Don’t jump the gun: understanding pre-emptive rights

In Connective Services Pty Ltd v Slea Pty Ltd1, the High Court considered the scope of the implied prohibition in section 260A(1) of the Corporations Act 2001 (Cth) (Corporations Act) against companies financially assisting a person to acquire shares in the company where the financial assistance will materially prejudice the interests of the company or its shareholders.

Facts

In 2003, the two appellant companies (the Connective companies) were incorporated to conduct a mortgage aggregation business. The shareholders in the Connective companies are:

  • Slea Pty Ltd (Slea) with 33.33%;
  • Millsave Holdings Pty Ltd (Millsave) with 50%; and
  • Mr Haron with 16.67%.

Since 2011, the directors of the Connective companies are Mr Haron, Mr Lees (who is associated with Millsave), and Mr Maloney.

The constitution of each Connective company contained an identical pre-emption clause which required that before a shareholder could transfer shares of a particular class, those shares must first be offered to existing shareholders of that class in proportion to the number of shares of that class already held by that shareholder.

Between 2009 and 2010 the sole director and sole shareholder of Slea, Mr Tsialtas, entered into an agreement with Minerva Financial Group Pty Ltd (Minerva) for the sale of his shares in Slea. Slea, Minerva and Mr Tsialtas also entered into a second agreement entitled “Accommodation Agreement”.

In 2016, the Connective companies commenced proceedings against Slea and Minerva. They claimed that both of the agreements entered into breached the pre-emptive rights provisions and alleged that Slea intended to transfer its shares in the Connective companies to Minerva without complying with them.

The relief sought by the Connective companies included an order to compel Slea to offer its shares in the Connective companies to Millsave and Mr Haron in accordance with the pre-emptive rights provisions.

A month later, Slea and Minerva applied to have the pre-emptive rights proceeding dismissed or stayed. Alternatively, they sought an injunction under s 1324 of the Corporations Act to restrain the Connective companies from prosecuting the pre-emptive rights proceeding on the basis that by doing so they were in contravention of the implied prohibition against financial assistance in s 260A(1) of the Corporations Act.

Decision

The High Court held that the three elements necessary to establish a contravention of s 260A(1) that were relevant to the appeal are:

  • 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.

The Connective companies denied the existence of each element in their ground of appeal to the High Court.  

Was Financial Assistance Given?

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, as has been held in the context of a differently worded provision in England, incurring due diligence costs which “smoothed the path to the acquisition of shares”.2

The court found that bringing legal proceedings against Slea was a necessary step for the vindication of any pre-emptive rights of Millsave and Mr Haron. However, those legal proceedings could have been commenced by Millsave and Mr Haron. Instead, the proceedings were commenced at the expense of the Connective companies. Therefore, the commencement of the pre-emptive rights proceedings by the Connective companies, at their expense, was financial assistance to Millsave and Mr Haron.

Were Shares or Units of Shares to be Acquired?

The Connective companies submitted that any financial assistance by the companies was not to acquire shares in the companies. The pre-emptive rights would not necessarily give rise to an acquisition.

However, section 260A(1) includes the words acquisition of “units of shares”. A “unit” of shares is defined in section 9 of the Corporations Act in terms that include “an option to acquire such a right or interest in the share”. The Connective companies thus financially assisted Millsave and Mr Haron to acquire shares, or units of shares, in the companies.

Did It Materially Prejudice the Company or Its Shareholders?

The Connective companies then submitted that any financial assistance they gave would not materially prejudice the interests of the companies or their shareholders or the ability of the companies to pay their creditors.

Before the primary judge, Slea led evidence that the estimated cost of the pre-emptive rights proceeding was between $525,000 to $755,000 in addition to any potential adverse costs orders.3  As a shareholder, Slea’s equity may be reduced by these costs of the pre-emptive rights proceeding, which is a step towards compelling Slea to offer its shares for transfer to Millsave and Mr Haron.

The pre-emptive rights proceeding could, and commonly would, have been brought by Millsave and Mr Haron in their own right. The Connective companies did not discharge their onus of proving that there was no material prejudice to them or their shareholders by giving the financial assistance to Millsave and Mr Haron.

Therefore, the Court of Appeal of the Supreme Court of Victoria was correct to conclude that section 260A(1) was contravened and that an injunction must be issued and the appeal was dismissed.

Lavan Comment

When transferring shares, shareholders should make sure that they are complying with any pre-emptive rights contained in the company’s constitution. Notwithstanding the company being restrained in this case from proceeding with its application, the affected shareholders would have been able to bring proceedings to require compliance with the pre-emptive rights clauses in the constitution.

Further, this judgment is a timely reminder that before issuing legal proceedings companies should carefully consider whether to do so would breach the implied prohibition contained in section 260A(1) of the Corporations Act.

Please contact Cinzia Donald if you require advice on compliance with your obligations under a company’s constitution or the Corporations Act.

 
16 October 2019
Corporate Disputes
AUTHOR
Cinzia Donald
Partner
AUTHOR
Lorraine Madden
Special Counsel
SERVICES
Corporate Disputes


FOOTNOTES

[1] [2019] HCA 33.

[2] Chaston v SWP Group Plc [2003] 1 BCLC 675 at 688 [38].

[3] Connective Services Pty Ltd v Slea Pty Ltd (2017) 53 VR 130 at 154 [82].