Financial Assistance – can a company help someone to buy its own shares?

Financial Assistance – can a company help someone to buy its own shares?

“Financial assistance” occurs where a company financially assists a person to acquire its shares, for example by making a loan to that person or providing a guarantee or other security to support that person borrowing from a bank to buy the shares.  A company is restricted from providing financial assistance unless it complies with section 260A of the Corporations Act 2001 (Cth) (Act).

Financial assistance arises regularly in our corporate and M&A practice, particularly with clients in the SME space, as the company will often be used to assist with financing a share sale and purchase transaction (e.g. by giving security for the incoming purchaser’s loan).  Company owners, directors and their advisers need to be broadly aware of what constitutes financial assistance and the process that must be followed to comply with the Act, in particular so that it is factored into the transaction timetable.

This article outlines the key considerations in determining whether financial assistance is being given by a company and identifies how to ensure compliance with the provisions of the Act.

The Act

Under section 260A of the Act, a company can only give “financial assistance” to acquire shares (or units of shares) in itself if:

  • giving the assistance does not materially prejudice the interests of the company or its shareholders or the company’s ability to pay its creditors; or
  • the assistance is approved by shareholders under section 260B; or
  • the assistance is exempted under section 260C.

“Units” of shares are defined as a right or interest, whether legal or equitable, in the share (s.9 of the Act).  Accordingly, entering into an option agreement or convertible note arrangement, for example, would be captured by these provisions.

Similarly, sub-sections (2) and (3) of section 260A clarify that financial assistance:

  • may be given before or after the acquisition of shares (or units of shares);
  • can take the form of paying a dividend; and
  • extends to the acquisition of shares (or units of shares) by issue, transfer or any other means.

It follows that the scope of “financial assistance” is broad and depends on the “commercial realities of the transaction … [to] decide whether it can properly be described as the giving of financial assistance by the company”, not the form of the assistance (Charterhouse Investment Trust Ltd v Tempest Diesels Ltd [1986] BCLC 1, at 10).

Financial assistance

Any action by the company can be financial assistance if it eases the financial burden that would be involved in the process of acquisition or if it improves the person’s “net balance of financial advantage”, in relation to the acquisition (Connective Services Pty Ltd v Slea Pty Ltd (2019) 373 ALR 65 (Connective Services), at 22).

In Connective Services, it was held that the company funding legal proceedings to enforce pre‑emptive rights under its constitution, directed at compelling one shareholder to offer shares to other shareholders, constituted financial assistance.  So, the concept of financial assistance is extremely broad.

One of most common forms of financial assistance is where the company grants security to a third‑party lender to assist the incoming shareholder to acquire shares.

In particular, if the company is granting security over its own assets to secure another person’s liability as part of a broader transaction for the acquisition of its shares, then legal advice should be sought to determine whether this raises an issue of financial assistance.

Materially Prejudice

A company can comply under section 260A(3) of the Act where the financial assistance is not materially prejudicial to the company and the directors resolve that the company give the financial  assistance on this basis.

When considering whether the financial assistance “materially prejudices”, the test has two limbs:

  • Does the financial assistance materially prejudice the interests of the company or its shareholders?

Generally, the court tends to focus more on the impact of the relevant transactions on the company, rather than the shareholders, when considering whether the interests are materially prejudiced (Re HIH Insurance Limited (in prov liq) and HIH Casualty and General Insurance Limited (in prov liq); Australian Securities and Investments Commission v Adler (2002) 41 ACSR 72 (Adler) at 340-343).

In Adler, Santow J states that the assessment of material prejudice is by reference to the transaction with its interlocking elements giving rise to the financial assistance, taking into account its financial consequences for the interests of the company or its shareholders.  This is to determine where the net balance of financial advantage lies from the giving of the financial assistance (Adler at 349).

  • Does the financial assistance materially prejudice the company’s ability to pay its creditors?

This is a relative test.  An example is “where cash is converted into an unsecured loan without interest to the purchaser of shares” (Ford’s Principles of Corporations Law, looseleaf, Butterworths, Sydney at [24,710], quoted in Adler at 344), as a company asset is being converted into one of lesser quality.

Therefore, in Adler, the court examined the net detriment to the company from a poor bargain, not just the cashflow impact of the transaction.  While the target company may obtain intangible benefits from the transaction (e.g. through sharing resources and synergies with the existing business of the incoming shareholders), those benefits are tenuous when compared with the credit and balance sheet impact of guaranteeing a purchaser’s finance debt.

Overall, the test is objective and the court does not give weight to whether or not the directors believed that it is not materially prejudicial – the test is factual and requires an assessment of and comparison between the position before the giving of the financial assistance and the position after it to see whether the company or its shareholders or its ability to pay its creditors is in a worse positions.

This means that even if the directors resolve that the transaction is not materially prejudicial, if the company subsequently suffers a loss or detriment as a result of the financial assistance, the directors would still be liable for contravening section 260A.

The civil penalties are against the persons “involved” in the Company’s contravention (i.e. the directors), not the Company and actual knowledge of material prejudice is not necessary to make out the offence either (Adler at 3).

White-wash Process – shareholder approval in accordance with section 260B

Where the financial assistance will be material, a company can instead obtain approval of shareholders in accordance with section 260B in order to comply with the Act.

The following procedure must be followed:

  • meeting of directors held to consider and approve the financial assistance and issuing a notice of meeting to shareholders;
  • Form 2602 (Notification of financial assistance details) lodged with ASIC;+
  • once Form 2602 is lodged and received by ASIC, the notice of meeting can be issued to shareholders (noting that 21 days’ notice is usually required for a shareholders’ meeting, unless the shareholders consent to shorter notice);
  • shareholders’ approve of the financial assistance at a general meeting (by way of a special resolution (with the members affected by the financial assistance unable to vote) or unanimous resolution);
  • Form 205 (Notification of resolution) and Form 2601 (Notification of intention to give financial assistance) lodged with ASIC; and
  • the company must wait at least 14 days after Form 2601 is lodged and received by ASIC before giving the financial assistance.

Depending on the circumstances, this process can take anywhere between three to eight weeks to comply with.  As such, it is crucial that financial assistance be identified in the early stages of a transaction so that it can be planned for appropriately.

Exempted under section 260C

There are limited circumstances where financial assistance will be exempted from s 260A, including:

  • where the company is a financial institution and the assistance is given in the ordinary course of business and on ordinary commercial terms;
  • where financial assistance is given under an approved employee share scheme (generally, approval is by a resolution passed at a general meeting of the company);
  • a reduction of share capital or a share buy-back in accordance with Part 2J.1; or
  • a discharge on ordinary commercial terms of a liability that the company incurred as a result of a transaction entered into on ordinary commercial terms.

We often see exempt financial assistance for approved employee share schemes, a reduction of share capital or a share buy‑back.

Attitude of lenders

Financiers tend to exercise vigilance when their customers are involved in share transactions because of the possibility that section 260A of the Act may be breached, in which case they are at risk of aiding and abetting a breach of the section.

In Hunters Products Group Ltd (In Liq) v Kindly Products Pty Ltd (1996) 14 ACLC 826 the Australia and New Zealand Banking Group Limited (ANZ) was found to be knowingly concerned in the breach of the financial assistance provisions and liable for aiding and abetting the contravention.  As a result, the ANZ was ordered to repay the funds paid in breach of the section as compensation to the liquidator of the company that gave the financial assistance.

Where a bank or third-party financier will be lending funds to, or taking security from, a company for the purpose of a person acquiring shares in that company the relevant lender will require the whitewash procedure to be followed as a condition of advancing funds.

Practical observations

Complying with the financial assistance provisions is generally a matter of process and provided the process is followed, it is not a major impediment to completing a successful transaction.  Where we have seen financial assistance present a challenge for clients is if it arises at the last minute and after the parties have already committed to a transaction timetable that does not allow for that process.

We recommend that clients seek legal advice in the early stages of a transaction (in conjunction with their financier and accountant) so that if there is going to be financial assistance, the transaction can be structured to allow sufficient time to carry out the white-wash procedure (if necessary).

Clients should always seek legal advice before giving financial assistance, as a contravention under the Act carries civil penalties that extend to persons “knowingly involved” in the contravention (i.e. directors of the Company).

We regularly advise clients on complying with the financial assistance provisions of the Act and are able to assist with identifying financial assistance and preparing the relevant documentation to ensure the appropriate approval is obtained.

This article was co-written by Paralegal, Emily Taylor.