Eiffel Towers Ltd, a listed company, was a builder and property developer specialising in projects in Brisbane’s central business district. It has five directors. Giscard is the managing director and Henri is the chief financial officer. They are the only

Reading

Text, Chapters 9 & 10

Objectives

On successful completion of this module, you should be able to:

· understand the different means by which company finance can be raised

· understand when a disclosure document is (and is not) required

· know the different types of disclosure documents and advise on which is appropriate in a given factual scenario

· understand what a debenture is (and contrast it to an unsecured note)

· describe the obligations associated with the creation and issue of debentures

· understand the rules governing the creation, perfection, validity and priority of security interests

11.1 Introduction

The most important feature of large companies, in particular those listed on stock exchanges, is that they provide a mechanism for the pooling of funds from many investors who wish to participate in particular business ventures. A significant objective of the Corporations Act is to encourage such investment so companies can raise capital which is necessary for the financial operations from time to time. On the other hand, Corporations Act also aims to protect members of the investing public by requiring full and accurate disclosure of relevant information concerning the activities of the companies seeking to raise funds. Companies can raise capital through issuing securities, e.g. shares and debentures. This module discusses such issues.

11.2 Disclosure documents

Company wishes to issue shares to the public must comply with Ch 6D of the Corporations Act. Ch 6D applies to offers of securities in a company: s 700. ‘Securities’ includes shares, debentures and interests in managed investment schemes: s 761D. Under s 706 a company must not offer newly issued shares without a disclosure document, unless an exception applies. There are four types of disclosure documents:

– prospectus (most common)

– short form prospectus

– profile statements

– offer information statements

Subject to some very limited exceptions under section 708, the Corporations Act prohibits companies from raising finance through the issue of securities unless disclosure is made to investors. The object of this requirement is to provide investors with adequate information to enable them to make an informed decision about the investment, before they invest in the company.

Reading activity 11.1

1. What types of disclosure document are there?

2. What is the meaning of ‘securities’ for the purposes of Chapter 6D?

3. Can a proprietary company issue a disclosure document?

4. What is the general rule for which offers to issue securities need disclosure, under section 706?

5. Review sections 708 and 708AA. Which offers do not need disclosure?

6. What is a small scale offering?

7. What is a sophisticated investor?

11.2.1 Contents of disclosure documents

There are different content requirements for the various types of disclosure documents. More detailed information must be set out in a prospectus, which is regarded as a full disclosure document, than in the other types of disclosure documents.

Prospectus is the most common type of disclosure document. Section 710 contains a general disclosure requirement which obliges the company to disclose all information investors and their advisers would reasonably expect the prospectus to contain, to make an informed decision in relation to whether or not to acquire the securities. Section 711 sets out a long list of specific matters that must also be included in the prospectus. This list includes, for example, disclosure of any interests in the company which any person associated with the prospectus has, has had, or has agreed to receive. You should read section 711 and be familiar with the listed items.

As to other types of disclosure documents, section 714 sets out the disclosure requirements for a profile statement and section 715 does the same for an offer information statement.

Reading activity 11.2

1. What does section 715A require of a prospectus?

2. According to Regulatory Guide 228, what will satisfy the requirement for a ‘clear, concise and effective prospectus’?

3. What information would you normally expect to find in a prospectus?

4. What is the consequence of breaching section 710?

5. What is the difference between prospectus and short form prospectus?

6. What is a supplementary or replacement disclosure document? Under what circumstances such a document must be lodged with ASIC?

7. What is a stop order? Who has the power to issue such an order?

11.2.2 Liability for defective disclosure documents

It is a criminal offence under section 728 to offer to issue securities where there is a misstatement or omission from the disclosure document or where a new circumstance has arisen since the disclosure document was lodged that would require disclosure under either the general or specific tests above. Also, a statement about the future is deemed to be misleading if reasonable grounds did not exist for making the statement at the time it was made: s 728(2).

Section 729 entitles a person who has suffered loss or damage as a result of relying on information in a disclosure document that breaches section 728, to claim compensation against the company, the directors & underwriters, as well as any person responsible for that particular statement who consented to its inclusion in the prospectus. To succeed in a claim under section 729, the claimant must be able to show:

· that he or she has suffered loss

· because of the offer of securities under a disclosure document (that is, establishing causation)

· that there has been a breach of section 728.

The claim may be brought against one or more of the people named in section 729. Possible defences to an action under s 729 are contained in s 731, s 732 and s 733. You should look at these closely.

Reading activity 11.3

1. What conduct is prohibited by section 728(1)?

2. How does section 728(2) help to interpret (or prove a breach of) section 728(1)?

3. What criminal offence is created by section 728(3)?

4. Which persons named in section 729 have liability for the entire document?

5. What defences are available in sections 731-733? Do they all apply to prospectuses?

11.3 Debentures

A company generally has the legal capacity to borrow, including the borrowing of funds from investors who in return are issued debentures of the company: section 124(1). The company is also authorised to grant ‘security interests’ over its assets to persons from whom it borrows funds. Under the replaceable rule in section 198A, the power to borrow money on a company’s behalf and to issue debentures is vested in the directors.

A ‘debenture’ is the right to enforce a company’s undertaking to repay a debt: s 9. Previously, the Corporations Act defined ‘debenture’ as the evidence of a company’s indebtedness – hence, the instruments or documents by which companies borrow funds are today still referred to as ‘debentures’. Technically, however, a debenture is the right to enforce the debt; the instrument or document creates that right. Debentures are intangible personal property, and therefore are readily transferable. Debentures can be quoted and traded on the Australian Securities Exchange, if the company and the debentures comply with the ASX listing rules.

11.3.1 Issuing debentures

Chapter 6D requirements

As a debenture falls within the definition of ‘securities’ contained in s 92, any offer to issue debentures to the public is governed by the fundraising provisions in Chapter 6D. For example, you will remember s 727 of the Corporations Act prohibits an individual or entity from making offers for the issue of securities (including debentures) or distributing application forms for such offers, unless a disclosure document for the offer has been lodged with ASIC or is exempted under s 708. This is only one of the many requirements of chapter

6D, discussed above.

Chapter 2L requirements

In addition to the Ch 6D requirements, which apply equally to all types of securities that are offered to the public (eg, to debentures as well as shares), Chapter 2L expressly states that it applies to offers of debentures to which Chapter 6D applies. This means that, if chapter 6D applies to an issue of debentures, Chapter 2L will also apply. Even if Chapter 6D applies to an issue, but no disclosure document is required due to an exemption by ss 708(14) or 708A, chapter 2L will still apply: s 283AA(1). Before a company can issue debentures, Ch 2L obliges the company to make arrangements for the appointment of a trustee under s 283AB and subsequently enter into a trust deed with the trustee under s 283AC: s 283AA(1). Failure to do so is an offence: s 283AA(2).

Reading activity 11.4

Read sections 283AB, 283AC, 283AD, 283AE, and 283BD of the Corporations

Act and answer the following questions:

1. What must the trust deed contain? What is the consequence of non- compliance?

2. Who can be a trustee? Who cannot be a trustee? What is the consequence of non-compliance?

3. If a trustee resigns, what happens until a new trustee is appointed? Who can replace the trustee? When must the trustee be replaced?

11.3.2 Duties of the company (the ‘borrower’)

Because the company is borrowing money from the investor who is investing in debentures in the company, the company is often referred to as ‘the borrower’. The company is obliged, under s 283BB, to carry on its business in an appropriate and efficient manner, and to make its financial records available for inspection by the trustee. Additionally, s 283BE requires the company to notify the trustee of any charges over company property which the company creates. S 283BF obliges the company to provide the trustee and ASIC with quarterly reports about certain specific information relevant to the company’s affairs, including quarterly financial reports.

11.3.3 Role of the trustee

The trustee is the trustee for the debenture-holders in respect of the holding of any charge or security for repayment of the debentures. Under s 283AB, the trustee is obliged to protect the interests of debenture-holders and, to this end, the trustee has the right under the trust deed to enforce the company’s duty to repay the debt (see s 283AB(1)(a)). Under s 283DA, the trustee must also exercise reasonable diligence to monitor the company’s behaviour to ensure that the company complies with the terms of the debenture, the trust deed and the Corporations Act. To aid this process, ss 318 and 313 give the trustee the right to receive a copy of the company’s financial report and auditor’s report. The trustee needs to determine whether any breaches have occurred and, if so, must notify the company and ASIC. In these circumstances, the trustee is also able to call a meeting of debenture holders under s 283EB(1).

Normally, the trust deed specifies that the company will be in breach of the trust deed if it enters into arrangements to borrow funds from another source, or fails to keep the value of charged property above a minimum amount. The trust deed may also include a ‘negative pledge’, which is a promise by the company which restricts its ability to enter into subsequent borrowing or security arrangements with other lenders.

11.3.4 Statutory rights of debenture holders

Debenture holders who hold more than 10% of the nominal value of the issue debentures are entitled to require the company to call a meeting of debenture holders: s 283EA.

11.4 Secured finance

Few people will bear the risk of lending to, or depositing money with, a limited company unless the repayment is adequately guaranteed. Thus we have laws which permit the company to grant a conditional interest over company assets to a person who is or will be owed money from the company, to reduce the risk of non-repayment of the debt. This is known as a ‘security’ or ‘security interest’.

11.4.1 Personal property securities reform

Previously, until 30 January 2012, security interest was created in a document known as a

‘charge’ or ‘company charge’. Company charges were governed by the Corporations Act, and many needed to be registered at ASIC to be enforceable if the company entered liquidation. The law changed in 2010 with the passage of the Personal Property Securities (Corporations and Other Amendments) Act 2010, which repealed the provisions of the Corporations Act which dealt with company charges, and instead brought most charges – both those previously granted (whether registered at ASIC or not) as well as those to granted in the future – under the ‘umbrella’ of the already-existing Personal Property Securities Act 2009 (which until that date had dealt with security interests granted by companies, but not those granted by individuals). This has the benefit of bringing all security interests onto a single system and a single register, regardless of whether it was an individual or a company who granted the security interest.

The reforms became operative on 30 January 2012. As part of the transition to the new system, ‘old’ charges that were registered on ASIC’s register of charges under the Corporations Act prior to October 2011 were automatically ‘transitioned’ across onto the personal property securities register, and have not lost any priority they may have had due to the timing of their previous registration on ASIC’s register of charges. Charges that have been created after 30 January 2012 could not be registered at ASIC and instead the only registration option was registration on the personal properties securities register.

Reading activity 11.5

1. What is a PPSA security interest?

2. Are conditional sale agreements and hire-purchase agreements covered by the reforms?

3. Who is the grantor? Who is the secured party? Where are these terms defined? What terms do they replace under the old law?

4. When does a security interest become enforceable in a circulating security interest? Where is default defined?

5. What is the importance of the difference between a circulating security interest and a non-circulating security interest? If you are the secured party, which type of security interest would you rather have?

11.4.2 Perfection of security interests

Previously, an unregistered charge that was listed in section 262 as requiring registration would be unenforceable in a liquidation if the charge was not registered within 45 days after it was created and the company became insolvent within six months. Section 262 has now been repealed, and replaced by the system of ‘perfection’.

The timing of registration was also important under the previous law, as generally speaking a charge that was registered earlier had priority over a later-registered charge (which

essentially meant that if both charges covered the same asset, the first one had first rights over that asset if both charges became enforceable).

Reading activity 11.6

1. How does registration occur? What is a ‘financing statement’ and what does it contain?

2. When is registration effective? What is the registration time and why is it important?

3. Why are priority rules important?

4. What are the default priority rules? Of the following, who has priority (make sure you refer to relevant sections of legislation as authority):

a. Two unperfected security interests over the same collateral?

b. A perfected security interest and an unperfected security interest, both covering the same collateral?

c. Two perfected security interests over the same collateral?

Module 11 Tutorial Questions

1. H Ltd has issued a prospectus which specifies that the company has recently obtained a large and lucrative contract, and the additional capital will be used for carrying out that contract. In fact, at the date of issue of the prospectus, the company was still negotiating for the contract, and afterwards the negotiations fell though and the company did not btain the contract.

On the basis of the prospectus, Y applied for, and was allotted, 5000 ordinary shares at an issue price of $1 each, payable in full on application. Y has now discovered that the company does not have the benefit of the contract. Advise Y on his civil remedies. Assume the shares are now worth 50 cents each.

2. David, an outstanding mining engineer, submitted a report which was published in the prospectus issued by Gold Bullion Ltd. A rush to purchase shares in the company followed. Unfortunately, some of the statements made by David in his report were untrue. Is David liable?

3. In an attempt to raise funds, A Pty Ltd approaches the local bank, B Bank Ltd, for a loan. A debenture was issued to B bank on 1 September 2013 for $500,000. Ten days later, a security interest was created in favour of B bank over all of A’s assets.

To expand its business, A later entered into a loan agreement with another local bank, C Bank Ltd, for a loan of $200,000. To safeguard the payment, C bank insisted on security for the loan, and so a security interested was created over the uncalled share capital of A on 1 October 2013. C bank had heard about the earlier charge to B bank but had been told, through an employee of B, that it had not yet been registered, since the manager had gone overseas for a holiday and the matter was waiting on her return. Notice of this security interest over the uncalled share capital was filed on the PPSA register by C bank on 20 October 2013. Notice of B bank’s security interest was filed on the same register on 23 October the same year.

(a) Identify the grantor, secured party, collateral, and security agreement in this case.

(b) When are the security interests of B and C attached?

(c) Advise each of the banks as to their rights under the PPSA with respect to the registration and priority personal property securities.