Lenders are aware of the prohibition in section 260A of the Corporations Act 2001 against a company financially assisting a person (whether by borrowing or giving security) to acquire shares in the company. The High Court has now explained the full scope of that prohibition.

In Connective Services Pty Ltd v Slea Pty Ltd [2019] HCA 33 the High Court of Australia (in a unanimous judgment of the five judges) prohibited Connective, at the expense of Connective but at the instigation of the two majority shareholders (Millsave and Mr Haron), from pursuing proceedings against a minority shareholder (Slea) who sold its shares in Connective without first offering those shares to the other two shareholders.

Under a pre-emption clause in Connective’s Constitution each shareholder was required to offer those shares to existing shareholders before those shares could be transferred to another party.

Slea and the purchaser Minerva applied to have Connective’s proceedings dismissed or stayed and sought an injunction under section 1324 of the Corporations Act to restrain the Connective companies from prosecuting the proceedings on the basis that by doing so they were in contravention of the implied prohibition in section 260A(1) of the Corporations Act against financial assistance.

Section 260A(1) of the Corporations Act provides that a company may only financially assist a person to acquire shares in the company if giving the assistance does not materially prejudice the interests of the company or its shareholders, or the company’s ability to pay its creditors, or the assistance is approved by shareholders under section 260B (that section also requires advance notice to ASIC), or if the assistance is exempted under section 260C. The proceedings had not been approved by shareholders and were not exempt.

The High Court considered the three elements necessary to establish a contravention of s 260A(1) that were relevant to the action are: (i) financial assistance given by the company; (ii) to acquire shares or units of shares in the company; and (iii) which materially prejudices the interests of the company or its shareholders or its ability to pay its creditors.

What is “financial assistance”?
The High Court held that the commencement of the pre-emptive rights proceeding by Connective was financial assistance within the meaning of section 260A(1), and that the Connective companies did not discharge their onus of proving that there was no material prejudice to the Connective companies or their shareholders. The Connective companies eased a financial burden in the process of any acquisition of shares by Millsave and Mr Haron. The commencement of the proceedings by the Connective companies, at their expense, was financial assistance to Millsave and Mr Haron. Further, costs would be incurred by the Connective companies in conducting the proceedings that would not, even if they succeed, be entirely recoverable.

The judges concluded:

“The financial assistance need not involve a money payment by the company to the person acquiring the shares. Any action by the company can be 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” in relation to the acquisition. For instance, the assistance might involve the company paying a dividend by means other than by payment of cash, issuing a debenture, granting security, or agreeing to pay consultancy fees….”

“The broad concept of financial assistance … extends beyond direct contributions to the share price. Examples of financial assistance by a company include the reduction of the financial burden of acquisition by payment of the costs of stamp duty, valuation costs, or … incurring due diligence costs which “smoothed the path to the acquisition of shares”….

“Bringing legal proceedings against Slea was a necessary step for the vindication of any pre-emptive rights of Millsave and Mr Haron. Those legal proceedings could have been commenced by Millsave and Mr Haron. If they had been so commenced, then it would plainly have been financial assistance for the Connective companies to provide the funds for Millsave and Mr Haron’s proceedings just as it would have been financial assistance to provide funds for stamp duty, valuation costs, or due diligence costs. Instead, the proceedings were commenced at the expense of the Connective companies, in which Millsave and Mr Haron hold 66.67% of the shares. The Connective companies eased a financial burden in the process of any acquisition of shares by Millsave and Mr Haron. The commencement of the pre-emptive rights proceeding by the Connective companies, at their expense, was financial assistance to Millsave and Mr Haron.”

“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.”