House of Representatives

Explanatory Memorandum

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

12. Chapter 2J: Transactions affecting share capital

12.1 The Bill will insert a new Chapter 2J - Transactions affecting share capital, comprising:

(a)

Part 2J.1 - Share capital reductions and share buy-backs

(b)

Part 2J.2 - Self-acquisition and control of shares

(c)

Part 2J.3 - Financial assistance

(d)

Part 2J.4 - Interaction with general directors duties.

12.2 Chapter 2J sets out various procedures and requirements that will have to be complied with when companies undertake share capital transactions. However, compliance by a company with these procedures and requirements will not relieve the companys directors of their duties under the Law or at common law (Bill s 260E). In particular, a director who is involved in a share capital reduction may be in breach of their duty to act honestly in the exercise of their powers and the discharge of their duties (current s 232), even though the reduction is authorised by Part 2J.1.

12.3 Schedule 5 of the Bill will establish new streamlined procedures for share capital reductions: these procedures are designed to remove unnecessary restrictions on capital reductions, and to protect the interests of shareholders and creditors. The current buy-back provisions will be re-enacted and placed with the share capital provisions in Part 2J.1 and, where relevant, will be amended to bring them into line with the share capital provisions.

Capital reductions

12.4 Under the doctrine of capital maintenance the creditors of a company limited by shares 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.

12.5 Under the existing statutory procedure for capital reductions at section 195, a company may reduce its share capital in any way if:

(a)

the reduction of capital is authorised by the companys articles, and

(b)

the reduction of capital is approved by a special resolution of the company, and

(c)

the reduction of capital is confirmed by the Court.

12.6 The procedure may also apply when a company appliers amounts that have been paid into its share premium account (current s 191(1)) or capital redemption reserve (current s 192(5)).

12.7 Schedule 2 of the Bill will rewrite existing section 195 of the Law in plain English (Bill ss 256A(2), 256B, 256C, 256D, 256E, and 256F).

12.8 Schedule 5 Item 18 of the Bill will repeal these rewritten provisions and replace them with a new procedure, which will allow a company limited by shares to reduce its share capital in ways in addition to those specifically authorised by law. The new procedures are described below. Other provisions of the Law that may be relevant to share capital reductions are listed in the table in Schedule 5 Item 18 section 256E of the Bill. After the commencement of Schedule 5, a company will not be able to make a capital reduction unless it complies with Bill Schedule 5 Item 18 section 256B(1) (Bill Schedule 5 Item 18 s 256D(1)).

12.9 When Schedules 2 or 5 of the Bill commence, a company may have already begun the current statutory procedure by calling a meeting for the purpose of existing section 195 or Bill section 256A(1)(b)(i). In these cases, the provisions of the Law as they stood before the relevant commencement will continue to apply to that reduction (Bill s 1429 and Bill Schedule 5 Item 31 s 1450).

No need for authorisation by constitution

12.10 The Law currently provides that a company may reduce its share capital only if it is authorised to do so by its constitution (current s 195(1)). However, the constitutions of most companies include, as a matter of course, a provision authorising capital reductions (Table A regulation 39 is an example of such a provision). This means that the Laws requirement for constitutional authorisation is not, in practice, an effective brake on capital reductions.

12.11 The Bill therefore omits from the Law with the commencement of Schedule 2 of the Bill the requirement that a capital reduction be authorised by the companys constitution. Companies that have a constitution will be able to include a provision restricting or prohibiting the exercise of their power to reduce their share capital. This will, in effect, give members the same power to prevent a reduction of share capital that they currently have through the requirement that the reduction be authorised by the companys constitution.

No need for Court confirmation

12.12 The Law currently requires that capital reductions be confirmed by the Court (current s 195(1), Bill s 256A(1)(b)(ii)). Court decisions have interpreted section 195 as providing the following safeguards for shareholders and creditors:

(a)

relevant information must be provided to shareholders before voting on a resolution to approve a reduction of capital

(b)

the impact of the reduction on the companys assets must not be such as to prejudice the companys creditors

(c)

the reduction must be fair and reasonable to all of the companys shareholders

(d)

shareholders and creditors must be given notice of the reduction of capital, and an opportunity to stop an improper reduction of capital.

12.13 However, it is not appropriate for every capital reduction to be subject to the time and expense that Court confirmation involves, particularly as the safeguards that this brings can be provided in different ways. Currently, even a reduction that in fact offers no threat to the interests of members or creditors must nevertheless be confirmed by the court. Schedule 5 Item 18 of the Bill therefore omits the requirement that reductions of capital be subject to court confirmation. The interests of shareholders and creditors will be protected by other safeguards, described below.

Shareholder approval

12.14 Under the Bill, reductions of share capital will continue to require shareholder approval (Bill Schedule 5 Item 18 s 256B(1)(c)). An equal reduction will have to be approved by a resolution passed at a general meeting of the company (Bill Schedule 5 Item 18 s 256C(1)). This is consistent with the approach taken in section 257C of the Bill in relation to shareholder approval for equal access share buy-backs over the 10/12 limit. The following requirements will apply to an equal reduction:

(a)

the reduction must relate only to ordinary shares

(b)

it must apply to each holder of ordinary shares in proportion to the number of shares they hold

(c)

it must be on terms that are the same for each holder of ordinary shares (Bill Schedule 5 Item 18 s 256B(2)).

12.15 The terms of the reduction may differ from 1 shareholder to the next because the shares have different accrued dividend entitlements or different amounts unpaid on them. The terms may also differ between shareholders to ensure that, when the reduction is complete, shareholders are left with a whole number of shares. These differences would not result in any inequity in the treatment of shareholders, and the Bill therefore allows them to be ignored in working out whether the terms of the reduction are the same for each holder of ordinary shares (Bill Schedule 5 Item 18 s 256B(3)).

12.16 A reduction of capital that is not an equal reduction is a selective reduction (Bill Schedule 5 Item 18 s 256B(2)), and must be approved by either:

(a)

a special resolution passed at a general meeting of the company, or

(b)

a resolution agreed at a general meeting to by all ordinary shareholders (Bill Schedule 5 Item 18 s 256C(2)).

12.17 Selective reductions require a special resolution, or unanimous shareholder agreement at a general meeting, because they have the capacity to advantage some shareholders over others. Where a selective reduction is approved by a special resolution, a vote may not be cast in favour of the resolution by a person who is to receive consideration as part of the reduction, or whose liability in respect of amounts unpaid on shares is to be reduced (Bill Schedule 5 Item 18 s 256C(2)(a)). This is intended to ensure that the resolutions approval reflects the wishes of the companys disinterested shareholders and corresponds to the approach taken in section 257D of the Bill in relation to shareholder approval for a selective share buy-back.

12.18 The Bill also includes a procedure to protect minority shareholders against their shares being cancelled under the guise of a capital reduction. In addition to the other shareholder approval requirements, a reduction of capital that involves the cancellation of shares will require approval by a special resolution passed at a meeting of the shareholders whose shares are to be cancelled (Bill Schedule 5 Item 18 s 256C(2)).

12.19 The Bill also inserts a new section into the Bill designed to ensure that the Corporations Law does not contravene section 51(xxxi) of the Constitution (Bill s 1362BA).

Information for shareholders

12.20 The current statutory procedure for capital reductions has been interpreted as requiring companies to ensure that when shareholders approve a capital reduction, they are properly informed of the effects of the reduction on themselves and other shareholders : Re Campaign Holdings Pty Ltd (1989)
15 ACLR 762 ;
8 ACLC 64 . The Bill incorporates this obligation by requiring companies to include, with the notice of meeting at which shareholder approval for a capital reduction will be sought, a statement setting out all information known to the company that is material in deciding how to vote on the resolution (Bill Schedule 5 Item 18 s 256C(4)). The company will not be required to disclose information if that would be unreasonable having regard to previous disclosures made by the company.

12.21 Determining whether it would be unreasonable to require disclosure will involve consideration of the circumstances and context of the previous disclosure. For example, a company that had previously disclosed material information in its last annual report may need to include the information in its disclosure statement if its relevance to the capital reduction would not be apparent to shareholders. These rules about shareholder information correspond to those required for shareholder approval of share buy-backs (Bill s 257D(2)).

Creditor and shareholder protection

12.22 Creditors interests will be protected by the requirement that a company will only able to reduce its share capital if the reduction does not materially prejudice the companys ability to pay its creditors (Bill Schedule 5 Item 17 s 256B(1)(b)).

12.23 Whether prejudice is material will be a question of judgment to be determined in light of all relevant circumstances, including the particular characteristics of the company and the situation of the companys creditors.

12.24 In addition to shareholder approval, the Bill will also require that a capital reduction be fair and reasonable to the companys shareholders as a whole (Bill Schedule 5 Item 17 s 256B(1)(a)). 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

(d)

whether the reduction involves an arrangement that should more properly proceed as a scheme of arrangement.

12.25 The mechanism for approving a selective capital reduction by special resolution potentially gives rise to the expropriation of vested property rights, in that the shares of persons who did not vote for the resolution to approve the reduction may nonetheless be cancelled. This expropriation may only be challenged on the basis that the capital reduction was not fair and reasonable to shareholders as a whole. The statutory test may be satisfied even though the reduction is not fair and reasonable for every individual member. The appropriation may also be challenged as oppressive conduct under current section 260. However, the fair and reasonable test focuses on the effect and not the purpose of the reduction. Accordingly, the principles set out in Gambotto v WCP Ltd (1994-95)
182 CLR 432 do not apply to the expropriation of rights under this mechanism.

12.26 In any Court challenge to a reduction the company will have the onus of proving that the reduction is fair and reasonable to the companys shareholders as a whole and does not materially prejudice the companys ability to pay its creditors (Bill Schedule 5 Items 28-30).

Notice of the reduction of capital

12.27 It is important that a companys creditors are able to receive advance notice of a proposed capital reduction, so that they can exercise their rights (for example, to seek an injunction under current section 1324). The Law currently envisages that creditors will receive notice of capital reductions by requiring the company either to discharge or secure its debts, or obtain its creditors consent to the reduction (current s 195(3), Bill s 256C(4)). However, the Court has a discretion to make an order dispensing with the need for this notice (current s 195(4), Bill s 256C(6)), and will usually do so if the company is able to show that all of its secured and major trading creditors have consented to the reduction, and demonstrate that after the reduction its assets will exceed its liabilities.

12.28 For a selective reduction of capital, the requirement to lodge the notice of the meeting and the accompanying disclosure statement with the ASC before sending them to shareholders (Bill Schedule 5 Item 18 s 256C(5)) and the requirement to give the ASC at least 14 days notice of shareholder approval before making the reduction (Bill Schedule 5 Item 18 s 256C(3)) will mean that a company will usually be required to give at least 35 days notice to the ASC of a proposed reduction of capital. Creditors and other interested persons will therefore be able to receive advance notice of a proposed reduction through the ASCs Alert system. (This service gives a subscriber notice of a specified type of document lodged with the ASC in relation to a specified company.) For companies to which the short notice rules are available, the ASC will be given at least 14 days notice of a proposed reduction of capital through the requirement to lodge a copy of the shareholder-approval resolution within 14 days after it is passed, and to not make the reduction until 14 days after lodgment (Bill Schedule 5 Item 18 s 256C(3)).

12.29 If a company reduces its share capital on terms involving the cancellation of a share, it will be required to lodge a notice with the ASC setting out particulars relating to the cancellation (Bill s 254Y). For large proprietary companies and public companies, the impact of the capital reduction will also be reflected in the financial statements they lodge with the ASC (Bill s 319).

12.30 The Bill will set out the consequences of a company making a capital reduction that does not comply with Bill Schedule 5 Item 18 subsection 256B(1) (Bill Schedule 5 Item 18 s 256D). In order to promote commercial certainty, the Law currently denies a right to challenge a capital reduction once the ASC has issued a compliance certificate (current s 195(6) - (8)). The Bill will ensure that this certainty is achieved more directly, providing that the validity of a capital reduction is not affected by the fact that it is undertaken in contravention of the capital reduction procedures (Bill s256F(2)(a), Schedule 5 Item 18 s 256D(2)(a)). Further, a company that makes a reduction of capital that does not comply with Bill section 256A(1) or Schedule 5 Item 18 section 256B(1) will not be guilty of an offence (Bill s256F(2)(b), Schedule 5 Item 18 s 256D(2)(b)). However, any person who is involved in the contravention will contravene the Law, and may be subject to civil penalty orders and criminal consequences under current Part 9.4B (Bill s 256F(3), Schedule 5 Item 18 s 256D(3) and Item 27).

Stopping an improper capital reduction

12.31 The Law currently enables a person whose interests would be affected by a contravention of the Law to seek an injunction to prevent the contravention (current s 1324(1)). The Bill facilitates shareholders and creditors taking action to stop an improper capital reduction by treating:

(a)

a companys contravention of the fair and reasonable test as affecting the interests of a shareholder; and

(b)

a capital reduction that would prejudice the companys ability to pay its creditors as affecting the interests of a creditor or member of the company (Bill Schedule 5 Item s 28-30).

12.32 Consistent with the present approach of the courts, in an application for an injunction the onus of proof will be on the company to show that the reduction is fair and reasonable, or that it would not prejudice the companys ability to pay its creditors (current s 588G; Bill Schedule 5 Item 30).

12.33 Companies will be required to lodge the following documents with the ASC in connection with a capital reduction:

(a)

the notice of the shareholder approval meeting, together with any shareholder information statement - to be lodged before the notice is sent to shareholders (Bill Schedule 5 Item 18 s 256C(5))

(b)

a copy of the resolution approving the transaction - to be lodged within 14 days after it is passed (Bill Schedule 5 Item 18 s 256C(3))

12.34 These documents will give shareholders and creditors access (through the ASCs Alert system) to sufficient information to decide whether they should seek an injunction.

12.35 In line with the approach taken in relation to share buy-backs, the ASC will be able to refer to the Corporations and Securities Panel a reduction of capital that is unreasonable having regard to its effect on the control of the company or another company (Bill Schedule 2 Item 226). If the Panel declares that a persons conduct in relation to shares was unacceptable, it may make a wide variety of orders, including an order cancelling agreements or directing a company not to make payments of amounts due by the company in respect of the shares.

Capital reductions and par value

12.36 The Law currently requires the nominal value of a companys issued share capital to be a multiple of the number of shares it has on issue (current s 117 (1)(b), Bill s 117(2)(k)). Therefore, when a company reduces its share capital under current section 195 it must either cancel, or reduce the par value of, some of its issued shares.

12.37 The introduction of no par value breaks the nexus between the nominal value of a companys share capital and the number of shares it has on issue (Bill Schedule 5 Item 1). No par value will make it possible for a company to cancel a share without making a corresponding reduction of its share capital account.

12.38 As the cancellation of a share for no consideration will not affect the companys financial position or its ability to pay its creditors, modified rules will apply to these reductions. In particular, there is no need to require that the reduction not materially prejudice the companys ability to pay its creditors (Bill Schedule 5 Item 18 s 256B(1)). Further, a selective reduction involving the cancellation of shares will require the approval by special resolution of the shareholders whose shares are to be cancelled (Bill Schedule 5 Item 18 s 256C(2)). This is intended to ensure that selective share cancellations for no consideration will be approved by the requisite majority of those shareholders whose shares are being cancelled.

Other reductions of capital

12.39 Division 3 of Part 2J.1 (Bill s 258A - 258D) sets out capital reductions that are authorised by law, and which therefore do not need to comply with Bill section 256A(1)(b) or Schedule 5 Item 18 section 256B(1) of the Bill:

(a)

The common-law prohibition on companies reducing their share capital does not apply to unlimited companies. The Bill will preserve the existing statutory exemption from the share capital reduction rules for these companies (Bill s 258A).

(b)

The Law currently contains an exemption from the capital reduction provisions to cover the situation where, under a company-title home unit scheme, the company grants a lease or right of occupancy or use in relation to the unit (current s 195(13) - (14)). This exemption is preserved and, to avoid doubt, expressly covers rights in the nature of contractual rights that are granted under such schemes (Bill s 258B). The Bill will also incorporate the effect of Part 14 of the existing State covering clauses, by authorising the transfer by a company of an estate or interest in land to a person in exchange for their rights under a company title home unit scheme (Bill s 258B).

(c)

In order to remove any doubt about the validity of brokerage or commission paid to the underwriter of a share issue, the Bill will preserve and streamline current sections 203 and 204. A company will be able to pay brokerage or commission to a person in respect of their agreeing to take up schemes, without any need to comply with the share capital procedures (Bill s 258C). A particular advantage will be the removal of the existing restriction on the amount of any brokerage or commission that may be paid.

(d)

The Law currently authorises a company to cancel shares that have been forfeited and reduce its share capital by the amount of shares cancelled (current s 193(1)(e)). The Bill preserves this exemption by authorising companies to cancel shares that have been forfeited under the terms on which they are on issue (Bill s 258D). The cancellation will have to be authorised by resolution passed at a general meeting. Companies that want a power to forfeit shares will no longer need to include the power to forfeit shares in their constitutions.

(e)

The effect of the existing exemption from the share capital reduction procedures for share cancellations made in the context of a takeover (current section 195(15)) will be continued. Any share capital reduction involved in the cancellation of a share as a result of a takeover offeree returning share certificates under current section 667(3) will be authorised (Bill s 258E, Schedule 5 Item 22 s 258E). The Bill will also authorise a share capital reduction involved in the cancellation of shares issued on an out-of-date prospectus application form and returned to the company under current section 1024E(7) (Bill s 258E, Schedule 5 Item 22 s 258E).

(f)

Currently, a capital reduction that involves the cancellation of paid-up share capital that is lost or not represented by available assets is subject to the requirements of current section 195, which include court confirmation. Under the Bill, a cancellation of paid-up share capital that is lost or not represented by available assets will be authorised (and therefore exempt from the procedures in Bill Schedule 5 Item 18 subsection 256B(1)) unless the cancellation also involves cancelling shares (Bill Schedule 5 Item 18 s 258F). As with existing section 195(1)(b), this section will not apply in the case of trading losses incurred in the ordinary course of business, but is intended to apply in cases where company assets disappear (for example, are stolen, or destroyed by fire).

12.40 A redemption of redeemable preference shares that is funded out of the proceeds of a new issue of shares made for the purpose of the redemption is a reduction in share capital, and would ordinarily need to comply with the capital reduction procedures. However, it will be taken to be authorised for the purpose of Bill section 256A and Bill Schedule 5 Item 18 section 256B, and will not need to comply with the capital reduction procedures established by Part 2J.1 (Bill s 258E(1)(a) and Schedule 5 Item 22 s 258E(a)). This is intended to preserve the practical effect of current subsection 192(2).

12.41 Currently, a company is prohibited from paying interest (dividends) on share capital in respect of shares that are issued to finance capital works, unless the company complies with specific approval procedures and statutory conditions (current s 202). The Bill will repeal that prohibition and allow these payments to be made as selective capital reductions. After commencement of Schedule 2 of the Bill, the Law as it stood immediately before commencement of Schedule 2 will continue to apply to a court order made prior to that commencement approving a scheme under section 202, or an application for such an order (Bill s 1430).

Share buy-backs

12.42 The Laws share buy-back rules were inserted by the First Corporate Law Simplification Act 1995 in Division 4B of Chapter 2 of the Law. The Bill will re-enact the rules in Division 2 of Part 2J.1 (Bill s 257AA, 257A, 257B, 257C, 257D, 257E, 257F,257G, 257H, 257J).

12.43 The definition of employee share scheme buy-back has also been amended by incorporating reference to persons who currently fall within the definition of participating employee, avoiding the need to refer to 2 separate definitions (Bill Schedule 2 Item 196). The definition of participating employee will be repealed (Bill Schedule 2 Item 203).

12.44 The following consequential amendments will make the share buy-back rules consistent with the new capital reduction rules:

(a)

a company will be permitted to buy back redeemable preference shares on terms different from the terms of redemption on which the shares are on issue (Bill s 254J(2))

(b)

a new requirement will be introduced that a buy-back not materially prejudice the companys ability to pay its creditors (Bill s 257A(a))

(c)

the company will be required to give 14 days notice to the ASC before making a buy-back approved by shareholders (Bill s 257F).

12.45 Also, the purpose section will be relocated and apply generally to Part 2J.1 (Bill Schedule 5 Items 17 and 19).

12.46 The ASX Business Rules previously required trading of a marketable parcel of shares, defined as a minimum number of securities trading at a particular price (for example, 200 shares where the price did not exceed 25 cents). However, a number of exceptions permitted dealings in smaller parcels known as odd lots. Consistent with the introduction of the electronic trading system (CHESS), the concept of dealing in odd lots has been abolished, and the rules amended to permit trading in units of 1 security. Although the requirement for trading marketable parcels has been abolished, the concept of marketable parcel has been retained because of its relevance to the Securities Clearing House Business Rules (in particular, the prohibition on creating new holdings of less than a marketable parcel).

12.47 The Bill will bring the Law into line with these changes by replacing the term odd lot buy-back with minimum holding buy-back (Bill s 257B(1), Schedule 2 Items 200, 201, 206). The concept of minimum holding buy-back (which will be defined by reference to the listing rules concept of marketable parcel) has been used because, for persons unfamiliar with the ASX rules, it describes the content of the rule more accurately than marketable parcel. The Laws definition of marketable parcel will be repealed (Bill Schedule 2 Item 199).

12.48 Currently it is possible for an odd lot buy-back to involve the buy-back of only some of a shareholders shares. Under the Bill, a minimum holding buy-back will have to involve buying back all of the shareholders shares in a listed corporation, and those shares must be fewer in number than a marketable parcel.

12.49 The Bill will also expand the concept of on market buy-back to include a buy-back undertaken by a company on a securities market outside Australia that has been declared by the ASC for the purposes of the section (s 257B(7)).

Part 2J.2 - Self-acquisition and control of shares

Direct self-acquisitions

12.50 The Law currently prohibits a company from acquiring its shares or units of its shares, or lending money on the security of those shares (current s 205(1)). The Bill maintains this prohibition (Bill s 259A and 259B). Section 259A of the Bill also provides for the prohibition to be subject to the following 2 exceptions, which are based on exceptions in the current provisions:

(a)

the acquisition of a share under a court order (current s 205(8)(f))

(b)

the acquisition of an interest (other than a legal interest) in fully-paid shares in the company if no consideration is given for the acquisition (current s 205(8)(e)) - this exception reflects the common law principle in Kirby v Wilkins [1929] 2 Ch 444.)

12.51 Further, a company will not infringe the prohibition if it acquires its own shares following the share buy-back procedures in Division 2 of Part 2J.1 (Bill s 259A). Under those procedures, a share is cancelled immediately after the registration of the transfer to the company (Bill s 257H(3)).

12.52 To facilitate employee share schemes, companies will be able to take a security over shares issued under a member approved employee share scheme (Bill s 259B(2)). The employee share scheme will have to be approved by resolution at a general meeting of the company. If the company is a subsidiary, the scheme will also have to be approved by resolution at a general meeting of the companys listed holding company in Australia or, if it doesnt have one, by any holding company that does not itself have a holding company incorporated in Australia (Bill s 259B(2)).

12.53 The term domestic corporation, which is used in the provision, will be defined to mean a corporation incorporated or formed in Australia or an external Territory (Bill Schedule 2 Item 194). This is intended to avoid the unnecessary time and expense that would be involved where the companys listed holding company is a foreign corporation.

12.54 The Bill will insert a definition of employee share scheme (Bill Schedule 2 Item 195), which will include schemes for the acquisition of shares by a corporation. However, the corporations membership must be entirely comprised of employees or salaried executive directors of the company or a related body corporate. This will enable the beneficiaries of a scheme greater flexibility in organising their affairs.

12.55 There will also be an exemption in the case of a security taken over shares in a company whose ordinary business includes providing finance (current s 205(8)(d); Bill s 259B(3)). Providing finance will be defined in section 9, to mean lending money, giving guarantees or security for loans, and drawing, accepting, negotiating or discounting a bill of exchange, cheque, payment order or promissory note so that someone can obtain funds (Bill Schedule 2 Item 204).

12.56 A company that acquires a legal interest in its shares through exercising the security must cease to hold those shares within 12 months of the acquisition (Bill s 259B(4)), and voting rights attaching shares cannot be exercised while the company holds the shares (Bill s 259B(5)).

12.57 The Bill will set out the consequences of a companys contravention of the prohibitions in sections 259A and 259B. To promote certainty and protect the interests of third parties, the contravention will not affect the validity of the acquisition or security, or of any contract or transaction connected with it (Bill s 259F(1)). While the company will not be guilty of an offence, any person who is involved in the contravention will contravene the Law (Bill s 259F(2)) and may be subject to civil penalty orders and criminal consequences (Bill Schedule 2 Item 238).

Indirect self-acquisitions

12.58 The Bill will make 3 changes to the rules on indirect self-acquisitions in current section 185 and paragraph 205(1)(b). First, the Bill will extend the prohibition on indirect self-acquisitions to situations where a company is able to control another entity that holds an interest in the company (Bill s 259B(1)). For example, the prohibition will apply where a partnership controlled by the company holds an interest in the company.

12.59 Secondly, the existing application of the prohibition to cases where the holding company is a company limited by guarantee or an unlimited company (current s 185(10)) will not be continued under the Bill.

12.60 Thirdly, the prohibition will be extended to cover cases of actual control, rather than merely legal control as under the present subsidiary/holding company definition. The definition of control in section 259E of the Bill is based on the current accounting standards definition (AASB 1024). A company will control an entity where it has the capacity to determine the outcome of decisions about the entitys financial and operating policies (Bill s 259E(1)).

12.61 Control will not need to be actively exercised: what is relevant is the practical influence that the company can assert (Bill s 259E(2)(a)). Therefore, the mere fact that an entity acts in a manner consistent with the interests of a controlling company may be sufficient to indicate control. While control may also be indicated by economic dependence of an entity on the company (for example, where a company is a major creditor of an entity), control of voting power will usually be more important. A short-lived (for example, for a number of hours only) ability to control the outcome of decisions taken by the company would be unlikely to satisfy the control test. This is because such a short-term ability is unlikely in practice to give a company the ability to determine the outcome of decisions about the companys policies. Any practice or pattern of behaviour must be taken into account in assessing a companys capacity (Bill s 259E(2)(b)).

12.62 To make the test as closely aligned as possible with the definition of control in the accounting standards:

(a)

the fact that the company and another unrelated entity have an equal interest in the entity (as may occur, for example, under a joint venture agreement) will not of itself mean that the company controls the entity (Bill s 259E(3))

(b)

where a company is under a legal obligation to exercise its capacity to control an entity for the benefit of someone other than its own shareholders (for example, a trustee whose relationship with a trust does not extend beyond the normal responsibilities of a trustee) it will not be taken to control the entity merely because of that obligation (Bill s 259E(4)).

12.63 The Bill also incorporates a number of measures intended to allow companies to take some steps preparatory to the unwinding of a controlled member relationship. For example, a company that controls an entity at commencement will be able to increase the capacity that gives it that control, and entities that are wholly-owned subsidiaries will be able to transfer the shares to another wholly-owned subsidiary. However, in each case, the entity must within 12 months either cease to hold the shares or cease to be controlled by the company that has issued them (Bill s 259D(1)).

12.64 In line with the current paragraph 185(8)(a), the Bill prohibits a controlled entity voting at meetings of its controlling company (Bill s 259D(3)). However, if this prohibition is contravened, the relevant meeting or resolution will only be invalid if the court considers both that substantial injustice has been caused or may be caused and that the injustice cannot be remedied by any other order of the court, and the court declares the meeting or resolution to be invalid (Bill Schedule 2 Item 239).

12.65 As at present, the entity will cease to be a member of the controlling company if the shares held by it are cancelled under a reduction of capital or share buy-back. If at the end of the 12 months the entity retains an interest in the controlling company and is still controlled by the controlling company, the controlling company will be guilty of an offence for each day that the situation continues (Bill s 259D(4)).

12.66 Currently, the Court may extend the 12 month period (current s 185(8)(b)). The Bill confers the power to extend the 12 month period on the ASC instead of the Court, as it does not involve a dispute between the parties and is analogous to the ASCs power to modify the Law in relation to takeovers (Bill s 259D(1)). To avoid uncertainty, and to promote compliance with the Law, the period may only be extended if the company applies for the extension before the end of the initial 12 month period.

Issue or transfer of shares to a controlled entity

12.67 The acquisition by a company of shares or units of shares in a holding company is currently regulated by sections 185 and 205(1)(b)(ii). Under the Bill, the issue or transfer of shares or units of shares by a company to an entity controlled by that company will generally be void (Bill s 259C(1)), although the ASC will have a discretion to exempt a company from the operation of this rule (Bill s 259C(2)). It is envisaged that the ASC would exercise this discretion to exempt investments by the statutory fund of a life insurance company in its holding company on conditions designed to provide appropriate safeguards including ensuring that the holding company is not able to inappropriately exercise control over its own shares.

12.68 The Bill will establish new exceptions for the issue or transfer of shares:

(a)

by a company to its existing members in a non-discriminatory manner (Bill s 259C(1)(c))

(b)

by a wholly-owned subsidiary of a body corporate to another wholly-owned subsidiary of that body corporate (Bill s 259C(1)(d)).

12.69 In each case the acquiring entity will be obliged to dispose of the shares within 12 months of the acquisition (Bill s 259D(1)).

Controlling an entity that holds shares in the company

12.70 A company can acquire control of an entity that holds shares in the company without itself having taken any active steps to acquire a new interest in the entity. For example:

(a)

company A holds 35% of company B

(b)

company B holds a small interest in company A

(c)

company C holds 51% of company B (and therefore controls company B)

(d)

the remaining 14% of company B is widely held.

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12.71 If C divests itself entirely of its 51% interest to unassociated small shareholders, A will be left with a controlling 35% interest in B, which holds shares A has on issue. In these circumstances, A will have obtained control of an entity (B) that holds shares in A, and A will be required to end its control of B, or B to dispose of these shares (Bill s 259D(1)(a)).

12.72 The Law currently prevents a body corporate that is a subsidiary of a holding company from voting at meetings of the holding company, and in some circumstances requires the subsidiary to dispose of its shares in the holding company. These requirements will continue to apply (Bill s 1434).

12.73 The rules in section 259D of the Bill apply only to obtaining control, increasing control and other transactions occurring after commencement. For example, if A obtained control of B prior to commencement, A would not be required to end its control of B, nor B to dispose of its shares in A. However, if A were to increase its control in B after commencement, then within 12 months either A must end its control of B, or B must cease to hold the shares (Bill s 259D(1)).

Unacceptable self acquisition schemes

12.74 Division 4A of Part 2.4 of the Law (Unacceptable self-acquisition schemes) will be repealed. Instead, the ASC will be able to apply to the Corporations and Securities Panel for a declaration where a company acquires a relevant interest in at least 5% of its voting shares (the substantial shareholder threshold) and that acquisition has an unreasonable effect on the control of the company or another company (Bill Schedule 2 Item 226).

Part 2J.3 - Financial assistance

12.75 The giving of financial assistance by a company for the purchase of its own shares is prohibited by current paragraph 205(1)(a), unless the company complies with an expensive shareholder-approval procedure. The prohibition performs a useful function in deterring a range of undesirable transactions having the potential to prejudice a companys financial position. However, it impedes many normal commercial transactions.

12.76 The Bill therefore prevents a company giving financial assistance to a person to acquire shares, or units of shares, in the company or a holding company if the transaction would materially prejudice the interests of the company or its shareholders, or materially prejudice the companys ability to pay its creditors (Bill s 260A(1)(a)). This is subject to the exception that a company will be able to give financial assistance if the transaction has been approved by the companys shareholders in the manner set out in section 260B (Bill s 260A(1)(b)). This approach is intended to minimise the difficulties the rule currently causes for ordinary commercial transactions. In particular, for transactions which do not involve material prejudice, the new rules will make it unnecessary to decide whether the transaction involves the giving of financial assistance. The new rules will bring the requirements for financial assistance more closely into line with those proposed for capital reductions.

12.77 Whether a particular transaction involves a material prejudice, and therefore requires shareholder approval, will be a question of fact to be answered in light of the circumstances of each case. For example, material prejudice to the company, its shareholders, and the companys ability to pay its creditors may occur if a company withdraws a large amount of money from its bank and lends it to a company that is bordering on insolvency, or if it guarantees a loan to a company that is likely to default. In particular, it will not be possible to determine whether the transaction involves material prejudice merely by reference to arbitrary rules, such as the percentage impact the transaction will have on the companys profit.

12.78 Shareholder approval of a financial assistance transaction may be given by:

(a)

a special resolution passed at a general meeting of the company, with no vote being cast in favour of the resolution by the person acquiring the shares or units of shares, or their associates, or

(b)

a resolution agreed to by all ordinary shareholders (Bill s 260B(1)).

12.79 The restriction on persons acquiring shares from voting in favour of the resolution is intended to avoid the vote on a special resolution being controlled by those who will directly benefit from the financial assistance. The procedure for approval by resolution agreed to by all ordinary shareholders has been added, to avoid a situation where all shareholders are prohibited from voting in favour of a resolution to approve the financial assistance.

12.80 When a company giving financial assistance will have a different holding company before and after the acquisition to which the financial assistance relates, shareholder approval by special resolution will be required from the company that will be its holding company after the acquisition occurs (Bill s 260B(2) and (3)). This is designed to ensure that the transaction is approved by the shareholders who will have to bear any burden associated with the transaction once it is completed.

12.81 A copy of any required special resolution will need to be lodged with the ASC within 14 days after it is passed (Bill s 260B(7)).

12.82 Currently, if shareholder approval is sought for a subsidiary giving financial assistance, the transaction must be approved by any listed corporation that is its holding company or, if there is no listed holding company, any ultimate holding company that is incorporated in Australia (current s 205(10)). However, in practice this leads to unnecessary expense where the listed corporation is a foreign company. Further, if there is no listed holding company and the ultimate holding company is incorporated outside Australia, there is no requirement for shareholder approval by any holding company of the company.

12.83 The Bill will therefore confine the need to seek shareholder approval to listed corporations which are formed in Australia and, if there is no Australian listed holding company, require shareholder approval by any Australian holding company that does not itself have a holding company incorporated in Australia (Bill ss 260B(2) and (3)).

12.84 Where shareholder approval is required, the notice of meeting must be accompanied by a statement setting out all known information that is material to the decision how to vote on the resolution (Bill s 260B(4)). This requirement is intended to ensure the members make an informed decision how to vote on the resolution. A copy of the notice of meeting, and documents that will accompany the notice, must be lodged with the ASC before the notice of meeting is sent to members (Bill s 260B(5)), and the company must lodge with the ASC, at least 14 days in advance of giving the financial assistance, a notice stating that the giving of financial assistance has been approved under section 260B (Bill s 260B(6)). This will enable creditors and the other interested persons to receive notice of a proposed financial assistance transaction through the ASCs Alert system.

12.85 The Law currently contains a range of exceptions to the prohibition that relate to financial assistance given in the ordinary course of commercial dealing, and financial assistance given in the ordinary course of a moneylending business (current s 205(8) and (9)). These exceptions will be preserved (Bill s 260C).

12.86 In order to promote certainty and protect the interests of third parties, the fact that financial assistance is provided in contravention of section 260A will not affect the validity of the assistance, or of any contract or transaction connected with it (Bill s 260D(1)). While the company will not be guilty of an offence, any person who is involved in the contravention will contravene the Law (Bill s 260D(2)), and may be subject to civil penalty orders and criminal consequences (Bill Schedule 2 Item 238).

Employee share schemes

12.87 The Bill includes a number of provisions designed to facilitate employee share schemes. In particular, a company will be able to:

(a)

follow a simpler procedure for buying back shares issued under an employee share scheme (Bill s 257B)

(b)

take a security over shares issued under an approved employee share scheme (Bill s 259B(2))

(c)

give financial assistance for the acquisition of its shares under an approved employee share scheme (Bill s 260C(4)).

12.88 The concept of employee share scheme is currently limited to schemes that have as their purpose the acquisition of shares in a company by, or on behalf of participating employees. In the case of the Laws financial assistance provisions, the concept is further limited to schemes for the acquisition of fully-paid shares. Under the Bill, employee share scheme will be defined to mean a scheme for the acquisition of shares:

(a)

by employees of the company or a related body corporate, or directors of the company, or of a related body corporate, who hold salaried employment or office in the company or body corporate

(b)

for the benefit of those employees and directors (for example, whose shares are issued to a trustee to be held on trust for the employees or directors)

(c)

by a corporation, all of whose members are employees or executive directors (Bill Schedule 2 Item 195).

12.89 This will give companies increased flexibility in structuring their share schemes.

Transfer and transmission of shares

12.90 The Bill will move to Part 7.13 of the Law the following rules dealing with transfer and transmission of shares: section 208, section 213, Table A regulation 6, 19 - 25 (Bill Schedule 2 Items 234, 236, Schedule 3 Items 29, 30). The sections inserted by Bill Schedule 2 Items 234 and 236 will be replaceable rules. Schedule 3 Items 29 and 30 of the Bill will commence operation before the items in the other Schedules (Bill clause 2). The Bill will make consequential amendments to take account of the renumbering of current section 208 as section 1096A of the Bill (Bill Schedule 2 Items 212 - 214) and current section 213 as section 1091C (Bill Schedule 2 Item 209).

12.91 The Bill will also add a new replaceable rule dealing with the transmission of shares on mental incapacity (Bill Schedule 2, Item 235), based on the provision concerning transmission of shares on bankruptcy (Bill Schedule 2 Item 234 s 1091AB).

12.92 Table A subregulations 19(1) and (2) have been omitted because the absolute discretion to be vested in the directors of a proprietary company should be sufficient to enable them to control the transfer of the companys shares (Bill Schedule 2 Item 236 s 1091E). This provision will also allow proprietary companies to protect their closely-held status without needing to rely on a provision to similar effect in a constitution.

Schedule 3 penalties

12.93 Schedule 3 of the Law will be amended to insert penalties for contraventions of provisions inserted by the Bill, and to omit references to sections that will be repealed by the Bill (Bill Schedule 2 Item 241).