the Option Agreement, which was referred to as ‘the March 2016 Share Issue’. This was significantly lower than the price that the Early Investors had paid for their shares – the Court found that they had paid between $0.098 and $0.14 per share.
The consequences of issuing a large number of shares for a significantly lower price resulted in the value of each share being diluted.
The Court found that the shares of the Early Investors had reduced by 63.4%.
The Liquidators brought an action for unreasonable director-related transactions pursuant to section 588FDA of the Act, breach of director fiduciary obligations, breach of director statutory duties and knowing assistance of the director in obtaining fiduciary property.
The Court did not find a breach of director statutory duty, director fiduciary duty or third party liability pursuant to knowing assistance provisions.
The Court had to determine if adequate disclosure of the Option Agreement had been provided to the Early Investors, so as to make the March 2016 Share Issue a reasonable transaction in the circumstances. If it was not reasonable then the transaction would be void under section 588FF of the Act.
Mr Lao sought to rely on the provision of an ‘Information Memoranda’ and the content of presentation seminars as adequate mechanisms of disclosure of the share issue rights. These provided information regarding the investment to investors.
The Liquidators argued that there was inadequate disclosure of the potential detriment that shareholders might suffer.
Although Information Memoranda had been provided to prospective investors, the Liquidators submitted that:
- The Information Memoranda did not disclose the Option Agreement held by the Founding Shareholders;
- evidence tendered by witnesses highlighted that not everyone had received an Information Memorandum;
- the presentation seminars lacked any reference to the Option Agreement. Instead, the presentation merely stated that a maximum of 240 million shares could be issued.
The Liquidators also submitted that the transaction was unreasonable as it exposed Aviation 3030 to civil litigation, regulatory action and liquidation and denied Aviation 3030 the opportunity to sell those shares to investors at the market price.
The Court ruled that the March 2016 Share Issue was an unreasonable director-related transaction.
The Court found that inadequate disclosure had occurred at the time the Early Investors acquired their shares. Moreover, the dilution of the value of the Early Investors’ shares had a retrospective effect.
His Honour speculated that the purpose of this retrospectivity allowed the Founding Shareholders to benefit from a highly profitable venture only after realising that the venture would be successful.
Justice Anastassiou did not believe that concerns of civil litigation, regulatory action and liquidation, and a denial of the opportunity to issue shares made the March 2016 Share Issue unreasonable.
This could be attributed to Justice Anastassiou focussing on the effect of the retrospective Option Agreement as the basis for unreasonableness.
The March 2016 Share Issue was deemed void under section 588FF of the Act and Mr Lao was ordered to pay $9,044,000, reflecting the price that the Early Investors would have paid for the 76 million shares to the Liquidators.
To avoid contravening the unreasonable director-related transactions provision while exercising Option Agreements, directors should ensure that the existence and effects are disclosed to potential shareholders.
Information for prospective shareholders conveyed through memoranda, presentation seminars or other means should include the existence of any Option Agreement, the parties to the Option Agreement, the price of the shares under the Option Agreement and the fact that this is likely to have a dilution effect on the total shareholding in the company.
This will allow investors to assess the impact of such a transaction on their own shareholder position and avoid assertions of unreasonableness of the exercise of such options in cases where the company later enters into liquidation.
Liquidators in considering possible unreasonable director related transactions need to identify what information was provided about the proposed transaction, to whom, when and whether this can be considered reasonable in the circumstances.
If you have any questions regarding this decision or any matters raised by it, please feel free to get in contact with Alicia Hill of the MST Dispute Resolution and Litigation team on (03) 8540 0200 or by email at email@example.com