House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

11. Chapter 2H: Shares

11.1 Chapter 2H-Shares will comprise the following Parts about:

(a)

Issuing shares, and converting shares from one type to another (Part 2H.1)

(b)

Redemption of redeemable preference shares (Part 2H.2)

(c)

Partly-paid shares (Part 2H.3)

(d)

Capitalisation of profits (Part 2H.4)

(e)

Dividends (Part 2H.5)

(f)

Notifying the ASC of the issue or cancellation of shares (Part 2H.6).

11.2 Some rules dealing with shares are currently found in Table A. Chapter 2H will replace these rules and bring all the rules together, to make them more accessible and easier to follow. Currently, a company may either rely on the rules in Table A, or determine its own rules through its constitution. This flexibility is retained by the Bill, because a company will be able to remove or substitute replaceable rules, which are identified as replaceable rules in the provisions heading (Bill s 135). Replaceable rules are binding on the company in the same way as a contract.

Part 2H.1 - Shares

Authorised share capital

11.3 Most companies are companies limited by shares. The companys members contribute capital to the company and, in return, are issued shares in the company. The companys memorandum of association must state the amount of share capital with which the company proposes to be registered and the division of that share capital into shares of a fixed amount.

11.4 The total amount of the companys share capital is referred to variously as its nominal share capital (see, for example, current s 195(2), current s 1308(1)), authorised share capital (see, for example, Corporate Regulations Schedule 5, cl 15(1)(a)), or its registered capital (see, for example, Attorney-General v Anglo-Argentine Railway
[1901] 1 KB 617 ).

11.5 The fixed amounts of the shares into which a companys share capital is divided are known as the par or nominal values of the shares. An issue of shares in excess of the companys authorised share capital is void: Bank of Hindustan China & Japan Ltd v Alison (1871) LR 6 CP 222.

11.6 However, the concept of authorised share capital no longer achieves its original goal of allowing a companys creditors to assess the size of the companys business undertaking. There are 3 reasons for this:

(a)

a company does not have to issue shares up to the amount of its authorised share capital

(b)

a company may finance its activities through debt

(c)

a company may increase or decrease the amount of its authorised share capital by ordinary resolution, and without notice to its creditors.

11.7 In light of these considerations, the Law will no longer include the requirement in current s 117(1)(b) that a company limited by shares must include in its constitution a statement indicating the amount of its authorised share capital. Consequently, there will be no need for a process to increase or decrease authorised share capital and current s 193(1)(a) and (e) will be repealed.

11.8 Currently, a companys authorised share capital may be used to prevent the directors from diluting the shareholders interest in the company or bringing new members into the company without the consent of existing shareholders. This facility may be particularly useful in the case of joint venture companies. However, the same effect can also be achieved by having a constitution which sets a numerical limit on the number of shares that the directors may issue.

11.9 A provision in a companys constitution which states the amount of the companys share capital, or divides the share capital into shares of a fixed amount, will be repealed on commencement of Schedule 2 of the Bill. As a transitional measure for existing companies, if 100 members, or members holding 5% of votes, serve a notice on the company before commencement, or within 3 months after commencement, stating that the members want the following transitional arrangements to apply, the Bill will amend the companys constitution by inserting a new provision preventing it from issuing more shares than it could have issued prior to commencement (Bill s 1427). A company will be able to amend this new provision in the same way as any other provision in its constitution.

Issuing and converting shares

11.10 A companys power to issue shares is currently dealt with in Table A regulation 2, which provides for shares in a company to be issued by the directors. The Bill will provide that a company has the power to issue shares (Bill s 124(1)(a)). In order to avoid doubt, it will also provide that a companys power to issue shares includes the power to issue:

(a)

bonus shares

(b)

preference shares (including redeemable preference shares)

(c)

partly-paid shares (Bill s 254A(1)).

11.11 Bonus shares are shares for whose issue no consideration is payable to the company (Bill s 254A(1)(a)).

11.12 A preference share is a share that gives its holder some right or preference (for example, a guaranteed minimum dividend entitlement) not enjoyed by the holder of a share of another type. The rights attached to a preference share in respect of the following matters must either be approved by special resolution, or set out in the companys constitution (if any):

(a)

repayment of capital

(b)

participation in surplus assets and profits

(c)

cumulative and non-cumulative dividends

(d)

voting

(e)

priority of payment of capital and dividends in relation to other shares or classes of preference shares (Bill s 254A(2)).

This will ensure that the interests of existing shareholders are protected, by requiring them to agree to the terms of the preference shares.

11.13 A redeemable preference share is a preference share, the terms of issue for which provide that it is liable to be redeemed. A redeemable preference share may be redeemed:

(a)

at a fixed time, or on the happening of a particular event

(b)

at the companys option

(c)

at the shareholders option (Bill s 254A(3)).

11.14 A company will be able to determine the terms on which its shares are issued, and the rights and restrictions attaching to the shares (Bill s 254B).

11.15 The Bill will remove the concept of stock from the Law (stock is a number of shares that have been grouped together). Companies will be prohibited from issuing stock or converting shares into stock (Bill s 254F), and will have to convert any existing stock into shares (Bill s 1428). The Bill will repeal the current requirement for the register of members to show details of stock holdings, although as a transitional measure the register must continue to show stock details until all stock has been converted into shares (Bill s 1428). The reference to stock in current subsection 216B(5) will also be repealed (Bill Schedule 2 Item 211). However, the references to stock in current paragraphs 655(1)(b) and (d) will be retained, because they are necessary to accommodate the structure of foreign corporations.

11.16 The current prohibition against a company issuing bearer shares (referred to as share warrants in current section 189) will be retained (Bill s 254F).

11.17 Table A regulation 38 currently provides that a companys existing members must be offered unissued shares before they are issued to non-members. This right will be rewritten in a replaceable rule requiring the directors of a proprietary company to offer shares of a particular class to the existing holders of shares of that class before issue (Bill s 254D). This will give the existing holders the opportunity to take up shares before they are offered to others. It will be possible for the members in general meeting to waive the benefit of this rule by resolving to authorise the directors to issue shares without first giving the existing holders of shares an opportunity to take up the shares (Bill s 254D(4)).

11.18 Currently, the Court has a discretion to validate the issue or allotment of shares that have been invalidly issued, created or allotted (current s 194). The Bill will retain this discretion, and the class of persons who may apply to the Court will be broadened to include any persons whose interests have been or may be affected by the invalidity (Bill s 254E). After commencement, the Law as it stood immediately before commencement will continue to apply to a Court order made prior to commencement validating or confirming an issue or allotment of shares, or an application for such an order (Bill s 1430(b)).

11.19 If the Court exercises its discretion to make an order validating, or confirming the terms of, a purported issue of shares, then upon a copy of the order being lodged with the ASC, the order will have effect from the time of the purported issue (Bill s 254E(2)). For example, if shares are invalidly issued on 1 March, and the Court makes an order validating the issue, the shares are taken to have been validly issued on and from 1 March.

11.20 A company is currently able to divide its share capital into a smaller or larger amount. It may consolidate its shares and divide them into shares of a larger amount (current s 193(1)(b)), and subdivide its shares into shares of a smaller amount (current s 193(1)(d)). Under the Bill, companies will retain the ability to convert some or all of their shares into a larger or smaller number of shares (Bill s 254H, Schedule 5 Item 11 s 254H). As at present, the interests of minority shareholders will be protected against abuse of this power by the majority by:

(a)

the procedures for varying or cancelling class rights (Bill Part 2F.3)

(b)

the remedies available in cases of oppression or injustice (Bill Part 2F.1).

11.21 The Bill will expressly preserve the current right of companies to capitalise profits. At present, a company can only capitalise profits without issuing shares if it increases the par value of existing shares. With the abolition of par value this restriction will not apply to the capitalisation of profits (Bill s 254S).

No par value

11.22 A share is a proportionate interest in the net worth of a companys undertakings. A person trying to gauge the size of a shareholders investment in a company would need to look beyond the par value of the shareholders shares, because par value is simply an arbitrary monetary denomination attributed to the shares. Rather, a potential investor would be interested in the proportionate size of the shareholders actual contribution to the capital of the company. For example, if a shareholder owns 10% of all issued shares in a company, a potential investor would be interested in the current value of those shares (that is, 10% of the current net value of the companys undertakings). The fact that the shares have a par value of, for example, $1 each would give no indication of the current value of the shares.

11.23 Par value may also be misleading to an unsophisticated investor. A share with a par value of $5 being offered for sale at $2 may appear to be a bargain. However, the share might in fact be worth less than $2.

11.24 In its November 1990 report, Shares of no par value and partly-paid shares (Report No 11), the Companies and Securities Law Review Committee canvassed the arguments about par value, and recommended that companies be given the option of issuing no par value shares. However, the Bill does not adopt this approach because a system that permitted both par value and no par value shares would unnecessarily complicate the Law and its administration.

11.25 The Bill will provide that shares no longer have par value (Bill Schedule 5 Item 10 s 254C). This will also apply to shares issued before commencement of Schedule 5 (Bill Schedule 5 Item 31 s 1444). These changes will have the effect of preventing companies from issuing par value shares. The Bill will preserve the effect of existing contracts and other instruments, executed before commencement, that refer to the par value of a share (Bill Schedule 5 Item 31 s 1445).

11.26 As a consequence of the removal of the concept of par value shares, the Laws requirements for minimum subscriptions on share allotments will be amended by removing the requirement for the calculation of the minimum subscription to include the nominal value, or nominal amount, of shares (Bill Schedule 2 Item 230). A company will still be able to specify a minimum amount payable on application for a share, by setting out that requirement in the offer document.

11.27 The Bill will enable shareholders to more directly ascertain the amount unpaid on their shares (if any), by requiring that amount to be indicated in the register of members and on share certificates (Bill Schedule 2 Item 208). To ascertain this under the current Law, shareholders must consult the register of members and calculate the difference between the par value of their shares and the amount paid or agreed to be paid on their shares.

11.28 The Bill will also make it possible to calculate after the commencement of Schedule 5 of the Bill the amounts paid and unpaid on a share issued before that commencement by treating:

(a)

the amount paid on the share as the sum of all amounts (except any premium) paid to the company at any time for the share

(b)

the amount unpaid on the share as the difference between the issue price (not including any premium) and the amount paid on the share (Bill Schedule 5 Item 31 s 1445).

11.29 Further, a shareholders liability for calls in respect of amounts unpaid on a share issued before commencement of Schedule 5 of the Bill will continue after commencement and will not be affected by the share ceasing to have a par value (Bill Schedule 5 Item 31 s 1448).

11.30 The following amendments of the Law will be made to accommodate the move to no par value shares:

(a)

references to the par or nominal value of a companys share capital (or a class of share capital) or the amount paid up on shares will be removed (Bill Schedule 2 Items 215, 217-220, 225, 227 and 237)

(b)

paragraph (a) of the definition of prescribed occurrence in current section 603 will be amended to refer to the conversion by a company of all or any of its shares into a larger or smaller number of shares (Bill Schedule 2 Item 223)

(c)

provisions that refer to the amount of any share premium that may form part of the consideration on the issue of a share will be amended or omitted (Bill Schedule 2 Items 216, 221 and 224)

(d)

the obligation for a companys register of members to show the amount unpaid on shares will not apply if all the companys shares were issued before commencement and the register shows the par value of shares as they were immediately before commencement (Bill Schedule 2 Item 210).

11.31 In order to reduce the transition costs associated with the abolition of par value for shares, these amendments will take place when Schedule 2 of the Bill commences, rather than when Schedule 5 of the Bill commences.

Redeemable preference shares

11.32 The Bill will repeal the requirement that the issue of redeemable preference shares be authorised by the companys articles (current s 192(1)). The Bill also will move the existing rules in Table A relating to redeemable preference shares into the Law (Bill ss 254J, 254K and 254L), including the rule that a redemption must be in accordance with the terms on which the shares are on issue (Bill s 254J(1)). However, redeemable preference shares will be able to be cancelled pursuant to a capital reduction or share buy-back on different terms (Bill s 254J(2)). If shares are redeemed in contravention of the Law, the Bill will validate both the redemption and any contract or transaction connected with it (Bill s 254L(1)). This is intended to protect the interests of third parties not involved in the contravention, whose interests would be adversely affected by the transaction being invalidated. However, a person involved in the contravention will contravene the Law and may be subject to civil penalty orders and criminal consequences (Bill Schedule 2 Item 238).

11.33 The current prohibition on shares being converted into redeemable preference shares after their issue will be retained (Bill s 254G(3)).

11.34 Several changes will be made to the rules on redeemable preference shares, to accommodate the abolition of par value shares:

(a)

Currently, the redemption of nominal share capital must be made out of profits or the proceeds of a fresh issue of shares, and any premium payable on redemption must be provided for out of profits or out of the share premium account (current s 192(3)(b) and 192(4)). The abolition of par values means that companies will no longer have a share premium account out of which to fund a redemption. Accordingly, redeemable preference shares issued after commencement will only be redeemable out of profits or the proceeds of a fresh issue of shares made for the purpose of the redemption (Bill Schedule 5 Item 12 new s 254K(b)).

(b)

The current requirement for companies to establish a capital redemption reserve when shares are redeemed out of profits (current s 192(5)) will be repealed. Upon a companys shares ceasing to have a par value, any amount standing to the credit of the companys capital redemption reserve become part of the companys share capital (Bill Schedule 5 Item 31 s 1446).

(c)

an amount standing to the credit of the companys share premium account will become part of the companys share capital (Bill Schedule 5 Item 31 s 1446).

11.35 Although companies will not be able to redeem redeemable preference shares issued after commencement out of their share premium account, they will be able to use the amount that stood to the credit of their share premium account immediately before commencement to:

(a)

pay any premium on the redemption of redeemable preference shares or debentures issued before commencement; or

(b)

write off preliminary expenses incurred or discounts allowed, on or before commencement, on the issue of shares or debentures (Bill Schedule 5 Item 31 s 1447).

11.36 The Law currently provides that an option granted by a public company that is exercisable 5 years after the date of grant is void (current s 216). However, retaining this provision is difficult to justify. Although it is intended to prevent public companies giving out options whose value is uncertain because their exercise date is so far away, share prices can fluctuate dramatically over periods much shorter than 5 years. The Bill therefore repeals s 216.

11.37 In order to protect the interests of shareholders and creditors, the Bill will require a company to be solvent immediately after the redemption of redeemable preference shares that are redeemable at its option; for other redeemable shares, the company will have to be solvent immediately after the shares are issued (Bill Schedule 2 Item 222). If a company is not solvent at the relevant time its directors may be subject to civil penalty orders and criminal consequences (Bill Schedule 2 Item 238) in the same way as they may be liable for insolvent trading under current sections 588G and 588H. For the purpose of shareholders and creditors obtaining an injunction under section 1324, a contravention of these provisions will be taken to affect the interests of a creditor or member of the company (Bill Schedule 2 Item 240).

Partly-paid shares

11.38 The Bill will expressly recognise a shareholders obligation to pay calls on partly-paid shares (Bill s 254M). However, a company will be able to pass a special resolution restricting the companys right to make calls on unpaid share capital to situations where the company becomes externally administered (Bill s 254N). This preserves the effect of current subsection 188(2), except that the companys reserve capital will be able to be called up if the company becomes an externally-administered body corporate, rather than when the company is being wound up. This will make the companys unpaid share capital available in a range of circumstances involving insolvency, not just winding-up.

Dividends

11.39 Currently, dividends to shareholders can only be paid out of profits or by issuing shares from the share premium account (current s 201(1)). Where a dividend is to be paid out of profits, the profits must exist at the time the dividend is declared: Marra Developments Ltd v B W Rofe Pty Ltd (1977)
2 NSWLR 616 . A shareholder may recover from the company as a debt any final dividend that has been declared. The debt arises when the declaration is made or from a later date on which the dividend is to be paid in accordance with the declaration: Industrial Equity Limited v Blackburn (1977)
137 CLR 567 at 572. Interest on the debt is payable from the time the debt arises.

11.40 The Bill will allow companies to avoid the problems that would arise if profits that would have been sufficient to cover the dividend when it was declared have ceased to exist when the time comes to pay the dividend. Under the Bill, a debt will not arise until the time fixed for payment has arrived, unless the company has a constitution that provides for the declaration of a dividend. Directors will be able to revoke a decision to pay a dividend at any time before the time fixed for payment, and thus avoid a debt being incurred (Bill s 254V).

11.41 Currently, a company may only pay dividends in accordance with its constitution: Oakbank Oil Co v Crum (1882) 8 App Cas 65, at 71. The Bill will include a replaceable rule allowing directors to pay a dividend without the need for constitutional authorisation (Bill s 254R(1)).

11.42 A directors resolution to pay an interim dividend does not create a debt and may be revoked or amended before the dividend is paid: Marra Developments Ltd, at 622; Brookton Co-operative Society Ltd v FCT (1981)
147 CLR 441 . The effect of the Bill will be to extend this rule to all dividends, not just interim dividends. Under the replaceable rules interest will not be payable on a dividend (Bill s 254U(2)). Interest will be payable on a debt, but the debt will not arise until the time fixed for payment of the dividend (Bill s 254V).

11.43 By providing that dividends must be paid out of profits (Bill s 254T), the Bill will require that the profits exist at the time fixed for payment of the dividend. The directors will be able to determine that a dividend is payable and fix the amount, the time for payment and the method of payment (Bill s 254U (1)), so it will not be necessary for them to declare a final dividend before the date for payment. Nor will the declaration of a final dividend be required for liability to pay the dividend to arise: that will happen if the time fixed for paying the dividend arrives without the decision to pay the dividend being revoked (Bill s 254V).

11.44 If a company issuing partly-paid shares anticipates that dividends might be set off against outstanding calls to the company, it should ensure that this is authorised by its constitution or the terms on which the shares are on issue.

11.45 A company may not pay a dividend if to do so would leave it unable to pay its debts as they fall due: Peter Buchanan Ltd v McVey
[1955] AC 516 ; QBE Insurance Group Ltd v ASC (1992)
8 ACSR 631 at 649. If the company does pay a dividend in those circumstances, the directors who authorised the payment of the dividend may be liable to pay the amount of the dividend to the company: Hilton International Ltd v Hilton (1989)
1 NZLR 442 ; Ammonia Soda Co v Chamberlain (1918)1 Ch 266, per Warrington LJ at 292.

11.46 Similarly, under the amendments to be made to current section 588G, directors may be liable to compensate the company in relation to dividends that render the company insolvent, in much the same way that they may currently be liable for insolvent trading by the company (Bill Schedule 2 Item 222). For the purpose of obtaining an injunction under current section 1324, a contravention by directors of this provision will be taken to affect the interests of a creditor or member (Bill Schedule 2 Item 240).

11.47 If dividends are paid otherwise than out of profits, the directors may be liable for a reduction of capital in contravention of the capital reduction provisions (Bill s 256F(3), Schedule 5 Item 18 s 256D(3)). However, the Bill will validate a dividend that is not paid out of profits (Bill s 256F(2)(a), Schedule 5 Item 18 s 256D(2)(a).

11.48 In the case of a public company, every share will have the same rights in relation to dividends, unless the companys constitution provides otherwise, or different dividend rights are provided for by special resolution (Bill s 254W(1)). For proprietary companies, the Bill will insert a replaceable rule authorising the directors to pay dividends as they see fit, subject to the terms on which the shares are on issue (Bill s 254W(2)).

Notice requirements

11.49 Companies will be required to notify the ASC within 1 month of the issue or cancellation of shares (Bill ss 254X and 254Y). Section 254X of the Bill differs from current section 187 in that:

(a)

it refers to issuing shares, which incorporates the current concept of making an allotment of shares (this change in terminology is also reflected in a consequential change to current section 1037 (Bill Schedule 2 Item 232)

(b)

there will no longer be any obligation to lodge the shareholders name and address

(c)

where shares are issued for non-cash consideration under a written contract, there will no longer be an obligation for the contract to be lodged - companies will have the option of lodging prescribed particulars about the issue of the shares.

11.50 The notification must set out the amount paid or agreed to be considered as paid on each share. However, this is not intended to permit the directors to deem an amount to have been paid which exceeds the value of the cash and non-cash consideration actually received for the share.

11.51 Currently, details of the person to whom shares are allotted are generally required to be included in the return of allotment (current s 187(1)(d)). However, this information is not required to be updated and therefore becomes inaccurate as soon as the person sells the shares. The Bill therefore does not require the notice to include this information.

11.52 It will not be necessary for companies to lodge a separate notice for every issued or cancelled share in order to comply with these provisions. For example, it would be possible for companies to lodge regular notices with the ASC that note all of the shares issued or cancelled during the period (of up to 1 month) covered by the notice.