How Not to Enforce a Pre-Emptive Rights Provision - Shareholder Disputes

12 November 2019 in Articles

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Written by Eduard Ferreira, Senior Associate

On 9 October 2019 The High Court of Australia gave a judgment in Connective Services Pty Ltd v Slea Pty Ltd [2019] HCA 33 that has important consequences for a company that wants to enforce pre-emptive rights provisions in its constitution. Pre-emptive provisions are provisions that require shareholders to offer their shares to existing shareholders of the company before offering to sell the shares to outside parties.

Connective Services Pty Ltd’s (Connective Services) constitution contained pre-emptive rights provisions. Slea Pty Ltd (Slea) was a shareholder of Connective Services that attempted to sell its shares in breach of the pre-emptive rights. Connective Services commenced proceedings (Pre-emptive Proceedings) to compel Slea to offer its shares to existing shareholders first.

Slea, in turn, commenced proceedings to stay or dismiss the Pre-emptive Proceedings on the basis that they amounted to financial assistance for the purchase of Connective Services’ shares in contravention of section 260A(1) of the Corporations Act 2001.

Section 260A(1) of the Corporations Act prevents a company from financially assisting a buyer to acquire shares in the company unless the financial assistance does not prejudice the interests of the company, its shareholders, or the company’s ability to pay its creditors.

The High Court said that, to decide if there was material prejudice to the interests of the company or its shareholders or creditors, the court will compare the position before the giving of financial assistance with the position after the giving of financial assistance to see whether there is any prejudice to the company, or its shareholders, or its ability to pay its creditors, as a result of the financial assistance.

The Court gave the following examples of what would amount to financial assistance:

  • Payment of stamp duty or valuation costs by the company easing the buyer’s burden to acquire the shares.
  • Payment of due diligence costs by the company smoothing the buyer’s path to acquire the shares.

The Court said the burden to prove that Connective Services did not contravene section 260A(1) of the Corporations Act rested on Connective Services.

The High Court found that by paying for the Pre-emptive Proceedings, Connective Services provided financial assistance for the acquisition of its own shares. The Court explained that if the existing shareholders commenced proceedings in their names and Connective Services paid their legal costs it would definitely have amounted to financial assistance. In the same way, by commencing proceedings in its own name and paying the legal costs, Connective Services eased the financial burden on the existing shareholders, to acquire Slea’s shares.

The next question the High Court had to decide was whether the financial assistance materially prejudiced the interests of Connective Services, or its shareholders, or its ability to pay its creditors.

The evidence was that the Pre-emptive Proceedings would cost between $525,000 and $755,000, not taking into account potential adverse cost orders. Slea’s equity as a shareholder might be reduced by the payment of these costs, which is a step towards compelling Slea to offer its shares to the other shareholders. The existing shareholders did not provide any evidence of why they did not commence the proceedings in their own names. The Court decided that Connective Services failed to prove that the financial assistance did not materially prejudice Connective Services, or its shareholders, or its ability to pay its creditors.

The Court said that the Pre-emptive Proceedings would not have amounted to financial assistance if:

  1. The existing shareholders, and not Connective Services, commenced and paid for the proceedings.
  2. Connective Services provided evidence that the proceedings did not materially prejudice its interest or the interests of its shareholders or its ability to pay creditors.
  3. Connective Services’ shareholders passed a resolution to commence the proceedings, pursuant to section 260B of the Corporations Act.
  4. The proceedings fell within the exemptions to the financial assistance provisions, listed in section 260C of the Corporations Act.

A company or shareholders faced with a situation where they may wish to enforce pre-emptive rights provisions in the company’s constitution need to carefully consider how to go about enforcing those provisions.

If you require any further information, please don't hesitate to contact us.