Last week’s High Court decision highlighted the inherently broad application of the Corporations Act 2001 (Cth) (Corporations Act) financial assistance provisions.

The High Court’s decision in Connective Services Pty Ltd v Slea Pty Ltd [2019] HCA 33, focussed on the scope of section 260A(1) of the Corporations Act relating to financial assistance by a company to acquire shares in the company where the financial assistance is said to materially prejudice the interests of the company or its shareholders.

Facts

In 2003, the appellant companies (Connective Services Pty Ltd and Connective OSN Pty Ltd) (Connective Services) were incorporated to conduct a mortgage aggregation business. The shareholders of Connective Services were: - Slea Pty Ltd (Slea); - Millsave Holdings Pty Ltd (Millsave); and - Mark Haron (Haron).

In 2009, the sole director and shareholder of Slea entered into an agreement to sell his shares to Minerva Financial Group (Minerva).

The constitutions of both entities in the Connective Services contained a pre-emption clause relating to the transfer or sale of shares in Connective Services (Pre-Emptive Rights).

Connective Services instituted proceedings against Slea and Minerva (joining Milsave and Haron as defendants) (Defendants) on the basis that there had been a breach of the Pre-Emptive Rights. The Defendants sought an injunction under section 1324 of the Corporations Act to restrain Connective Services from prosecuting the proceedings on the basis that by doing so they were in contravention of the implied prohibition of section 260A(1) of the Corporations Act against financial assistance.

Section 1324(1B) of the Corporations Act provides that:

If the ground relied on in an application for an injunction is conduct or proposed conduct of a company or other person that it is alleged constitutes or would constitute: (a) a contravention of …paragraph 260A(1)(a); the Court must assume that the conduct constitutes, or would constitute, a contravention of that paragraph, section or provision unless the company or person provides otherwise.

Relevantly, section 260A(1) of the Corporations Act provides:

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.

The High Court held that Millsave and Haron were required to bring legal proceedings against Slea to vindicate their Pre-Emptive Rights. If Millsave and Haron had instituted proceedings, this would have indicated that it would have been financial assistance for Connective Services to fund those proceedings.

Instead, Connective Services commenced and funded these proceedings. Millsave and Haron are the majority shareholders of Connective Services. The High Court held that the commencement of the Pre-Emptive Rights proceedings was financial assistance within the meaning of section 260A(1) and that Connective Services did not discharge their onus of proving that there was no material prejudice to Connective Services or their shareholders.

The High Court found that the costs of conducting the proceedings would not be recoverable even in circumstances where Connective Services was successful. This constituted a contravention of section 260A of the Corporations Act and the High Court issued the injunction as sought by the Respondents.

Ramifications

Connective Services were required to discharge the onus that their conduct did not materially prejudice the interests of the company or its shareholders or the company’s ability to pay its creditors. Connective Services, in this instance, were unable to demonstrate that its conduct alleviated the need for the majority shareholders to institute proceedings against the other shareholders.

This decision has arguably broadened the scope of ‘financial assistance’ under the Corporations Act, as it has now extended to include where a company was, in effect, taking on the financial burden of instituting proceedings to enforce the Pre-Emptive Rights for the benefit of the shareholders.

Given the broad implications of this decision and the wording generally in the financial assistance provisions, it is advisable to take a conservative approach when considering whether any conduct could constitute financial assistance and in turn, contravene section 260A of the Corporations Act. There are significant penalties associated with breaching section 260A, including criminal penalties where the breach is dishonest. An effective way to avoid breaching section 260A is seeking shareholder approval pursuant to section 260B of the Corporations Act.