The High Court delivered its judgement in Connective Services Pty Ltd v Slea Pty Ltd [2019] HCA 33 on 9 October. The case concerns the operation of s260A(1) of the Corporations Act 2001 (Cth) and the question of what constitutes financial assistance. Is funding by a company of legal proceedings directed at enforcing the pre-emptive rights of some shareholders (by compelling one shareholder to offer shares to fellow shareholders), financial assistance?

[Note: The full text of the decision Connective Services Pty Ltd v Slea Pty Ltd.  Read the High Court's summary Connective Services Pty Ltd v Slea Pty Ltd [2019].]

In a nutshell…

Slea Pty Ltd (Slea) was one of three shareholders in a mortgage aggregation business called Connective Services Pty Ltd (Connective Services).  Connective Services' constitution included a pre-emption clause requiring that shareholders offer their shares to their fellow Connective Services shareholders before the shares could be transferred to any other party.

Slea entered into an agreement to transfer its shares to a third party, Minerva Financial Group (without complying with this pre-emptive rights provision). To prevent this, Connective Services commenced proceedings to compel Slea to offer its shares to the other Connective shareholders.  Slea then sought an injunction under s1324, to restrain Connective Services from prosecuting the proceedings on the basis that the proceedings contravened the prohibition against financial assistance in s 260A(1).

The High Court held that the legal proceedings brought by Connective Services against Slea to enforce a pre-emptive rights provision for the benefit of the other Connective Services shareholders at Connective's expense, did constitute 'financial assistance' and issued the injunction.

Further, the court found 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'.  

Section 260A(1)

Section 260A(1) provides that a company may financially assist a person to acquire shares in the company only 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.

The Court considered that the three elements necessary to establish a contravention of s 260A(1) (relevant to the case in question) are: 1) financial assistance given by the company; 2) to acquire shares or units of shares in the company; and 3) which materially prejudices the interests of the company or its shareholders or its ability to pay its creditors.

Clarification: what is 'financial assistance'?

The court held that financial assistance need not involve any diminution or depletion of assets, but rather is a commercial/financial question. '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 Court held.

Approach to determining whether there has been 'material prejudice'

The Court held that 'the issue of material prejudice to the interests of the company or its shareholders or creditors requires an assessment of and comparison between the position before the giving of the financial assistance and the position after it to see whether the company or its shareholders or its ability to pay its creditors is in a worse position'.

'It does not assist to gloss the concept of material prejudice by the introduction of further concepts, which themselves require further explanation, such as whether there has been a diminution of the assets of the company, whether there has been a transaction, or whether there was a net transfer of value to the person acquiring the shares'.

'To acquire shares or units of shares'

The Court held that the words 'to acquire' require a 'sufficient link between the financial assistance and the acquisition of the shares or units of shares. Section 260A(1) does not require that an acquisition actually take place, since the provision can be contravened and injunctions can be ordered before any acquisition actually takes place. In this sense, 'to acquire', like the express words of s 205(1) of the Corporations Law, includes conduct that is in connection with the process of an acquisition of the shares or units of shares and not limited to conduct for the purpose of acquisition. Acquisition also has broad connotations. It does not require a transaction or transfer. It includes acquisitions by issue or transfer or any other means.'

Onus was on Connective Services to prove that there was no 'material prejudice'

Section 1324(1B)(a) provides that where the ground relied on in an application for an injunction under s 1324 is an alleged contravention of s 260A(1)(a), the Court must assume that the conduct constitutes or would constitute a contravention of s 260A(1)(a) unless the company or person proves otherwise.

In this case, Connective Services was required to disprove that its conduct constituted a contravention of s260A(1). The Court held that it ultimately did not do so. The Court reasoned that if the other two Connective Services shareholders had brought proceedings against Slea to vindicate their pre-emptive rights, and the proceedings were funded by Connective Services, then it would have constituted financial assistance (in contravention of 260A(1)) because it would have eased the financial burden incurred in the process of the acquisition of the shares by those shareholders.

As it was, the Court held that the commencement of the pre-emptive rights proceedings by Connective Services was financial assistance within the meaning of s 260A(1) and that Connective Services 'did not discharge their onus of proving that there was no material prejudice to the Connective companies or their shareholders'.

Best to exercise caution?

The judgement states 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'.