Restrictions on the co paying dividends S254T Restrictions on a company acquiring its own shares or those of its controlling entity

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Gordon Clement Simpson
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1 TOPIC 5: Share capital, debt capital and dividends 1. ISSUE/ALLOTMENT OF SHARES Co determines terms on which shares are issued and rights /restrictions attaching to shares S254B Members can be allotted shares on/after registration S117(2)(k) o Share issues specified in a registration application are taken to be issued upon registration S120(2) A co has general power to issue shares/ make public offerings (S124) through directors (S198A) and may issue preference shares, bonus shares and partly paid shares S254A o In doing so directors must exercise their share issue power for a proper purpose o Where directors breach their duties under S181 and issue of shares for an improper purpose, members are given a personal remedy under the principles established in Residues Treatment & Trading Co Ltd v Southern Resources Ltd Are there any restrictions on who the shares can be offered to? Companies have mandatory disclosure o Unless S708 applies companies that seek fund from the public require o Pty co may make private offerings of shares (S254D-RR): Before issuing shares, directors of pty co must offer them to existing SHs S254D(1) Directors may issue any shares not taken up under S254D(1) as they see fit S254D(3) Co can circumvent this requirement S254D(1) if they pass an ordinary solution S254D(4) Ensure that activity does not require disclosure to investors under S113(3) Existing non-employee shareholders are no more than 50, by offering shares and exceeding the limit of shareholders it can have, company automatically becomes public and are subject to public company obligations such as preparing financial statements and other necessary disclosures as stated in Ch 6D o Public co have no restrictions regarding share issues as long as they comply with the disclosures as set out in Ch 6D public offerings must issue a product disclosure statement and prospectus that is prepared and lodged with ASIC SHs are liable to pay calls in accordance with terms of issue S254M(1) o Co limited by shares: SH liability is limited to the amount owing (if any) to the co for the shares bought S516 In other words SH can only pay calls on partly paid shares o NL (mining co) : SH cannot be liable on calls to recover unpaid amounts for shares S254M(2) o But if call is made on share and the call is unpaid after 14 days, SH cannot be paid a dividend and must forfeit their share until they pay their call S254Q ASIC must be notified for share issues S254X 2. CAPITAL MAINTAINENCE Statutory rules The requirement that the company maintain their share capital finds its expression in: Restrictions on the co paying dividends S254T Restrictions on a company acquiring its own shares or those of its controlling entity 1

2 Restrictions on a company giving financial assistance to a person to acquire shares in the company or its holding company A company is not permitted to reduce its share capital except: o In the way set out in div 1 of 2J.1 o Under buyback complying with div 2of 2J.1 o Through redemption of redeemable preference shares o In other circumstances in Div 3 Paying a Dividend Drs may determine a div is payable and fix the amount, time and method of payment S254U(1) RR Interest is not payable on a divs254u(2)-rr Profitable companies do not have to declare a div and may instead chooe to accumulate profits earned against future contingencies Div Rights Each share in a class of shares in a public co has same div rights unless the constitution or special resolution provides otherwise S254W(1) For a private company, directors may pay div as they see fit, subject to terms of issue (RR- terms of issue are RR) S254W(2) When can a co pay a div? A co must not pay a div unless S254T: (a) The co s assets exceed its liabilities immediately before the div is declared and the excess is sufficient to pay the div Co must conduct a balance sheet test immediately before declaring a div, in accordance with accounting standards S254T(2) Declare problematic as cos typically do not declare a div as this incurs a debt to SHs S254V(2) o Declare = recommended by the board and approved by members at a meeting Instead, directors typically fix the amount /time/method of div payment S254U(1)RR, which does not incur a debt S254V(1) o If they merely fix, then the requirements that A>L is perhaps inoperative (b) The payment of div is fair and reasonable to the SHs as a whole Adequacy of consideration paid to SHs Whether SH would be deprived of some rights (Re Fowlers) o Compare to what SH would get on winding up surplus assets, full purchase price of shares repaid Whether reduction is being used as a takeover and to circumvent take-over provisions \ (c) Does not materially prejudice the co s ability to pay other creditors Material prejudice occurs where there is material diminution of co assets (Adler) o Onus is on those supporting the transaction (Adler per Santow J confirming Kinarra) Consequences of paying a unpermitted div 1. Transactions might constitute a capital reduction under S256B(1). If so: Transaction still remains valid and co not guilty of an offence S256D(2). However: Persons involved breach a CPP S256D(3) o See S79 for definition of persons involved If persons are involved dishonestly they commit a criminal offence S256D(4) 2

3 2. Injunction /damages under S1324 can be sought by persons whose interests are affected by the div 3. Paying a div may also breach directors duties, which will still apply even if transaction is authorized by these sections S260E 4. Possible insolvent trading S588G: Paying a dividend constitutes incurring a debt and if doing so causes insolvency of the co, directors are personally liable under S588G. Insolvency: unable to pay all its debts as and when they become due S95A This is because if a company pays a dividend, it is deemed by S588G(1A) of the CA to have incurred a debt at the time the dividend is paid or, if the company has a constitution which provides for the declaration of dividends when the dividend is declared, see S254V. Insolvent trading applies if A person is a director at the time, the company pays or declares the div i.e incurring the debt Company is insolvent when the debt is incurred or becomes insolvent by incurring the debt and At that time, there were reasonable grounds for suspecting the company is or would become insolvent If the provisions apply, then a director contravenes S588G(2) by failing to prevent the company from incurring the debt, that is from paying and declaring the div if he or she is aware at the tome what there are reasonable grounds for suspecting the co is or would become insolvent or if a reasonable person in their position would be aware of those grounds. S588G(2) is a cpp- accordingly, CPP consequences follow, IN addition S588J and S588K allow courts to order the director to pay compensation for the loss or damage incurred by unsecured creditors as a result of the dorector s failture, and under S588M, the company s liquidator and co s unsecured creditors can seek compensation. Defenses in S588H may be available for the director: reasonable grounds to expect solvency, reasonable reliance on other people, absence from management for illness or some other good reason, reasonable steps to prevent the co from incurring the debt. GEN law: As in Trevor v Whitworth, co is generally prohibited from reducing its share capital. 3 exceptions to the capital maintenance doctrine: Capital reductions SBB Financial Assistance Capital reductions (shares cancelled against members will) 2J.1 Co could argue (action) constitutes a valid capital reduction, provided the reduction S256B(1): (a) Is fair and reasonable to the co s shareholders as a whole Adequacy of consideration paid to SH SH has or has not been deprived of some rights o Compare to what SH would get on winding up surplus assets, full purchase price of shares repaid Whether reduction is being used as a takeover and to circumvent take over provisions (b) Does not materially prejudice the co s ability to pay other creditors Material prejudice occurs where there is material diminution of co assets (Adler) Onus is on those supporting the transaction (c) Is approved by SH under S256C A. First determine 1 whether reduction is equal or selective? 2. Whether it involves a cancellation of shares? 3

4 o Equal reduction = every ordinary SH s OS are reduced in proportion to how many shares they own S256B(2) o Selective reduction = anything other than an equal reduction S256B(2) B. For equal reduction: reduction must be approved by an ordinary res passed at a GM S256C(1) B. For selective reduction: reduction must be approved by S256C(2) o A special res at a Gm of the co (where votes of people who are to receive consideration as part of the reduction don t count) OR o A unanimous res of ordinary SHs C. Additional requirement: reduction involves cancellation of shares, the reduction must be approved by a spec res of SHs whose shares are to be cancelled S256C(2) o Only those SHs who shares are to be cancelled can attend other SHs or strangers cannot attend (Winpar holdings) D. Notice +information to accompany notice of meeting to be lodged with ASIC S256C(4)(5) Consequences for capital reduction Co must not make reduction unless it complies with S256B(1): S256D(1) Transaction remains valid and co not guilty of an offence S256D(2) However: 1. Injunction/damages under S1324 can be sought by persons whose interests are affected by the capital reduction If seeking injunction under S1324 to restrain the co from making capital reduction is on the basis that reduction is not fair and reasonable as price offered was less than share price, per Elkington v CostaExchange Ltd, interests of all shareholders, not just minority are to be considered in determining whether the selective reduction is fair and reasonable 2. Persons involved breach a civil penalty provision (CPP) S256D(3) Involved is where person S79: - Aids/abets/ counsels/ procures breach or - Induces breach by threats/ promises/other means or - Has in anyway (by act /omission, directly/indirectly) knowingly concerned in/ party to breach Adler suggests persons involved must have actual knowledge of all essential facts 3. If persons are involved dishonestly, they commit a criminal offence S256D(4) 4. Capital reductions may also breach director s duties, which still apply even if transaction is authorized by these sections S260E 5. Possible insolvent trading: S588G a reduction of capital constitutes incurring a debt for the purposes of S588G: S588G(1A) Share buy backs (SBB) 2J.1 Rule: Generally, a co cannot acquire shares in itself: S259A Exception: A co may buck back its own shares provided that S257A 1. The SBB does not materially prejudice the co s ability to pay its creditors (per Adler) 2. The co follows the procedures set out in S257B-257H 1. Identify type of SBB (a) Minimum holding buy-back: a buy-back of all a SH s shares in a co if the shares are less than the marketable parcel (<$500 worth of shares) S9 (b) Employee share scheme: a scheme where shares can be acquired by/for the benefit of employees (S9) (c) On market buy-back: A buyback resulting from an offer made by a listed co on a financial market S257B(6) 4

5 (d) Equal access schemes: the co offers to buy-back ordinary shares from every person who holds them to buy back the same percentage from each SH on the same terms S257B(2)(3) 2. Minimum holding: No special procedural requirements under S257C-257G apply, only requires shares to be cancelled after it is acquired by the company S257H and co must notify ASIC of the cancellation S254Y. 3. Member approval? Does SBB exceed the 10/12 limit? (Only if SBB is type B, C or D) SBB will exceed 10/12 limit if the co buys back 10% (or more) of the smallest number of voting shares held in the co within the previous 12 months S257B(4)(5) - So e.g. if co currently has 100 voting shares, but at some point in the last 12 months had only 50 voting shares, then a buyback of 5 voting shares would exceed the 10/12 limit - If S257B(4) and (5) applies : then ordinary res of SHs passed at a GM of the company is required S257C. If it does not apply, (no 10/12) then co may buy back shares without members approval. - Co must then include with notice of the meeting a statement setting out all information known to the company that is material to the decision for voting on the resolution S257C(2) - Notice of meeting should be lodged with ASIC, then SHs S257C(3) 4. For selective buy-backs, either a special resolution passed at a GM with no votes cast in favor by those whose shares are being bought S257D(1)(a) or a unanimous resolution by all ordinary SHs S257D(1)(b). 5. For all SBB: Once transfer of shares is registered, all shares and rights attaching to the shares must be cancelled S257H(1) and ASIC must be notified of the cancellation per S254Y. In particular, for selective buy-backs: special resolution is required and persons who shares are to be bought back and their associates are not allowed to vote on the resolution. Consequences of unpermitted SBB Where a co buys back its shares in a way that is not allowed by Div 2 of Pt 2J.1 of the CA, the transaction remains valid and co not guilty of an offence S259F(1). 1. Injunction/damages under S1324 can be sought by persons whose interests are affected by the SBB Note S1324(1B) assumption see injunctions page 2. Buy-back will be a prohibited self-acquisition and any person involved in the contravention contravenes S259F(2) which is a civil penalty provision. See S79 for definitions of persons involved 3. If persons are involved dishonestly, they commit a criminal offence S259F(3) SBB may also breach directors duties, which may still apply even if transaction is authorized by these sections S260E 5. Possible insolvent trading S588G SBBs constitute incurring a debt for the purposes of S588G: S588G(1A) Financial assistance for the purchase of company shares 2J.3 Co could argue that it has validly reduced its capital by providing financial assistance to [party] to acquire shares in it (S260A). Co appears to have provided FA by [doing X] (Burton) 1. Is there FA? Impoverishment Test: FA requires the co to diminish its resources to provide [party] with something it needs/wants. Question of fact to be determined in light of the circumstances : ASIC v Adler Mere payment of debt in the ordinary course of business is not FA (Burton) o Something extra would need to be shown e.g. extra interest, payment ahead of time etc (Burton) Can be provided before/after the acquisition of shares (S260A(2)(a)) Includes paying a dividend S260A(2)(b); making a loan/gift so one can acquire shares in the co; buying one s property on inflated terms so that one can acquire shares in the co 5

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