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LAW00004 Company Law

SCHOOL OF LAW & JUSTICE

Session 2, 2018

TOPIC 6

Financing the Corporation

Topic 6 Financing the corporation AIM: At the end of this topic you

should be able to:

•  Describe equity finance and shares •  Describe debt finance and debentures •  Explain the role of the Personal Property Securities Act

2009 (Cth) in security interests •  Outline corporate fundraising in public companies •  Explain the capital maintenance doctrine •  Explain a company’s financial and auditing obligations •  Outline the consequences of failing to comply with the

financial reporting obligations •  Explain the auditor’s role and liability

Topic 6 Part 1

•  Equity finance and shares •  Debt finance and debentures •  Registration of Security Interests •  Managed Investment Schemes

Corporate Fundraising •  Retain profits •  Garner further contributions from existing shareholders •  Borrow money through loans •  Issue ‘securities’: Equity finance and shares Debt finance and debentures - defined in section 9 •  Definition of ‘securities’ sections 92, 700 and 761A •  Security ‘fundraising’ rules Ch 6D •  Debenture issues + Ch 2L and Personal Properties

Securities Act 2009 (Cth) (PPSA)

Distinction between Share Capital and Loan Capital

Equity finance - capital provided by the shareholders of a company Debt finance - from debtors (a loan or bank overdraft) - but also through debentures It is the fact that the shareholder has rights in the company as well as against it, which ... distinguishes the member from the debenture holder whose rights are against the company... but never in the company itself.

Gower’s Principles of Modern Company Law, Gower et al, (4th ed., 1979), 399.

Equity Finance

•  Equity Finance = funds raised by company by issuing shares in company.

•  Regulated by Chapter 2H of the Corporations Act.

EQUITY FINANCE What is a share? •  Share ownership - confers rights and obligations

•  A share = “bundle of rights” - defined by •  company’s internal rules •  Section 1070A(1) •  general law eg, Gambotto

•  Share = chose in action = form of personal property section 1070A

•  Share does not confer a proprietary interest in the company’s assets

EQUITY FINANCE •  Share issue - regulated by Ch 2H Corporations Act. •  Section 124 empowers companies to issue shares •  Shares issued > allotted to holders, become

members when names entered on register of members

•  Shares - distinct classes with different rights •  Specific rights - usually set out in CC

Why have different classes of shareholders?

•  Confining control of the company •  Differential distribution of dividends •  Minimise taxation liability •  Attract investors by offering shares with preferential

rights •  Motivate staff

Protection of Class Rights attached to shares Ch 2F.2, sections 246B-G Note in particular section 246D

Classes of shares Ordinary shares Preference shares • Cumulative/non-cumulative • Participating/non-participating • Convertible/non-convertible • Redeemable/non-redeemable

• Deferred or Founder’s shares • Governor’s shares: • Employee’s or worker’s shares: • Bonus shares

Transfer of shares Shares = personal property section 1070A Ability to transfer shares limited by: •  CC •  Pt 7.11 Title and transfer - a duly executed instrument

of transfer must be delivered to the company •  Pre-emption section 254D (RR) (Pty Co.)

Shares in listed companies are most commonly transferred through a broker under CHESS - Clearing House Electronic Sub-register System https://www.asx.com.au/documents/resources/chess- brochure-march-2016.pdf No actual signatures are required

Restrictions on transfers

•  CC can contain restrictions on the transfer of shares. Such restrictions eg, section 254D (RR) are more common in pty companies.

•  Companies listed on ASX cannot have such restrictions.

Transfer of shares • Directors must not delay in deciding to refuse registration: general law and section 1071E

• Section 1071F - refused registration > apply to court for review

• For "just cause", the refusal to register must be bona fide in the interests of the company

• Section 1072G (RR) (Pty Co.) • If CC prescribes specific requirements > take precedence.

• Section 175 Correction of Register

Transmission of shares •  ‘Transmission’ = transfer of shares effected by the

operation of law •  This change in ownership of shares may be due to: •  Death section 1072A •  Bankruptcy sections 1072B & 1072C •  Incapacity section 1072D

•  Note that sections 1072A-D are RRs

DEBT FINANCE

Advantages • Interest may be tax deductible • Creditors not entitled to voting rights • Debt contracts fixed Disadvantages • Debt contracts fixed • Increases gearing ratio (debt:equity) • ‘Loan covenants’

DEBT FINANCE

• Companies - power to borrow money section 124

• Loan capital - governed by contractual relationship between lender and debtor (company)

• Lender may require security for the loan Corporations Act regulates : • security given by a company for a loan • loans to companies in the form of debentures

Debentures •  Section 124 company may issue debentures •  Section 9 definition - right to enforce a company's

undertaking to repay a debt •  The public usually associates the term with a secured

loan •  Section 283BH protects investors by providing that a

company may not use the term “debenture” unless it has given security for the loan

•  Debentures can be issued privately or to the public •  When issued to the public, a disclosure document is

required

Debentures •  Under a debenture - a trustee for the debenture-

holders appointed section 283AA •  Trustee acts on behalf of debenture-holders under

terms of trust deed •  Corporations Act now imposes direct statutory

obligations on borrowers and guarantors sections 283BA-283CE

Debenture holders Interests protected through appointment of trustee. Due to: •  The diverse nature of debenture holders •  As non-members excluded from information flows

within company •  Not entitled to:

•  receive financial reports •  attend meetings •  vote at meetings

Debentures • Trustee - holds rights under debentures on trust for individual beneficial holders

• Company - deals with trustee and not lenders • Trust deed - trustee to enforce the borrower’s duty to repay; any charge or security for repayment; and the rights of enforcement under the terms of the debentures or deed; section 283AB

• Trust deed - clauses that provide: •  Rights of debenture holders against the company; •  Company’s obligations, including limitations on

future borrowing •  Nature of any security attached to loan

Debentures

Trustee - given power under trust deed to: •  Enforce company’s duty to pay •  Enforce terms of the trust deed; •  Facilitate efficient operation of trust Trustee duties section 283DA

Capacity to provide securities

Company - can provide same sort of security for its borrowings as a natural person section 124 Section 124 also recognises: •  unique type of legal actor that is the corporation, and •  unique assets over which they can give security

interests (such as uncalled capital) •  and a circulating security interest over the company’s

property

Security interests

•  Company charge = security interest over company’s personal property

•  Personal property ie not real property •  Charge now out-dated - Personal Property Securities

Act 2009 (Cth) (PPSA)

Pre-PPSA •  Fixed charge •  Floating charge •  Crystallisation •  Registration with ASIC •  Competing priorities

Current position: security interests under PPSA

•  Chapter 2K Corporations Act has been replaced with Chapter 5 of the PPSA

•  Law regulating security interests changed •  Terminology changed - terms fixed and floating

charges not used in PPSA •  PPSA introduced a new process for creation and

registration of security interests over personal property (including debentures)

•  Security interests - registered on the Personal Property Securities Register

•  Charges registered on the ASIC Register migrated to PPS Register

See Study Guide p 103.

Interests other than shares or debentures: MANAGED INVESTMENT SCHEMES

•  Managed investment opportunities other than through shares or debentures.

•  For example, unit trusts including: •  cash management trusts •  equity trusts •  property trusts

•  Ch.5C Corporations Act We will not consider these provisions in this unit.

Topic 6 Part 2. •  Corporate Fundraising in Public Companies •  Types of disclosure documents •  Legal liability under the disclosure document

provisions •  Capital maintenance doctrine •  Accounts and Audit

CORPORATE FUNDRAISING IN PUBLIC COMPANIES

Disclosure documents; Prospectus & Pt 6D

•  Section 113(3) prohibits Pty Cos. soliciting public •  Public company offering to issue new securities must:

•  Prepare disclosure document section 706 •  Lodge it with ASIC section 718

•  Exempted offers under sections 708 or 708A •  Misleading or deceptive conduct in relation to issue

of securities

Excluded offer does not require disclosure section 708: • small scale • sophisticated investor • professional investor • executive officer • existing holder • no consideration • takeovers and schemes • debentures; • exempt bodies and public authorities

TYPES OF DISCLOSURE DOCUMENTS

Types of disclosure documents Corporations Act provides for different types of disclosure documents:

•  Prospectus or short form prospectus (or in some cases a transaction specific prospectus) section 709(1)

•  Profile statement section 709(2) & (3) •  Offer information statement (<$10M) section 709(4)

A disclosure document must be lodged with ASIC prior to distribution section 718

Disclosure requirements • Requirements for form and content - set out in sections 710-716

• Content requirements differ depending on the type of disclosure document being used:

• Prospectus - all information investors would reasonably require to make an informed - assessment of matters set out in the legislation. “general disclosure obligation” section 710

• Section 711 specific disclosures • Short form prospectus may simply refer to the prospectus document that has been lodged with ASIC section 712

Disclosure requirements (cont.) • Section 713 transaction specific prospectus (for offer of listed securities) - only required to contain information not previously disclosed

• Profile statement (in addition to prospectus) if ASIC approves. Must contain the information set out in section 714

• Disclosure obligation for an offer information statement is limited to the specific information required by section 715(1)

Supplementary and Replacement Disclosure Documents Section 719 •  Significant change > supplementary prospectus •  Drastic changes > replacement prospectus

Section 739 ASIC issue Stop Order Section 717 overview of procedure for offering securities

LEGAL LIABILITY RE DISCLOSURE DOCUMENTS

Wrongful conduct Breach of the disclosure provisions may give rise to civil or criminal liability Section 728 A person is prohibited from offering securities under a disclosure document if there is: •  a misleading or deceptive statement; •  an omission; or •  a new circumstance is not included

Liability – claims by investors Section 729 right to recover for loss or damage as a result of relying on information contained in disclosure document, against: •  Company, the directors and underwriters. •  Others (eg financial advisers, accountants, lawyers)

for statements made if named by consent

Case authority sections 728 & 729

For reference purposes only Cadence Asset Management Pty Ltd v Concept Sports Limited [2005] FCAFC 265

Defences to Legal liability re disclosure documents • Section 731 – prospectus “due diligence” defence

• Section 732 - offer information statement or profile statement - lack of knowledge defence

• Section 733 – all disclosure documents - general defences - “reasonable reliance”, “withdrawal of consent” and “unawareness”

CAPITAL MAINTENANCE DOCTRINE

Company raises initial capital by issuing shares. Capital converted into assets If needs further funds can: •  use its profits, •  make a call on existing uncalled shares, •  sell more shares •  borrow •  combination of these. Section 254X notify ASIC

Capital maintenance doctrine •  Main concern for creditors - issued share capital =

accurate reflection of funds available to repay any loans

•  Once company has acquired share capital, should

maintain that capital – in interests of shareholders and creditors, and allowing for normal fluctuations in commercial fortune

•  Common law – traditionally prevented companies

from reducing share capital - rule in Trevor v Whitworth (1887) 12 AC 409

Trevor v Whitworth (1887) 12 AC 409

•  Company bought back own shares •  Held bulk of purchase price as loan from seller •  Liquidator refused to recognise the former

shareholder as creditor Reasoning of Court •  Creditors relied on share capital when making

decisions about extending credit to company. •  Share capital could not be reduced - creditors had

reasonable expectation of using share capital to pay off debts

•  Company’s actions – reduced capital buffer for creditors and loan by the former shareholder = invalid capital reduction

Capital maintenance doctrine Rules relating to: •  alterations of share capital, •  companies dealing in their own shares, •  the determination and payment of dividends are in part, based on the rule in Trevor v Whitworth. See now •  Sections 256B-E – reductions in share capital not

otherwise authorised by law •  Sections 257A-J – Share buy backs •  Sections 259A-D Part 2J.2 Self-acquisition and control of

shares. •  Sections 260A-D –Part 2J.3 Financial Assistance

Dividends Common law - dividends must be paid out of profits and not used to reduce share capital Australasian Oil Exploration Ltd v Lachberg (1958) 101 CLR 119 •  Section 254T does not maintain the statutory rule that

dividends must not be paid except out of profits. Wambo Coal v Sumiseki Materials [2014] NSWCA 326 [57] •  Section 254V when action by a company in relation to a

dividend causes it to incur a debt. Timing of the debt important: •  Company’s ability to meet the declaration •  Liability of directors under section 588G (note that s.

588G(1A) specifically refers to incurring a debt by way of dividend).

ACCOUNTS AND AUDIT

Three fundamental reporting obligations:

•  to keep financial records section 286

•  to prepare financial and director’s reports for each financial year section 292

•  to have the financial reports audited section 301

Obligation to keep financial records

•  Companies (and registered schemes and disclosing entities) required to keep financial records section 286(1)

•  ‘Financial records’ defined in section 9 •  Includes electronic records section 1306 •  Electronic records must be convertible to hard copy

section 288 •  Records must be kept for 7 years section 286(2) •  Non-compliance – civil penalty provision sections 344

and 1317E and may be presumed to be insolvent section 588E

Obligation to prepare financial and directors’ reports Section 292 Companies (public companies, large proprietary companies and registered schemes) to prepare annual •  Financial report •  Directors’ report

Additionally, disclosing entities must prepare half-year reports sections 292(1)(a) and 302

Financial report consists of:

•  A profit and loss statement •  A balance sheet •  A statement of cash flows •  The notes to the financial statements •  Directors’ declaration about the statement & notes

Obligation to prepare financial and directors’ reports

•  Small proprietary companies (defined in section 45A(2) – not required to prepare annual financial reports unless directed to do so by:

•  Members holding 5%+ of votes sections 292(2) and 293

•  ASIC section 294

Financial reports must •  Contain certain documents section 295 •  Comply with accounting standards set by the Australian

Accounting Standards Board (AASB) sections 296(1) and 304

•  Give a ‘true and fair’ view of the financial performance of the company section 297

•  The directors’ declaration must attest that the financial statements comply with the accounting standards and give a true and fair view section 295(4)

Directors must take all reasonable steps to comply section 344 Failure to do so – contravention of civil penalty provision section 1317E ASIC v Healey [2011] FCA 717

Directors’ reports Must include: •  General information required by section 299 or 299A •  ‘Specific’ information required by section 300 or 300A •  Copy of auditor’s declaration under section 307C in

relation to audit

Half-year directors’ report Section 306 – to include: •  Review of operations and results •  Details of each director •  Copy of auditor’s declaration etc.

To Whom Must the Company Report?

A company has reporting obligations to: • members - copy of financial, directors’ and auditor’s report or a concise financial report section 314

• ASIC section 319 • if listed, the ASX

Consequences of Breaching Chapter 2M • Company commits an offence section 1311 • Director who fails to take all reasonable steps to ensure the company complies contravenes a civil penalty provision section 344(1)

• Criminal liability under sections 1308 and 1309 - false or misleading statements and false information.

Relief from compliance

Section 340 ASIC has power to relieve directors, companies and auditors of compliance if to comply with statutory requirements would: •  Make financial (or other) report misleading, or •  Be inappropriate in the circumstances, or •  Impose unreasonable burdens, and •  Not be retrospective

Obligation to have financial reports audited

Purpose •  Independent assessment •  Compliance with external reporting requirements Appointment Public companies – required section 327A Proprietary company – discretionary section 325 Small proprietary company – only if 5%+ of members or ASIC direct preparation of report sections 293-294 Small proprietary company – foreign corporate controlled company – required section 292(2)

Auditor’s statutory duties •  To form an opinion whether the financial report complies with required standards section 307

•  To report to members sections 308-309 •  To report to trustee for debenture-holders where the company is a borrowing corporation section 313(2)

•  To be a public watchdog for ASIC regarding suspected contraventions of the Corporations Act section 311

Criminal liability sections 1308 and 1309

Auditor’s general law duties Company Reasonable care and skill Liability for breach under: •  Contract •  Torts Outsiders •  Torts •  Proximity Esanda Finance Corp Ltd v Peat Marwick

Hungerfords(1997) 188 CLR 241

Auditor’s Liability Auditors may be liable for: • Breach of duty to use reasonable care and skill • Negligent misstatements • Misleading and deceptive conduct, item 18 of Sch 2 of Competition and Consumer Act 2010 (Cth)

• False or misleading statements, sections 1308 and 1309

Brief Summary of Audit Companies generally must appoint an auditor Small proprietary companies are not required to have their reports audited if the reports are prepared at the request of members who don’t want them audited The auditor's statutory duties are: •  to report to members •  to report to ASIC •  to report to the AASB on non-compliance

Brief Summary of Audit

The auditor's other duties are: •  to the company •  to outsiders (only in certain circumstances)

Auditors may be liable for: •  breach of duty to use reasonable care and skill •  negligent misstatements •  misleading and deceptive conduct •  false or misleading statements

KEY POINTS

•  Distinction between Share Capital and Loan Capital •  Disclosure documents •  Legal liability re disclosure documents •  Accounts and Audits and reporting •  Auditor’s Role and Liability (statute and general law)

Topic 6 Financing the corporation AIM: At the end of this topic you

should be able to:

•  Describe equity finance and shares •  Describe debt finance and debentures •  Explain the role of the Personal Property Securities Act

financial reporting obligations •  Explain the auditor’s role and liability

Next week

Lecture •  Topic 6 to be completed, Topic 8

Tutorial/Collaborate Attempt Activities 6.1.3 & 6.2.3