The Federal Court of Australia’s decision in Poseidon Nickel Limited1 is the latest in a recent spate of applications by companies seeking to validate share dealings that contravened the disclosure provisions in the Corporations Act 2001 (Cth) (Corporations Act).
The decision and those before it serve as a useful reminder for company officers to ensure they understand and comply with the “cleansing” provisions of the Act when issuing shares, and to obtain appropriate advice where necessary.
Institutional investors should also note the Court’s expectation that, as sophisticated market participants, such investors must satisfy themselves that the relevant disclosure requirements have been met.
“Cleansing” share issues
When issuing securities, a company must issue a disclosure document (typically, a prospectus) unless the Act says otherwise. Exceptions to the disclosure requirement include where the company is issuing securities:
- to sophisticated or professional investors;
- to employees of the company; or
- as part of “small scale” personal offerings totalling less than $2 million, to fewer than 20 investors, in a 12 month period.
Where securities are issued under a disclosure exception, the on-sale of those securities within 12 months requires disclosure unless the Act says otherwise. This on-sale restriction is intended to prevent avoidance of the primary disclosure obligation. When seeking quotation of securities on ASX, the issuing company must warrant to ASX that the issued securities can be on-sold within 12 months without disclosure.
On-sale disclosure is not required if the company “cleanses” the issued securities by releasing either:
- a cleansing notice under section 708A(5)(e) of the Act (with the notice setting out any excluded information that has been withheld from continuous disclosure, but which is material to an investor assessing the company and the securities); or
- a cleansing prospectus under section 708A(11) of the Act (which can be released after the date the securities were issued, but must be released before the securities are on-sold).
The Act sets out a number of pre-requisites for a company to be able to issue a cleansing notice. This includes, critically, that the securities are in a class that was quoted at all times during the previous three months and that trading has not been suspended for more than five days in the previous 12 months. The cleansing notice must also be issued within five business days after the date the securities are issued.
What if you got it wrong?
If company officers become aware of a breach of the disclosure provisions of the Act, an application for relief can be made to the Federal Court of Australia. The Court has wide powers under section 1322 of the Act to validate procedural and administrative errors. Relief from civil liability may also be granted. For the Court to make any orders under this provision, it needs to be satisfied that:
- the act, matter or thing, or the proceeding is essentially of a procedural nature;
- the person or persons concerned acted honestly; or
- it is just and equitable that the order be made.
Upon becoming aware of a breach, companies should also strongly consider preventing further trading by requesting a trading halt (and suspension if necessary) while a cleansing prospectus is prepared and lodged.
Between 17 December 2013 and 1 December 2017, Poseidon Nickel Limited (Poseidon) issued shares on 40 occasions without disclosure to investors, relying on a variety of exemptions under the Act.
However, in each case Poseidon either failed to release a cleansing notice in relation to those share issues, or released a cleansing notice when it was not eligible to (for example, because Poseidon’s shares had been suspended from trading for more than five days).
As a result, issues arose regarding the validity of subsequent sales in respect of a considerable number of shares in Poseidon. The “on-sellers” potentially faced civil liability for failing to provide a disclosure document or statement - a strict liability offence under the Act.
Poseidon sought, and obtained, orders from the Federal Court under section 1322(4) of the Act that subsequent dealings in the issued shares were not invalidated by the contraventions. The Court also granted most “on-sellers” of issued shares relief from any civil liability arising from the contraventions.
Significantly, the Court did not grant relief from civil liability to several institutional investors, on the basis they ought to have been aware of the on-sale disclosure requirements imposed on them. His Honour did not rule out granting such relief if those parties had applied for it, but the decision reiterates a higher burden placed on institutional investors to take active steps (including seeking advice where necessary) to ensure that issuing companies have validly “cleansed” the issued shares.
Poseidon is not alone, with a number of recent applications being made after companies had either failed to release a cleansing notice, released a cleansing notice too late, or released a cleansing notice when they were ineligible to do so.
The cleansing provisions are among the most frequently relied upon provisions of the Act and the temptation can arise for company officers and investors to make assumptions about compliance with those provisions. There are several pertinent sayings about assumptions.
Company officers and institutional investors must be careful to ensure the cleansing provisions are properly understood and complied with in the context of an individual share issue. Assumptions must be tested and advice sought if there is any uncertainty.
Where there has been an error, a remedy is available as long as quick, decisive action is taken.