House of Representatives

Explanatory Memorandum

Circulated by the Authority of the Parliamentary Secretary to the Treasurer, the Hon David Bradbury MP

Chapter 1 - Strengthening the non-binding vote - the 'two-strikes' test

Context of amendments

1.1 The Corporations Act 2001 (Corporations Act) requires a listed company to put its remuneration report to a non-binding shareholder vote at the AGM.

1.2 Many submissions to the PC inquiry noted that the introduction of the non-binding vote fostered more productive engagement between shareholders and boards on remuneration issues. Evidence suggests that some boards are responsive to the non-binding vote, and that the opportunity for shareholders to put forward their views is having a positive impact on remuneration polices.

1.3 However, there are cases where boards have not been responsive to shareholder concerns. The Corporations Act currently does not set out any requirements where a board proceeds with its remuneration proposals despite a negative shareholder vote.

1.4 Currently, if shareholders are dissatisfied, they have the power to vote to remove a director, although this could be a somewhat extreme response if the board is not given a chance to respond to concerns. This is particularly the case if the directors are generally having a positive impact on the value of the company.

1.5 This has prompted suggestions that the Corporations Act be amended to strengthen the non-binding vote. However, it is not considered ideal to make the shareholder vote on remuneration binding.

1.6 The PC inquiry concluded that there would be significant practical difficulties and risks associated with introducing a binding vote. If a binding vote was introduced, companies would not be able to finalise a contract with an executive until shareholder approval was obtained. This would be likely to create considerable uncertainty and delay, particularly if a company is looking to quickly secure a top executive. In addition, a binding vote could be disruptive to the operation of a company. It could result in a deadlock arising between shareholders and the board regarding the appropriate levels of executive remuneration.

1.7 The introduction of a binding vote for shareholders would also represent a fundamental change to the role of directors and would impact on their capacity to manage the company. A binding vote would absolve directors of their responsibility to shareholders on this issue, and would undermine their capacity to make key decisions affecting the performance of the company. It could also affect the competitiveness of Australian companies and their ability to attract and retain top executives.

Summary of new law

1.8 Under the new law, a 'two-strikes and re-election' process will be introduced in relation to the non-binding shareholder vote on the remuneration report.

1.9 The 'first strike' will occur where a company's remuneration report receives a 'no' vote of 25 per cent or more. Where this occurs, the company's subsequent remuneration report must include an explanation of the board's proposed action in response to the 'no' vote or an explanation of why no action has been taken.

1.10 The 'second strike' occurs where a company's subsequent remuneration report receives a 'no' vote of 25 per cent or more. Where this occurs, shareholders will vote at the same AGM to determine whether the directors will need to stand for re-election. If this spill resolution passes with 50 per cent or more of eligible votes cast, then the 'spill meeting' will take place within 90 days. A company will still need to provide the minimum notice period for holding a meeting, as required by the Corporations Act. A company will also need to comply with any minimum notice period set out in its constitution for the nomination of candidates for the board. This will ensure that shareholder nominated candidates can seek endorsement at the spill meeting.

1.11 This reform is intended to provide an additional level of accountability for directors and increased transparency for shareholders. Where a company receives significant 'no' votes on its remuneration report over two consecutive years, and has not adequately addressed concerns raised by shareholders, it is appropriate for the board to be held accountable through the re-election process.

1.12 This reform strengthens the non-binding vote and maintains the fundamental principle underlying Australia's corporate governance framework that directors are responsible for, and accountable to, shareholders on all aspects of the management of the company, including the amount and composition of executive remuneration.

Comparison of key features of new law and current law

Detailed explanation of new law

1.13 Under the new law, a 'two-strikes and re-election' process will be introduced, as set out below:

•

where a company's remuneration report receives a 'no' vote of 25 per cent or more, the company's subsequent remuneration report must explain the board's proposed action in response or, if the board does not propose any action, the board's reasons for inaction [Schedule 1, Item 19, paragraph 300A(1)(g)] ; and

•

where the company's subsequent remuneration report receives a 'no' vote of 25 per cent or more, a resolution must be put (known as the 'spill resolution') to shareholders at the same AGM. Notice of the spill resolution must be contained in the meeting papers for the AGM to ensure that notice has been given in the event that the second strike is triggered. The notice must explain the circumstances in which the resolution will apply. [Schedule 1, Item 9, subsection 249L(2)]

•

If the spill resolution passes with 50 per cent or more of the eligible votes cast, another meeting of the company's shareholders (known as the 'spill meeting') must be held within 90 days [Schedule 1, Item 13, section 250V] . A company will still need to provide the minimum notice period for holding a meeting, as required by the Corporations Act. A company will also need to comply with any minimum notice period set out in its constitution for the nomination of candidates for the board. This will ensure that shareholder nominated candidates can seek endorsement at the spill meeting [Schedule 1, Item 13, section 250W] .

1.14 The separation of the 'second strike' and the 'spill resolution' is intended to ensure that shareholders are not discouraged from voting against the remuneration report, because they fear removal of certain board members. It ensures that shareholders are free to express their concerns on the remuneration report, and is intended to provide a clearer signal of shareholders' views on the remuneration report.

1.15 At the spill meeting, those individuals who were directors when the directors' report was considered at the most recent AGM will be required to stand for re-election (other than the managing director, who is permitted to hold office indefinitely without being re-elected to the office, pursuant to the Australian Securities Exchange (ASX) listing rules) [Schedule 1, Item 13, subsection 250V(1)] . These directors will cease to hold office immediately before the end of the spill meeting. Any new directors elected at the spill meeting automatically hold office at the end of the meeting [Schedule 1, Item 13, subsections 250W(4) and (9)] .

1.16 In the case where none of the individuals who were directors when the directors' report was considered at the most recent AGM remain as directors of the company, then the company will not be required to hold the spill meeting. This is the case whether or not those directors have been replaced by new directors.

1.17 A company must hold the spill meeting within 90 days after the spill resolution is passed. However, this deadline does not mean that the timeframes for giving notice of the meeting or of resolutions to appoint directors can be disregarded [Schedule 1, Item 13, subsections 250W(2) and (3)] . When scheduling a spill meeting, a company must not disregard minimum notice periods contained in the Corporations Act or those contained in the company's constitution for shareholders to put forward nominated candidates. This will ensure that shareholder nominated candidates can seek endorsement at the spill meeting.

1.18 If the company fails to hold the spill meeting within 90 days of the spill resolution being passed, each person who is a director of the company at the end of those 90 days commits an offence [Schedule 1, Item 13, subsection 250W(5)] . Section 249CA of the Corporations Act empowers any director of a listed company to call a meeting of the company's members, and as such, any director could ensure that the spill meeting is held within the 90 days.

1.19 However, this offence does not extend to a director appointed at a point in time that would not allow the requisite amount of notice for the meeting to be given under existing section 249HA. [Schedule 1, Item 13, subsections 250W(5) and (8)]

1.20 A failure to hold the spill meeting within 90 days of the spill resolution being passed is a strict liability offence, as a failure to hold a spill meeting would be considered a serious breach of the requirements, particularly as it diminishes the ability of shareholders to hold directors accountable on remuneration issues. [Schedule 1, Item 13, subsection 250W(6)]

1.21 The Bill provides a mechanism that is intended to ensure that a minimum of three directors remain after the spill meeting, as required by existing section 201A(2) of the Corporations Act. As the managing director is not required to stand for re-election, at least one director of the company should remain following the spill meeting. To reach the minimum of three directors, the remaining positions will be filled by those with the highest percentages of votes favouring their appointment cast at the spill meeting on the resolution for their appointment (even if less than half the votes cast on the resolution were in favour of their appointment). If two or more individuals have the same percentage of votes, the remaining director/s can choose which individual is appointed as a director, and this appointment must be confirmed at the company's next AGM. [Schedule 1, Item 13, section 250X]

1.22 Under the new law, if a director survives the spill meeting, the duration of their appointment continues uninterrupted from the date at which they were last appointed to the board [Schedule 1, Item 13, section 250Y] . This is intended to provide continuity and ensures that such directors do not obtain a 'fresh start' in terms of the duration of their appointment.

Application and transitional provisions

1.23 The new law will apply to resolutions on the remuneration report held after 1 July 2011. That is, the spill resolution will be triggered where both strikes occur after 1 July 2011.