What is the restriction on such financial assistance?
Part 2J.3 of the Corporations Act 2001 prohibits a company from providing financial assistance to a person to acquire shares in the company or in its holding company unless either:
- The giving of the financial 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.
Breach of the provision does not invalidate the giving of the financial assistance nor is the company guilty of an offence. However, a person who is involved in a company's contravention of the restriction contravenes the Act and, if their involvement is dishonest, the person commits an offence under the Act. The breach of the restriction is a civil penalty provision which may result in orders to compensate a corporation for damage suffered by the corporation as a result of a contravention. In addition, if the contravention materially prejudices the interests of the corporation or its members, or materially prejudices the corporation's ability to pay its creditors or is serious, the Court may order a pecuniary penalty of up to $200,000 be paid.
How does it impact on a borrower? What does a borrower have to do?
Invariably, where financiers are involved in the provision of funds as part of a transaction involving the acquisition of shares in a company or its holding company, the financier will require that shareholder approval be obtained (commonly known as the whitewash procedure). This requires the preparation of an explanatory memorandum and appropriate shareholder resolutions and lodgement of the same with ASIC. This documentation must be provided before the notice of the meeting and explanatory memorandum is sent to the members. The financial assistance cannot be given for at least 14 days after lodgement of a further notice with ASIC indicating that the giving of the assistance has been approved.
Where the company involved or its holding company is a listed public entity or an entity which has a broad shareholder base, the whitewash procedures are costly and impractical.
In addition, despite the lodgement of documentation at ASIC, there is no public notification of the proposed financial assistance. As a result, unless a shareholder or creditor of the company continually updates its searches of the company to become aware of the documentation lodged with ASIC, no opportunity is given to shareholders and creditors to become aware of the proposed financial assistance and raise any issue, either with the company or ASIC, in respect of the same.
What happens in practice?
It is often the case that the funding to be provided by the lenders has nothing to do with the acquisition of the shares in relation to the matter. Despite this, and the inclusion of appropriate representations in financing documents in respect of the same, financiers often insist that the whitewash procedures be undertaken.
Indeed, we are aware of matters where despite the company advising that there was no connection between the financing facility and the acquisition of the shares (which was in respect of an offshore parent company a number of levels removed from the Australian group), the financier insisted on the whitewash procedure but then rejected the explanatory memorandum references to the possibility of the financing assisting the acquisition of the shares. Despite this rejection, the financier required that the whitewash procedures be undertaken even though it would appear that it acknowledged that there was no such connection.
Do the whitewash procedures have to be undertaken in all cases?
Directors clearly have the ability to determine whether or not the financial assistance is prohibited. They have the ability to determine that in their opinion, the financial assistance will not materially prejudice the interests of the company or its shareholders, or the company’s ability to pay its creditors. If the directors are validly able to make such determinations, the financiers to the company should not be entitled to override such determinations and insist on the whitewash procedures (unless they are aware of circumstances which contradict the directors’ views).
However, it is generally standard practice by financiers to require the whitewash procedures to be undertaken.
Due to the impracticality of the current provisions, the added cost and time associated with complying with the whitewash procedures (in circumstances where in reality such procedures are not required) and the lack of transparency in relation to the giving of the assistance and the ability of shareholders and creditors to object to the same, thought should be given to amending the Corporations Act 2001 such that any contraventions which may occur do not apply to arms-length financiers who are not aware of the financial assistance materially prejudicing either the interests of the company or its shareholders or the company’s ability to pay its creditors.
It should only be in the circumstances where financiers are aware of these matters (and therefore should be able to disregard directors’ views on them) that they should be potentially liable under the civil penalty provisions. By including such defence/exclusion for a financier, the unnecessary costs and time associated with the whitewash procedures can be removed from a large number of financing transactions thereby reducing the costs of financing.
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