Transcript CHAPTER 18 TRANSACTIONS AFFECTING SHARE CAPITAL At the end of this topic you should understand the doctrine of capital maintenance and its modern.

CHAPTER 18
TRANSACTIONS AFFECTING SHARE CAPITAL
At the end of this topic you should understand the doctrine of
capital maintenance and its modern application to:
• reduction of a company’s share capital; and
• dealings in the company’s own shares.
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Doctrine of Capital Maintenance
There are legal procedures when undertaking certain
transactions affecting share capital, including:
• reductions of capital;
• companies acquiring or controlling their own shares;
and
• companies giving financial assistance for the purchase
of their own shares.
These transactions are regulated by Ch 2J of the
Corporations Act.
Chapter 2J gives statutory effect to the “doctrine of capital
maintenance”, originally established by the general law.
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Doctrine of Capital Maintenance
That doctrine requires companies limited by shares to
maintain their issued share capital in order to protect
the interests of the company’s creditors and
shareholders.
Creditors and shareholders are “entitled to assume
that no part of the capital which has been paid into
the coffers of the company has been subsequently
paid out, except in the legitimate course of its
business”: Trevor v Whitworth (1887).
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Corporations Act Reforms
The strict application of the doctrine has been
gradually modified by the Corporations Act.
Chapter 2J permits a company to engage in the
following transactions under regulated conditions:
• reductions of share capital (Pt 2J.1);
• share buy-backs (Pt 2J.1); and
• giving financial assistance for the purchase of its
own shares: Pt 2J.3).
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Corporations Act Reforms
The rules which continue to give full effect to the capital
maintenance doctrine include:
• the requirement that dividends must be paid out of
profits, not capital;
• the requirement that redeemable preference shares be
redeemed out of profits or the proceeds of a new issue
of shares made for the purposes of redemption; and
• the general prohibition against a company dealing in its
own shares (Pt 2J.2).
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Protection of Creditors and Shareholders
Chapter 2J sets out the requirements with which a
company must comply when undertaking either a
capital reduction, share buy-back or financial
assistance transaction. The requirements address the
following concerns:
• the risk of the transaction leading to the company’s
insolvency;
• the fairness and reasonableness of the transaction
as between the company’s shareholders; and
• the disclosure to shareholders of all information
material to the transaction.
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Reductions of Share Capital
A reduction of capital includes many types of
transactions: see [18.50].
A company may have a legitimate business purpose for
undertaking share capital reductions: see [18.60].
A company proposing to undertake a reduction of capital
(other than those exempted under ss 258A-258F) must
comply with two sets of procedures:
• the requirements in ss 256A-256E; and
• any internal rule which restricts or prohibits the
exercise of the company’s power to reduce its share
capital.
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Reductions of Share Capital
Section 256B(1)(a) addresses the fairness of
transaction as between the company’s shareholders.
Section 256B(1)(b) addresses the risk of the
transaction leading to the company’s insolvency.
Section 256B(1)(c) requires shareholders to be given
the opportunity to vote in favour of or against the
reduction after being provided with all the relevant
information by the company: s 256C(4).
The type of shareholder approval required depends
on whether the reduction is an equal reduction or a
selective reduction.
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Reductions of Share Capital
An equal reduction is a capital reduction which:
• relates only to ordinary shares;
• applies to each holder of ordinary shares in
proportion to the number of ordinary shares they
hold; and
• is on terms that are the same for each holder of
ordinary shares: s 256B(2).
The reduction must be approved by a resolution
passed at a general meeting of the company:
s 256C(1).
.
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Reductions of Share Capital
A selective reduction is a capital reduction which is
not an equal reduction: s 256B(2).
A selective reduction must be approved by either:
• a special resolution (that is, a 75% majority of
those entitled to vote) passed at a general meeting
of the company: s 256C(2)(a); or
• a resolution passed by all ordinary shareholders
(not just all those present at the meeting or voting
by proxy) at a general meeting: s 256C(2)(b)
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Reductions of Share Capital
Section 256E contains a very important table listing
other provisions which are applicable to capital
reductions, such as the provisions relating to
insolvency, related party transactions, and continuous
disclosure.
Sections 258A-258F authorise some other capital
reductions which may take place without the need to
comply with s 256B: see [18.200].
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Requirements for a Capital Reduction:
ss 256A-256E
Requirements in
s 256B Corporations
Act
Restrictions in
internal management
rules (if any)
1. Fair and
reasonable
to shareholders
as a whole
2. No material
prejudice to
co’s ability to
pay creditors
3. Approval
by
shareholders
Selective
reduction
Equal reduction

Ordinary resolution s 256C(1)
Special
resolution
Unanimous
ordinary
resolution
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Companies Acquiring Their Own Shares
Companies are prohibited from directly acquiring their own
shares except in the special circumstances set out in s 259A.
The Corporations Act also prevents a company from
indirectly acquiring its own shares either by:
• taking security over shares in itself except as permitted:
s 259A;
• issuing or transferring shares in itself except as permitted:
s 259B;
• issuing or transferring shares in itself to an entity it
controls: s 259C; or
• obtaining or increasing control over an entity which holds
shares in the company: s 259D.
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Companies Acquiring Their Own Shares
The object of ss 259A-259D is to prevent a company from
purchasing its own shares for non-legitimate purposes: see
[18.220].
Section 259A allows a company to purchase its own
shares:
• s 259A(a) allows share buy-backs;
• s 259A(b) allows the acquisition of an interest in fully
paid shares in certain circumstances;
• s 259A(c) concerns situations where a company is
required to purchase shares by a court order; and
• s 259A(d) concerns situations where a company takes
security over its shares under an employee share
scheme.
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Share Buy-backs
A share buy-back is any transaction by which a company
buys back its own shares from existing shareholders.
The transaction involves an agreement between the
company and the selling shareholders to transfer shares to
the company in return for consideration provided by the
company.
They are one of the main exceptions to the prohibition
against companies buying their own shares.
The major practical difference with the requirements of a
share buy-back is that a share buy-back can only take
place with the consent of the shareholders whose shares
are being bought back.
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Share Buy-backs
The minimum requirements for a buy-back are very
similar to those for a reduction of capital: s 257A.
As with capital reductions, the purpose of these
requirements is to protect the interests of creditors
and the shareholders.
A company may wish to buy back its own shares for
the same business reasons that it undertakes a share
capital and reduction, as well as for additional
reasons: see [18.310].
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Share Buy-backs
The Corporations Act permits five types of share buyback:
• equal access buy backs: see [18.330];
• on-market buy-backs: see [18.340];
• employee share scheme buy-backs: see [18.350];
• minimum holding buy-backs: see [18.360]; and
• selective buy-backs: see [18.370].
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Share Buy-backs
Section 257B(1) is in the form of a table which sets
out the requirements for each type of buy-back.
The normal maximum size of limit for buy-backs is
10% of the shares within 12 months. This is referred
to as the “10/12 limit”: s 257B(4). The 10/12 limit may
be exceeded under certain conditions.
Section 257J contains an important table which lists
other provisions in the Corporations Act applicable to
buy-backs.
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Comparison of Capital Reduction and Share
Buy-backs
Issue
Capital reduction
Share buy-back
Role of shareholders
on losing
membership of
company
Effect on all
shareholders
No need for direct
shareholder consent
Shareholders bought
out must consent to
buy-back
Must be fair and
reasonable to
shareholders as a
whole
Must not prejudice
company’s ability to pay
its creditors
No equivalent
requirement
Effect on creditors
Must not prejudice
company’s ability to pay
its creditors
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Requirements for a Share Buy-back:
ss 257A-257J
Is s u e
C a p ita l re d u c tio n
S h a re b u y -b a c k
S h a re h o ld e r
a p p ro va l
 E q u a l re d u ctio n :
o rd in a ry re so lu tio n
 S e le ctiv e re d u ctio n :
sp e cia l o r u n a n im o u s
re so lu tio n
N o tice o f m e e tin g a n d
sta te m e n t o f m a te ria l
in fo rm a tio n
S h a re s ca n ce lle d
fo llo w in g re d u ctio n
 E q u a l a cce ss: n o t re q ’d
u n le ss > 1 0 /1 2 ru le
 S e le ctiv e : re q u ire s sp e cia l
o r u n a n im o u s o rd in a ry
re so lu tio n
N o tice o f m e e tin g a n d
sta te m e n t o f m a te ria l
in fo rm a tio n
S h a re s b o u g h t b a ck
ca n ce lle d
In fo rm a tio n
re q u ire m e n ts
E ffe c t o n s h a re
c a p ita l
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Financial Assistance for Purchase of a
Company’s Own Shares
To protect creditors, shareholders and the company,
s 260A permits a company to give financial
assistance to a person to acquire its shares, but only
under regulated conditions: s 260A(1), (2).
In the absence of a statutory definition, case law
provides many examples of financial assistance: see
[18.450].
Financial assistance is also permissible if: the
assistance is approved by the shareholders pursuant
to s 260B; or a company in the ordinary course of
commercial dealing provides financial assistance:
s 260C.
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Failing to Comply With Chapter 2J
Officers involved in the contravention are subject to the
civil penalty provisions. They can be liable for a pecuniary
penalty of up to $200,000 in respect of each breach or an
order banning them from managing a company, as well as
liability for breaches of general directors’ duties: s 260E.
They can also be liable to pay compensation to the
company.
Shareholders and creditors can apply to the court for an
injunction to restrain a company from undertaking a share
capital reduction in contravention of the procedural
requirements in Ch 2J.
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