Australia: Beware the Scope of ASX Listing Rule 7.1A

Last Updated: 6 December 2015
Article by Sarah Johnson

ASX Listing Rule 7.1A

ASX Listing Rule 7.1A was introduced in 2012 and enables eligible entities to issue up to a further 10% of their issued share capital, over and above the 15% placement capacity specified in ASX Listing Rule 7.1.

It applies to entities which are not included in the S&P/ASX300 index and which have a market capitalisation equal to or less than $300 million.

Shareholder approval of additional capacity under ASX Listing Rule 7.1A may only be obtained at the entity's Annual General Meeting and must be passed by a 75% majority.

ASX Listing Rule 7.1A.3 further provides that any equity securities issued under ASX Listing Rule 7.1A must be in an existing quoted class of the entity's equity securities.

However and as a recent decision and publication by the ASX indicate, not only may this additional capacity not be used for the issue of options, but also it may not be used for the issue of equity securities upon conversion of a convertible note.

Nature of Convertible Notes

Convertible notes have traditionally been considered as debt instruments, being a written promise to repay a debt with interest, at a specified time, with the option to convert the debt to equity in a company.

For example, section 82L of the Income Tax Assessment Act 1936 (Cth) defines a convertible note as:

"a note issued by a company that provides, whether in pursuance of or by virtue of a trust deed or otherwise:
  1. that the amount of the loan to the company that is evidenced, acknowledged or created by the note or to which the note relates:
    1. whether with or without interest;
    2. whether at the option of the holder or owner of the note or of some other person or not;
    3. whether in whole or in part; or
    4. whether exclusively or otherwise;
    5. is to be or may be converted into shares in the capital of the company or of another company or is to be or may be redeemed, repaid or satisfied by:

    1. the allotment or transfer of shares in the capital of the company or of some other company, whether to the holder or owner of the note or to some other person;
    2. the acquisition of such shares, whether by the holder or owner or by some other person, otherwise than as mentioned in subparagraph (vi); or
    3. application in or towards paying-up, in whole or in part, the balance unpaid on shares issued or to be issued by the company or by some other company, whether to the holder or owner or to some other person; or
  1. that the holder or owner of the note is to have, or may have, any right or option to have allotted or transferred to him or her or to some other person, or for him or her or some other person otherwise to acquire, shares in the capital of the company or of some other company."

The ASX's Guide, "Module 6 Hybrids (2): Convertible Notes" ( at page 16, states:

"A convertible note represents a loan by the investor to the issuing company. In return, the company pays you interest... If at maturity the note has not been converted, the issuer pays you the note's face value in cash."

ASX View

In a recent decision involving one of our clients, the ASX advised that it considered that convertible notes are equity securities for the purposes of ASX Listing Rule 7.1A and accordingly, as the convertible notes were not a quoted class, the securities to be issued on conversion of the note were unable to be issued under Rule 7.1A.

As a result of this decision, our client was required to call an urgent Special General Meeting to approve the previously issued convertible notes for the purposes of ASX Listing Rule 7.4 and to approve future issues of convertible notes and securities to be issued on conversion for the purposes of ASX Listing Rule 7.1.

This position was taken, and the decision subsequently upheld by the ASX Listings Committee, notwithstanding that the client had made several statements in its explanatory memorandum to its notice of annual general meeting at which the ASX Listing Rule 7.1A resolution was put to the effect that if the resolution was approved, the company intended to use the additional capacity, amongst other things, for the conversion of debt to equity.

Purpose of ASX Listing Rule 7.1A

The ASX's interpretation of ASX Listing Rule 7.1A.3 appears a narrow and technical interpretation of this rule which does not give full effect to the expressed intention and purpose of ASX Listing Rule 7.1A.

ASX Listing Rule 19.2 provides that an entity must comply with the ASX Listing Rules as interpreted "in accordance with their spirit, intention and purpose; by looking beyond form to substance; and in a way that best promotes the principles on which the listing rules are based".

In the Consultation Paper published by the ASX in 2013 in connection with the proposed introduction of ASX Listing Rule 7.1A, "Strengthening Australia's Equity Capital Markets – ASX Proposals and Consultation" the ASX states that the principal purpose of this rule is to "facilitate capital raising for mid to small caps" (see page 3).

Implicit in this purpose is the desire to assist mid to small caps to avoid the expense and market risk associated with calling additional meetings of shareholders to approve the issue of securities by permitting shareholders to prospectively approve to issue of up to an additional 10% of the company's securities.

ASX's market analyses in the 2013 Consultation Paper, indicate that the practical likelihood of relevant entities receiving the required approval of their ordinary security holders is extremely high (the Consultation Paper notes at page 12 that of these 244 meetings (including AGMs) held in 2011 by mid to small caps seeking capital raising approval, only one resolution was rejected).

It would therefore appear to be contrary to the express purpose of ASX Listing Rule 7.1A to require a company to incur the costs of procuring a further shareholder approval in respect of equity securities to be issued on the conversion of convertible notes, particularly where the conversion of debt to equity was specifically noted as a purpose to which the additional capacity may be put in the Explanatory Memorandum to the Notice of the AGM at which the ASX Listing Rule 7.1A approval was sought and received from shareholders and the fact that it is likely that such approval will be received in any event.

We note also that in its guidance on the operation of ASX Listing Rule 7.1A and specifically, the ASX Listing Rule 7.1A User Guide, there is no reference to entities which have such approval not being able to use its additional capacity under ASX Listing Rule 7.1A for the conversion of debt instruments into equity.

ASX Review

On 12 October 2015, ASX released its review of the operation of ASX Listing Rule 7.1A. The review includes discussion of changes that ASX is proposing to make to ASX Listing Rule 7.1A and related rules, as well as changes that have been proposed to ASX by external stakeholders.

In that review, ASX states:

"In a small number of cases, a company has issued non-quoted securities and has purported to use its rule 7.1A capacity to do so. In these cases, ASX has required the entity to reallocate the issue to its rule 7.1 capacity. If the entity's rule 7.1 capacity would be exceeded as a consequence of the issue, then the issue will be in breach of the rule and will result in a reduction of the entity's future rule 7.1 capacity. The reduction in the entity's future rule 7.1 capacity must be disclosed to the market."

The review paper goes on to state "ASX plans to produce a new Guidance Note covering listing rules 7.1 and 7.1A to assist market participants as understand and comply with the rules."

We hope ASX will take this opportunity to further explain and clarify the scope of ASX Listing Rule 7.1 and its reasons for taking the view that this additional capacity may not be used for the issue of equity securities on conversion of a convertible note.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Kemp Strang has received acknowledgements for the quality of our work in the most recent editions of Chambers & Partners, Best Lawyers and IFLR1000.

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Sarah Johnson
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