Identifying prohibited financial assistance in Australia

In Australia, a company can only ‘financially assist’ the acquisition of its own shares (or those of a holding company) in limited circumstances. There can be severe consequences for anyone involved in a contravention. However, the difficulty is often with identifying whether ‘financial assistance’ actually exists in a transaction and so this note focusses on circumstances when financial assistance might arise.

What is financial assistance?

The term ‘financial assistance’ is not expressly defined in the Corporations Act 2001 (Cth), it has no technical meaning and its essential features are not described. In essence, section 260A(1) of the Corporations Act 2001 (Cth) provides that a company may financially assist a person to acquire shares in the company itself (or its holding company) only 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 (the ‘no material prejudice’ exception).  It is possible to give financial assistance if this is approved by shareholders following a special ‘whitewash’ procedure. Certain other exemptions apply.

Examples of financial assistance

It is important to consider the possibility of financial assistance being present wherever there is a share acquisition. The assistance may be direct or indirect and it may be given before or after the acquisition of shares. The assistance merely needs to be for the purpose of, or in connection with, the share acquisition.

Financial assistance typically arises in the context of a target company financially assisting a purchaser to acquire its shares. The purchaser of the shares borrows monies from a financier to fund the purchase price and the target company grants a guarantee and security in favour of the financier as security for that loan. In this scenario, the financial assistance takes the form of the granting of the guarantee and security as these instruments ultimately benefit the purchaser by supporting its loan.

The cases illustrate that financial assistance may also take a variety of other forms, including:

• the issuing of a debenture;
• the payment of a dividend;
• the giving of a gift;
• the subscription for, and issue of shares in, the target company;
• the target company lending money to the purchaser of its shares;
• the target company giving a guarantee and security to the seller of its shares in support of deferred consideration owed by the purchaser;
• the target company giving security to the seller of its shares in support of its existing unsecured debts;
• the target company’s existing secured debt being refinanced, even where the debt is not applied towards the share acquisition;
• the target company paying transaction fees relating to the share acquisition;
• the target company providing indemnities in connection with the share acquisition;
• the target company giving some other side benefit to the seller of its shares;
• the target company purchasing assets from the intending purchaser of its shares with the purpose of putting the intending purchaser in funds for the share acquisition; and
• the release of a debt owed to the target company by its shareholder to enable the shareholder to sell the shares at a lower price.

Most recently, the High Court of Australia considered the issues in Connective Services Pty Ltd & Anor v Slea Pty Ltd & Ors [2019] HCA 33. In simplified terms, three shareholders (A, B and C) held shares in the relevant companies. A, B and C held identical pre-emption rights. The shareholder of A sought to sell its shares in A to a third party. The companies (rather than shareholders B and C) instituted court proceedings against A, B and C and the purchaser of A, claiming that the proposed sale of A by its shareholder breached the pre-emption rights. In a unanimous judgment, the High Court held that the commencement of court proceedings by the companies, at their expense, was itself financial assistance in favour of B and C within the meaning of section 260A(2). The companies had essentially sought to ease the financial burden in the process of the acquisition of the shares by B and C in the exercise of their pre-emption rights. The court provided a broad meaning to financial assistance and held that financial assistance need not involve any diminution of the company’s assets, stating:

“The financial assistance need not involve a money payment by the company to the person acquiring the shares. 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. For instance, the assistance might involve the company paying a dividend by means other than by payment of cash, issuing a debenture, granting security, or agreeing to pay consultancy fees.”

Consequences of prohibited financial assistance

Most financiers will not agree to a borrower’s request to rely on the ‘no material prejudice’ exception, owing  to the difficulty of establishing definitively that there will in fact be no material prejudice to the borrower and its shareholders and creditors. The borrower will instead be required to undertake the whitewash procedure as a condition of the facility.

A breach of section 260A does not affect the validity of the transaction and the company is not guilty of an offence. However, a person involved in a company’s contravention of section 260A will have contravened section 260D(2), which is a civil penalty provision. Further, if the involvement was dishonest, the person will have committed an offence. It is unsurprising, therefore, that financiers will be concerned not to be involved in any contravention by the borrower of the financial assistance rules as a consequence of any aspect of the transaction being financed.