Corporations Law In Principle - ( Chapter 18 Transactions Affecting Share Capital ) PDF

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CHAPTER 18

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Transactions Affecting Share Capital Useful Websites ..................................................................... 545 Aim ......................................................................................... 546 Recent developments ............................................................ 546 Related Topics ....................................................................... 546 Principles ............................................................................... 546 Introduction ............................................................................... 546 Doctrine of capital maintenance: Trevor v Whitworth rule ...................... 546 Corporations Act reforms ............................................................... 548 Protection of creditors and shareholders ............................................ 548 Reductions of share capital ............................................................ 549 Exempted reductions of capital ....................................................... 557 Companies acquiring their own shares .............................................. 557 Share buy-backs .......................................................................... 560

Failing to comply with Chapter 2J .................................................... 568 Remedies for contravening Chapter 2J .............................................. 569 Mentor: Test your Knowledge ............................................... 569 Practice Questions ................................................................. 569 Essay Questions .................................................................... 570 Problems for Discussion ........................................................ 570 Guide to Problem Solving ...................................................... 572 Further Reading ..................................................................... 573

Useful Websites ...................................................................................................................................... (See http://legal.thomsonreuters.com.au/browse/mentor/corplawhub.asp for links to websites on the Topic of Transactions Affecting Share Capital.)

Jeswynn, Yogaratnam, et al. Corporations Law: In Principle, Thomson Reuters (Professional) Australia Pty Limited, 2016. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/vu/detail.action?docID=4802969. Created from vu on 2020-12-13 16:00:50.

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Financial assistance for purchase of a company’s own shares ................. 565

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CORPORATIONS LAW: IN PRINCIPLE

Aim ...................................................................................................................................... At the end of this Topic you should understand the doctrine of capital maintenance and its modern application to: • reductions of a company's share capital; and • dealings in the company's own shares.

Recent developments ...................................................................................................................................... Corporations Amendment (Corporate Reporting Reform) Act 2010 (Cth)

Related Topics ...................................................................................................................................... Chapter 14 Members' Rights and Remedies; Chapter 16 Share Capital – General Nature; Chapter 17 Classes of Shares

PRINCIPLES Introduction [18.10] This Topic discusses the legal procedures with which a company limited by shares must comply when undertaking certain transactions affecting its share capital. They are:

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• reductions of capital; • companies acquiring or controlling their own shares; and • companies giving financial assistance for the purchase of their own shares. Corporations (Aboriginal and Torres Strait Islander) Act 2006 (Cth) (CATSI Act)

Similar to Chapter 16, the CATSI Act does not have corresponding provisions in relation to securities as the Corporations Act 2001 (Cth). This is because members of an Aboriginal and Torres Strait Islander corporation are not allowed to issue debentures or other securities.

Doctrine of capital maintenance: Trevor v Whitworth rule The transactions listed above at [18.10] are regulated by Ch 2J of the Corporations Act 2001 (Cth) (Corporations Act). The broad purpose of Ch 2J of the Corporations Act is to ensure that the interests of creditors and

[18.20]

Jeswynn, Yogaratnam, et al. Corporations Law: In Principle, Thomson Reuters (Professional) Australia Pty Limited, 2016. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/vu/detail.action?docID=4802969. Created from vu on 2020-12-13 16:00:50.

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shareholders are protected when companies undertake these transactions. Chapter 2J of the Corporations Act gives statutory effect to the “doctrine of capital maintenance”, originally established by the general law. That doctrine requires companies limited by shares to maintain their issued share capital in order to protect the interests of the company's creditors and shareholders. Creditors and shareholders are “entitled to assume that no part of the capital which has been paid into the coffers of the company has been subsequently paid out, except in the legitimate course of its business”: Trevor v Whitworth (1887) 12 App Cas 409 at 423-424 (see below). If the doctrine of capital maintenance was strictly applied, it would prohibit a company from undertaking any of the transactions listed above at [18.10] because they result in a reduction of the company's share capital. Trevor v Whitworth [18.25] Trevor v Whitworth (1887) 12 App Cas 409 (House of Lords) FACTS: A limited liability company was incorporated with paid up capital of £150,000, consisting of 15,000 shares of £10 each. The objects of the company allowed the entity to acquire and carry on a business manufacturing flannels. The memorandum did not authorise the company to purchase back its shares. Instead, two articles provided for the following:

The company later went into liquidation. A shareholder sued the company for the outstanding moneys owed to the shareholder as a result of an earlier buy-back of shares by the company. The liquidator, on behalf of the company, submitted that the company was not authorised to buy back the shareholder’s shares, and consequently, did not have to pay the outstanding balance to the shareholder. DECISION: The House of Lords held that a company incorporated under the Companies Act 1862 (UK)had no power to purchase its own shares. The reason for the prohibition, explained by Lord Watson (at 423-424), came to be commonly known as the capital maintenance rule: One of the main objects contemplated by the legislature, in restricting the power of limited companies to reduce the amount of their capital as set forth in the memorandum, is to protect the interests of the outside public who may become their creditors. In my opinion the effect of these statutory restrictions is to prohibit every transaction between a company and a shareholder, by means of which the money already paid to the company in respect of his shares is returned to him, unless the Court has sanctioned the transaction. Paid-up capital may be diminished or lost in the course of the company’s trading; that is a result which no legislation can prevent; but persons who deal with, and give credit to a limited

Jeswynn, Yogaratnam, et al. Corporations Law: In Principle, Thomson Reuters (Professional) Australia Pty Limited, 2016. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/vu/detail.action?docID=4802969. Created from vu on 2020-12-13 16:00:50.

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Article 179: “Any share may be purchased by the company from any person willing to sell it, and at such price, not exceeding the then marketable value thereof, as the board think reasonable”. Article 181: “Shares so purchased may at the discretion of the board be sold or disposed of by them or be absolutely extinguished, as they deem most advantageous for the company”.

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cont. company, naturally rely upon the fact that the company is trading with a certain amount of capital already paid, as well as upon the responsibility of its members for the capital remaining at call; and they are entitled to assume that no part of the capital which has been paid into the coffers of the company has been subsequently paid out, except in the legitimate course of its business.

Corporations Act reforms The strict application of the doctrine of capital maintenance has been gradually modified by reforms to the Corporations Act. However, the rules which still continue to give full effect to the capital maintenance doctrine include:

[18.30]

• dividends to be paid only where a three-part test based on net assess, fairness and solvency have been passed (s 254T, Corporations Act); • interests of shareholders and creditors are to be protected (s 256A, Corporations Act); • the general prohibition against a company dealing in its own shares except in limited circumstances (s 259A, Corporations Act); and

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• any financial assistance provided by the company to a person acquiring shares in the company must not materially prejudice the interests of the shareholders or creditors (s 260A, Corporations Act).

Protection of creditors and shareholders Chapter 2J of the Corporations Act sets out the requirements with which a company must comply when undertaking either a capital reduction, share buy-back or financial assistance transaction. The requirements for each transaction are listed separately, but there are noticeable similarities between the three sets. Broadly, each set of requirements addresses the following concerns:

[18.40]

• the risk of the transaction leading to the company's insolvency; • the fairness and reasonableness of the transaction as between the company's shareholders; and • the disclosure to shareholders of all information material to the transaction. Compare s 256A of the Corporations Act, which states the purpose of the capital reduction and share buy-back provisions, with s 260A of the Corporations Act, which states the conditions under which a company may give financial assistance for the purchase of its own shares.

Jeswynn, Yogaratnam, et al. Corporations Law: In Principle, Thomson Reuters (Professional) Australia Pty Limited, 2016. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/vu/detail.action?docID=4802969. Created from vu on 2020-12-13 16:00:50.

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Reductions of share capital What is a reduction of capital? ....................................................................................................................................................................... [18.50]

A reduction of capital includes the following transactions:

• the cancellation of shares and the repayment of capital by a company to its shareholders; • the reduction of the issue price of shares and the repayment of that capital to shareholders; • the swapping of shares with debentures or other debt instruments (shareholders change status to become creditors); • the cancellation of paid up capital that has been lost or is not represented by available assets (a lost capital reduction: see s 258F of the Corporations Act); or • the reduction or extinguishment of shareholders' liability to pay calls on partly paid shares. Reasons for undertaking a capital reduction ....................................................................................................................................................................... [18.60] A company may have a legitimate business purpose for undertaking a share capital reduction including:

• to return capital in excess of its needs to its shareholders; • to bolster earnings per share; and • to exchange equity for debt because it can raise debt finance on more attractive terms. Reductions of share capital may also be undertaken by companies to eliminate a minority member from the share register. Members can be eliminated by cancelling their shares and returning to them their investment in the company. Action of this kind may be taken where the person's continued membership of the company is having a destabilising effect on the company or to bolster the power of the directors or majority members at the expense of the minority members. Share capital reductions undertaken for such purposes may be subject to legal challenge by the minority shareholders as being oppressive, even where they comply with the procedures in Ch 2J of the Corporations Act.

Jeswynn, Yogaratnam, et al. Corporations Law: In Principle, Thomson Reuters (Professional) Australia Pty Limited, 2016. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/vu/detail.action?docID=4802969. Created from vu on 2020-12-13 16:00:50.

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• to bring share capital more into line with the net assets of the company;

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Regulation of capital reductions .......................................................................................................................................................................

A company proposing to undertake a reduction of capital (other than those exempted under ss 258A – 258F, Corporations Act) must comply with two sets of procedures:

[18.70]

• the requirements in ss 256A – 256E of the Corporations Act; and • any internal rule which restricts or prohibits the exercise of the company's power to reduce its share capital. If a company has an internal rule which prohibits reductions of capital, the company will be prevented from carrying out a reduction under any circumstances. Alternatively, if the internal rule restricts the circumstances in which a company carries out a capital reduction, the company must comply with those requirements in addition to the requirements in the Corporations Act: see Re RGC Ltd (1998) 29 ACSR 445; and Westchester Financial Services Pty Ltd v Acclaim Exploration NL (1999) 32 ACSR 499. Minimum requirements for a capital reduction ....................................................................................................................................................................... [18.80]

A capital reduction must comply with s 256B(1) of the Corporations

Act.

SECTION 256B(1) Company may make reduction not otherwise authorised Copyright © 2016. Thomson Reuters (Professional) Australia Pty Limited. All rights reserved.

(1)

A company may reduce its share capital in a way that is not otherwise authorised by law if the reduction: (a)

is fair and reasonable to the company’s shareholders as a whole; and

(b)

does not materially prejudice the company’s ability to pay its creditors; and

(c)

is approved by shareholders under section 256C.

A cancellation of a share for no consideration is a reduction of share capital, but paragraph (b) does not apply to this kind of reduction. [Notes to section not extracted]

Protection of shareholders and creditors .......................................................................................................................................................................

As noted at [18.40], the purpose of this set of requirements is to protect the interests of creditors and shareholders. Section 256B(1)(a) of the Corporations Act addresses the fairness of the transaction as between the company's shareholders. Section 256B(1)(b) of the Corporations Act addresses

[18.90]

Jeswynn, Yogaratnam, et al. Corporations Law: In Principle, Thomson Reuters (Professional) Australia Pty Limited, 2016. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/vu/detail.action?docID=4802969. Created from vu on 2020-12-13 16:00:50.

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the risk of the transaction leading to the company's insolvency. Section 256B(1)(c) of the Corporations Act requires shareholders to be given the opportunity to vote in favour of or against the reduction after being provided with all the relevant information by the company: s 256C(4), Corporations Act. Capital reduction must be fair and reasonable to shareholders as a whole

Section 256B(1)(a) involves two important concepts, neither of which is defined within the Corporations Act. A capital reduction must be “fair and reasonable” to “the company's shareholders as a whole”.

[18.100]

Fair and reasonable

The Explanatory Memorandum to the Company Law Review Bill 1997 (Cth) in respect of s 256B of the Corporations Act explained the first concept as follows at [12.24]:

[18.110]

“Fair and reasonable” is intended to be a composite requirement. Factors that might be relevant to determining whether a capital reduction is fair and reasonable to shareholders as a whole include the following: (a) the adequacy of any consideration paid to shareholders (b) whether the reduction would have the practical effect of depriving some shareholders of their rights (for example, by stripping the company of funds that would otherwise be available for distribution to preference shareholders) (c) whether the reduction is being used to effect a takeover and avoid the takeover provisions

In Re CostaExchange Ltd; Elkington v CostaExchange Ltd [2011] VSC 501 the court considered the notion of what is “fair and reasonable” under s 256B(1)(a). Re CostaExchange Ltd; Elkington v CostaExchange Ltd [18.115] Re CostaExchange Ltd; Elkington v CostaExchange Ltd [2011] VSC 501 (Supreme Court of Victoria) FACTS: A minority shareholder (Mr Elkington) brought an action against CostaExchange, claiming a breach of s 256B(1)(a) and 256D(1) of the Corporations Act. The breach related to a selective reduction in the company share capital and the resulting cancellation of minority shares for a price of $0.86 each. Mr Elkington claimed that $0.86 was an unfair price because it was less than the value formulated on a control basis. An independent expert had concluded that $0.86 each was fair and reasonable to shareholders as a whole, being less than “fair market value on a control basis”, and above “fair market value on a minority basis” (at [1], [30] – [40]). The proposed cancellation of minority shares and a future capital raising program were put and passed at a general meeting of shareholders. A special meeting of minority shareholders also approved the capital reduction.

Jeswynn, Yogaratnam, et al. Corporations Law: In Principle, Thomson Reuters (Professional) Australia Pty Limited, 2016. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/vu/detail.action?docID=4802969. Created from vu on 2020-12-13 16:00:50.

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