The High Court of Australia in Connective Services Pty Ltd v Slea Pty Ltd [2019] HCA 33 has upheld the decision of the Victorian Court of Appeal that companies which brought proceedings at their own expense to enforce ‘pre-emptive rights provisions’ in their constitutions for the benefit of some of their shareholders had contravened the implied prohibition against financial assistance in s 260A(1) of the Corporations Act 2001 (Cth) (“CA”) and should be restrained from prosecuting the proceedings under s 1324 of the CA.
Relevant provisions
Section 260A of the CA relevantly provides as follows:
“(1) A company may financially assist a person to acquire shares (or units of shares) in the company or a holding company of the company only if:
(a) giving the assistance does not materially prejudice:
(i) the interests of the company or its shareholders; or
(ii) the company’s ability to pay its creditors; or
(b) the assistance is approved by shareholders under section 260B (that section also requires advance notice to ASIC); or
(c) the assistance is exempted under section 260C.
Note: For the criminal liability of a person dishonestly involved in a contravention of this section, see subsection 260D(3). Section 79 defines involved.”
Section 1324(1) of the CA empowers the Court to grant an injunction where a person has engaged, is engaging or is proposing to engage in conduct, that constituted, constitutes or would constitute, a contravention of the CA. By s 1324(1B), if the ground relied upon in an application for an injunction is conduct or proposed conduct of a company or other person which it is alleged constitutes, or would constitute, a contravention of s 260A(1)(a), then the Court must assume that the conduct constitutes, or would constitute, a contravention of that provision unless the company or person proves otherwise.
Background
The case involved two companies (the so-called “Connective companies”) which each had the same three shareholders, one of which was Slea. Slea held 33.33% of the shares while the other two shareholders held 66.67% of the shares. The constitutions of the Connective companies each contained identical ‘pre-emptive rights provisions’ which provided that, before a shareholder could transfer shares of a particular class, the shares first had to be offered to existing shareholders of the particular class in proportion to the number of shares of the class already held by that shareholder.
The Connective companies brought proceedings claiming that certain agreements entered into between Slea’s sole director and shareholder and a company called Minerva breached the pre-emptive rights provisions and that Slea intended to transfer its shares in the Connective companies to Minerva without complying with the pre-emptive rights provisions. The Connective companies sought an order compelling Slea to offer its shares in the Connective companies to the other two shareholders in accordance with the pre-emptive rights provisions.
Slea and Minerva then applied to have those proceedings dismissed or stayed, seeking relief which included an injunction under s 1324 of the CA to restrain the Connective companies from prosecuting the proceedings on the basis that the proceedings contravened s 260A(1) of the CA.
A decision at first instance that the Connective companies had not contravened s 260A was overturned on appeal by the Victorian Court of Appeal. By grant of special leave, the Connective companies appealed to the High Court which agreed with the Court of Appeal that s 260A had been contravened and that an injunction must issue.
High Court
The High Court (Kiefel CJ, Gageler, Keane, Gordon and Edelman JJ) in a joint judgment said that the following three elements were necessary to establish a contravention of s 260A(1) of the CA for the purposes of the appeal (at [20]):
- financial assistance given by the company;
- to acquire shares or units of shares in the company; and
- which materially prejudices the interests of the company or its shareholders or its ability to pay its creditors.
Financial assistance
The Court said that “financial assistance” (at [16]; [21]-[22]; [33]):
- was a commercial concept and a broad concept;
- did not need to involve a money payment or direct contribution by the company to the person acquiring the shares;
- could be action by the company which eased the financial burden that would be involved in the process of acquisition such as payment of the costs of stamp duty or valuation costs, or which improved the person’s net balance of financial advantage in relation to the acquisition.
To acquire shares or units of shares
As for the element to acquire shares or units of shares in the company, the Court said that the words “to acquire” (at [23]):
- required that there be a sufficient link between the financial assistance and the acquisition of the shares or units of shares but that an acquisition did not actually have to take place;
- included conduct that was in connection with the process of an acquisition of the shares or units of shares and was not limited to conduct for the purpose of acquisition.
The Court further said that acquisition also had broad connotations and included acquisitions by issue, by transfer, or by any other means (at [23]).
Material prejudice
The Court then observed that the potential breadth of s 260A was constrained by the requirement of the implied prohibition that the financial assistance by the company to acquire its shares had to be materially prejudicial to the interests of the company or its shareholders (being the shareholders collectively and each shareholder individually) or its ability to pay its creditors (at [25]). The Court then said that the question of material prejudice (at [26]):
- required that there be an assessment of, and comparison between, the position before the financial assistance was given and the position after it was given to determine whether the company or its shareholders or its ability to pay its creditors was in a worse position; and
- should not be glossed over by the introduction of further concepts not found in the language of s 260A(1) and which would require further explanation such as whether there had been a diminution of the company’s assets, whether there had been a transaction, or whether there had been a net transfer of value to the person acquiring the shares.
Findings
The Court said that, by s 1324(1B) of the CA, in the application for an injunction based upon an alleged contravention of s 260A(1)(a), the Connective companies were required to disprove that their conduct constituted a contravention of s 260(1)(a) and that this meant that they were required to disprove each element of the conduct that would constitute a contravention of s 260A(1)(a), including those in the introductory words (at [28]). The Court then went on to make the following points (at [34]-[37]):
- The bringing of legal proceedings against Slea was a necessary step for the vindication of any pre-emptive rights of the other two shareholders. If those proceedings had been brought by the other two shareholders, it would clearly have been financial assistance for the Connective companies to have provided the funds for those proceedings just as it would have been financial assistance had the Connective companies provided funds for the payment of stamp duty or valuation costs. Instead, the proceedings had been brought at the expense of the Connective companies in which the other shareholders held 66.67% of the shares and so the Connective companies had eased a financial burden in the process of any acquisition of shares by the other shareholders. Thus, the commencement of the pre-emptive rights proceedings by the Connective companies at their expense was financial assistance to those shareholders.
- The argument by the Connective companies that any financial assistance was not to acquire shares because the pre-emptive rights proceedings would not create any new rights and that, in any event, the pre-emptive rights were only to be offered shares for purchase and would not necessarily result in an acquisition was not consistent with the breadth of the words “to acquire” which extended to all conduct in connection with the process of an acquisition of the shares or units of shares. Furthermore, the acquisition process did not exclude court recognition of pre-emptive rights merely because the exercise of the rights would not give rise to the acquisition of shares. Section s 260A(1) included the acquisition of “units of shares” and s 9 of the CA defined a “unit” of shares to include “an option to acquire such a right or interest in the share”. Thus, the Connective companies had financially assisted the other two shareholders to acquire shares, or units of shares, in the companies.
- As for material prejudice, the Connective companies would incur costs in prosecuting the pre-emptive rights proceedings which, even if they succeeded, would not be entirely recovered, as well as becoming subject to any potential adverse costs orders. These costs could reduce Slea’s equity as a shareholder which was a step towards compelling Slea to offer its shares for transfer to the other two shareholders. The pre-emptive rights proceedings could have been brought by the other two shareholders in their own right, yet no evidence had been put forward by the Connective companies that they had sought funding or indemnity from those shareholders against the costs liability. Therefore, the Connective companies had not discharged their onus of proving that there was no material prejudice to them or their shareholders by giving the financial assistance to the other two shareholders.
In conclusion, the Court said as follows (at [39]):
“Section 260A(1) does not abrogate the power of a company to enforce its constitution. However, together with s 1324(1B), it has the effect that if a company wishes to bring proceedings to enforce pre-emptive rights in its constitution, for the benefit of some of its shareholders but at the company’s expense, then the company is liable to be enjoined from doing so unless the assistance is approved by shareholders under s 260B, or unless the company can satisfy the court that bringing the proceedings at its own expense does not materially prejudice the interests of the company or its shareholders or the company’s ability to pay its creditors. The Connective companies failed to discharge this onus.”
