Topic Five Financing Corporations_5b6e9f04a38566cba2c82f5b978bce26.pptx

CRICOS Provider No. 00103D
BULAW5915 Corporate Law
Topic Five: Financing
Corporations

Introduction: - Sources of Finance
• Share capital – such as ordinary or preference shares.
• Debt finance – such as term loans, overdraft facilities, debentures,
promissory notes, bills of exchange, letters of credit.
• Trade finance – such as goods and services obtained on credit from
suppliers.
• Retained earnings – earnings from previous periods that have not
been distributed to the company’s members.
• Trade finance, overdraft facilities and retained earnings are
important sources of working capital used to keep the
company operating.

Financing Corporations
• Our focus in this topic is on the first two of these sources of finance
• Shares (members)
• Debt (creditors)

Shares – nature and implications
• A share is personal property; it is transferable; it is a ‘chose in action’
– giving certain rights which can be enforced at law by the holder.
Rights include a share in profits and to share in any surplus on the
winding up of the company.
• Recall -while a shareholder may be said to have ownership (property
rights) in the company (although even that is uncertain), it is the
company that owns company property – not the shareholders.

Compared with debt
• A legal relationship of debtor and creditor is created.
• This is governed primarily by contract law and, if borrowing is
secured, property law.
• A lender will have no membership rights, so no claim to profits or a
share in any surplus if the company is wound up.

Equity
• Dividends may or may not be payable
• No expectation of a return of capital while company is a going concern
• Equity holders have members’ rights
• Entitled to distribution surplus capital only after all creditors paid
• Residual claimants to assets
• Dividends are not deductible on the part of the company

Debt
• Company’s obligation to pay interest does not depend on profit
• Creditors expect repayment of principal at the end of the term
• Creditors are not members
• Has priority for repayment of principal and/or outstanding interest
• No right to share in surplus assets on winding up
• Interest payments may be tax deductible on the part of the company

Shares – advantages and disadvantages for the
company
Advantages
• The structure of shareholdings can
be helpful
• Normally dividend only if and when
declared
• In ‘widely-held’ companies, less
power for each shareholder
• In narrowly-held companies, power
of the few (probably the Board)
• Can raise capital through those
committed to the company’s future
• Can be a relatively cheap way of
raising funds
Disadvantages
• Value of the company can fluctuate
dramatically - this has an effect on
perceptions of the company
• The law requires that shareholders
be given information
• Shareholders are given some
statutory protection
• Shareholders can in some cases
use their voting power to control
the direction of the company

Shares – advantages and disadvantages for the
investor
Advantages
• Ownership enables
participation
• Shareholders’ meetings can
be fun
• Can get good returns
• Form of hands-on investment
• Risk takers
• Insight into business
• Can select on the basis of
ethics or values
Disadvantages
 Share value can vary or
disappear entirely
 Returns only if enough profit
 Risk averse investors may shy
away
 May be problems in management
that S/h cannot control
 In widely-held cos, little input or
control
 In narrowly-held cos, may be too
many expectations and/or conflict

Debt (debenture) – advantages and disadvantages
for the company
Advantages
 Can release as debenture
stock onto the market
 Debenture holders are
creditors not s/hs
 Often regarded as a secure
form of investment, therefore
popular with the risk averse
investor
 Interest is paid out of gross
rather than net income (tax-
deductible as an expense)
Disadvantages
 May be subject to scrutiny by
market and/or lender
 Interest payable even where
loss
 Large lender can cause
problems
 Credit rating may be damaged
where something goes wrong

Debt (debentures) – advantages and disadvantages
for the investor
Advantages
 Better chance of a return (paid
out earlier)
 Close to a guaranteed return
 May be secured against
company assets
 Can be bought and sold
without restriction (more about
that later)
Disadvantages
• Does not allow for participation
• Security may turn out to be
worthless or of little value
• May still not be paid
• May turn out to be ‘junk bonds’

Share Capital = Equity
• The share capital is the amount contributed by shareholders through
subscription.
• S124 CA gives power to issue shares.
• The legal nature of a share is set out in s1070A of the Act.
• A share is a claim to which the rights set out in the Act and the
company’s constitution (if applicable) attach.
• It is “personal property” that can be sold, mortgaged or gifted.
• Under s254B, a company can issue shares with different rights (“class
of share”).
• For listed companies, the ASX listing rules require ‘one vote, one
share’ so this is a restriction on the issue of shares with different
voting rights (although caution – some shares can still have restricted
voting rights (eg Preference Shares)) – rule 6.

Ordinary and preference shares
• Ordinary shares usually have rights to:
• Share equally in any dividends
• Vote at a general meeting of the company
• Be repaid a pro-rata share of capital after all other claimants
have been paid in a winding up
• Share in any surplus assets on a winding up
• Preference shares are a hybrid security which usually have rights to:
• Receive a fixed dividend
• Be repaid the principal in priority to ordinary shareholders
• But not to:
• Share in surplus assets of winding up
• Vote (except in limited circumstances)

Types of preference shares
• Cumulative preference shares – entitlement to a distribution carries
forward if no dividend is declared in a particular year.
• Redeemable preference shares – allow for repayment of the principal
at a particular time or on the occurrence of a particular event prior to
winding up of the company. More like debt than equity.
• Convertible preference shares – usually carry a right to a preferred,
fixed dividend for a particular term and then allow for, or require
conversion to, ordinary shares.

Partly paid shares
• Dealt with in Pt 2H.3 of the Act.
• The person pays only part of the price to the company at the time the
shares is issued (so on subscription), with the balance to be paid at a
later date.
• The company is entitled to make a ‘call’ at a later time for some or all
of the balance owing on the share. The obligation to pay a call is
supported by s 254M(1) of the Act.
• The constitution can provide for forfeiture due to an unpaid call or the
company can sue for payment.

Remember who has power to issue shares?
• It is a power of the company exercisable by the Board of Directors.
• Member approval may be required:
• If creating a new class of shares requires amending the
constitution.
• If there is a variation of class rights.
• If the related party transactions provisions apply.
• If member approval is required under the constitution or a
shareholders’ agreement.
• If the ASX Listing Rules require it (for listed companies
only).

An important aspect of shareholding
• Share capital – what does it reflect?
• Shareholders’ funds
• The value of the company and its operations
• A pool of money and assets available to pay creditors
(otherwise the company is spending other peoples’ money)
• All these lead to an assumption that normally a company should not
reduce its capital base = the capital maintenance rule

Maintenance of capital
• General principle of company law that a company must maintain its
paid up share capital: rule in Trevor v Whitworth
• Why? Because when a creditor deals with a company it (usually)
assumes that a company has paid up share capital used for
business purposes and that the credit will be used for its stated
purpose(s).

Maintenance of capital and exceptions
• Various scenarios and where/how permitted:
• Dividends (S254T)
• Acquiring own shares (Part 2J.2)
• Permitted buy-backs - (S259D - an exception to 2J.2)
• Financial assistance (Part 2J.3)
• Permitted if:
• no material prejudice to co, s/h or creditors (S260A) (cf
ASIC v Adler)
• Approved by S/H (S260B)
• Exempted under S260C
• Permitted reductions of capital – Part 2J.1

Dividends
• In paying dividends:
• Prior to 2010 – dividends may only be paid out of profits.
• After 2010 – s 254T provides that a company may not pay a
dividend unless:
• The company’s assets exceed its liabilities immediately
before the dividend is declared and the excess is sufficient
for the payment of the dividend (=solvency test);
• The payment of the dividend is fair and reasonable to the
company’s shareholders as a whole; and
• The payment of the dividend does not materially prejudice
the company’s ability to pay its creditors.
• Note: there has been some criticism that s254T has been poorly
drafted and its effect unclear.

Company acquiring its own shares
• Except in certain limited circumstances, the Act prohibits:
• a company acquiring its own shares: s 259A
• A company taking security over shares in itself or in a controlled
entity: s 259B
• the issue or transfer of shares to a controlled entity: s 259C
• The concept of ‘control’ is defined in s 50AA.
• The rationale: to avoid:
• Entrenched board/senior management control;
• Manipulation of share price by management;
• Creating false impression of assets held – if assets are
predominantly assets ‘in itself’

But permitted buy-backs
• Buy-backs are an example of the company reducing its capital –
• Involve the company offering to buy some or all of shareholders’
shares at a stated price.
• A company may have a legitimate need to return capital to its
member(s) or to restructure its balance sheet in a way that involves
capital being returned.
• Buy-backs are allowed in certain circumstances –s257A- J

Providing financial assistance
• Part 2J.3 only permits a company to ‘financially assist’ the acquisition
of shares in the company or its holding company if: (see sections
260A to D)
• it does not materially prejudice the interests of the company or its
members or its ability to pay its creditors, or
• it is approved by the company’s members (s 260B), or
• it is exempt under CA
• Examples of financial assistance:
• giving a loan
• giving a guarantee
• Material prejudice - question of fact to be determined in light of the
circumstances. Recall ASIC v Adler..

Permitted reductions of capital
• Reductions of capital may be made to:
• return excess capital, or
• cancel uncalled capital no longer required, or
• cancel capital no longer represented by assets
• Differ from a buy-back in that, once approved, members are bound to
participate even if they do not wish to.
• Company may reduce capital provided it:
• is fair and reasonable to the shareholders as a whole, AND
• does not materially prejudice the company’s ability to pay its creditors,
AND
• is approved by shareholders under s256C (by Ord Res)
• Dissenting shareholders have a right to ask for court review

Debt finance
• In particular loans and debentures
• Debt finance
• may be in the form of loan finance (often presented as a
debenture), or
• may be raised from many investors through an issue of
debenture stock and
• may be secured or unsecured (attached or not attached to
assets owned by the company)

‘Security’ - securities
The term is often used in two contexts.
One
to describe documents issued by companies in return for money invested
with the company. For example shares, debentures, notes and other
negotiable instruments may be described as ‘securities’.
Two
broadly, to describe an interest one person, the creditor, has in specified
property owned by another person, the debtor – with the creditor having
certain rights over the property which may be exercised in the event the
debtor fails to repay the debt.

Debt finance – secured or unsecured
So - a secured debt is one the repayment of which is secured by rights
over the company’s property
And an unsecured debt is one the repayment of which is not secured by
any rights over the company’s property – the creditor (financier) relies
upon the contractual terms of the financing agreement being met (and
often, particularly with a small company, on personal guarantees given
by the directors)

Debt finance
• Company borrows money or obtains some other form of financial
accommodation that will have to be repaid at a future time. The fee for
use (interest) is usually tax deductible.
• The power to raise funds through debt and specifically the issue of
debentures and the granting of a “circulating security interest” comes
from s124 of the Corporations Act.

What is a debenture?
See s9. A debenture of a company is a ‘chose in action’ that includes an
undertaking by the company to repay as a debt the money deposited
with or lent to the company.
Debentures may be considered “securities” (refer above to first meaning
of ‘security’) and in some cases are quoted and traded on ASX.
Debentures may be secured and therefore create a claim against the
company able to be exercised by the creditor (refer above to second
meaning of security) or not secured (see previous slide for difference).

Debenture
Chapter 2L of the Corporations Act requires, in certain circumstances, a
trustee for debenture holders. This chapter also contains particular
provisions designed to protect the rights of those who lend funds to a
company through public fundraising.
This is discussed later in this topic.

PPSA
In 2012 the Personal Property Securities Act 2009 (Cth) came into effect
and changed the way security interests in property were taken, and
registered. Aspects:
• Personal property (does not include, inter alia, land)
• Security interest
• Circulating security interest and non-circulating security interest
(previously floating and fixed charges)
• Grantor and secured party
• Security Agreement/ General Security Agreement
• Applies specific terms to denote process and status - Collateral,
attachment, perfection
• Registration and priorities of security interests

The PPSA does not apply to security interests in
land but has an impact.
Prior to 2012 financiers and other creditors relied upon taking security
interests in company assets by way of fixed and floating charges; and (for
the holder of a security interest in all or substantially all of the company’s
assets) holding a registered mortgage debenture granted by the borrower
(company).
If the company’s land (real property) and personal property secure the same
obligation to the secured party (previously known as the creditor) the
secured party may decide whether it wants to enforce its security interest in
personal property in the same way as it treats its interests in the land. If the
secured party decides to enforce its security under land law, the law of the
State in which the land is located will apply.
Even so - the distribution of proceeds of sale from the realisation of the
personal property must be in accordance with the PPSA.

How does the creditor get their money back if the
company fails to pay?
• The standard process is receivership
• We will discuss this more in relation to insolvency – covered in topic 6.
• Just be aware at this point that the receiver of a company acts on
behalf of a secured creditor or group of creditors where a company
has breached the terms of the loan agreement

Events of default include
A company:
• failing to pay interest
• trying to alter priorities/claims without consent
• selling the assets that provide security without actual or implied
consent
• going into liquidation
• having another secured creditor of the company calling in the
receivers
• becoming insolvent

Summary up to now
Our focus has been on the options and implications of the two main
sources of capital: shares and debt (commonly through debenture)
The final part of the topic focuses on the process of fundraising from the
public and the legal rules and restrictions imposed on such activity.

Fundraising can take various forms
• If it comes from a bank, financial institution, existing shareholders or
sophisticated investors, it may be assumed (normally) that those
creditors and investors know what questions to ask and what
information they need to make decisions.
• They may in some cases dictate what information must be provided
by the applicant

Introduction
• Where funds are sought from members of the public:
• See Ch 7 and Ch 6D, CA.
• Ch 6D requires that specific and detailed information needs to
be provided before members of the public are invited to lend
money or take up shares
• ASIC has a scrutinising, investigating, enforcement and
regulatory role

Primary Issues of shares (and debentures)
• Usually require Board approval
• There are differences between the powers to raise capital for
proprietary companies, public companies and publicly listed
companies. (Proprietary companies cannot raise funds from the
public, only from limited groups.)
• Shares – Directors must ensure they are complying with the company
constitution, the law and all relevant procedures and requirements,
and must act for a proper purpose.

Disclosure requirements in relation to share offers
• A company proposing to offer new shares for subscription must
comply with the extensive disclosure obligations contained in Ch 6D
of the Act, except in certain limited circumstances.
• Generally, a company offering new shares for subscription
must provide potential investors with a prospectus containing
detailed information about the company and the shares
• The CA imposes significant penalties and sanctions on
companies and their directors and advisors for non-compliance.

Secondary trading of shares
• Buying and selling of “already-issued securities”
• Less requirement for disclosure: Ss.707 and 708A
• Licensing requirements (see Ch 7)
• Prohibited market misconduct (esp s1041)

Overview of disclosure requirements - Ch6D in
context
• Ch2M – Periodic (requires directors’, financial, auditor’s reports)
• Ch6CA – continuous (price sensitive – applies only where securities
are publicly traded)
• Ch6D – fundraising (shares & debentures) – prospectus, offer
information statement. Ch 6D is the main focus in this part of the
topic.
• Ch7 – financial services – licensing and disclosure via Financial
Services Guide, Statement of Advice, Product Disclosure Statement.
(Note: Financial Services Licensing is not covered in this topic.)

When is disclosure required?
• Sec 706: a person must not make an offer of securities – including
distributing an application form for an offer of securities – that needs
disclosure to investors, unless a disclosure document has been
lodged with ASIC.
• See ss 92, 727 for meaning of securities

So, General Rules: Disclosure is Required
• When there is a new offer of securities – “primary trading” - to
members of the public
• In some cases of sale of existing securities – ‘secondary trading’ – to
members of the public

General Rules cont: some modification to where
disclosure is required
• Several measures to facilitate efficient fundraising – including:
• No prospectus needed for rights issues but still must ensure
market is provided with relevant information
• Unlisted companies offering shares to employees – reduced
disclosure rules
• Other circumstances

When isn’t a disclosure document required (detail)
– also see s708?
• Small scale personal offers
• Offers to ‘sophisticated investors’ – defined in the Act
• Offers to professional investors
• Offers to persons associated with the company
• Offers under dividend reinvestment plans and bonus share plans
• Offers for no consideration
• Certain offers made in special circumstances
• Rights issues by listed companies

Why is disclosure required? To ensure informed
decisions by investors, therefore:
• Disclosure should be of information that investors and their financial
advisors would reasonably require and expect in order to make an
informed investment decision.
• The actual information will also vary depending on the nature of the
securities (e.g. debt securities would require different information
than would shares)
• S.715A – information in disclosure documents must be worded and
presented in a ‘clear, concise and effective manner

Disclosure under Ch6D - new shares
• S.717 gives overview of relevant procedure and provisions of the CA
(also see s704 as to when applicable)
• S.705 – types of disclosure documents
• S.706 – disclosure required unless exempted under s708

What is a disclosure document?
• See s9 for definition of disclosure document
• Documents or documents required depends on the situation:
• Prospectus
• Short-form prospectus
• Profile statement
• Offer information statement (OIS)

What are the disclosure requirements (detail)?
• Company must prepare a prospectus or OIS
• Prospectus contents prescribed under s 711 and 710 (general) or
713 (continuously quoted securities).
• Can use a short form prospectus.
• OIS contents more limited – s 715
• Supplementary and replacement prospectuses – s 719

Liability/consequences where defective or
inadequate disclosure
• Failure to provide a disclosure document where required (s.727)
(breach carries fines or imprisonment (s1311))
• Misleading or deceptive or omitted information (s.728)
• Supplementary and replacement prospectuses (s.719)
• Right to compensation (s.729)
• Criminal proceedings (by ASIC – ss728 – 733)
• Civil proceedings (s728)
• Note that civil action can be for breach of process or rules OR
loss as a result of claims or omissions in the documents
• Defences: (ss.731-2)

Summary
• Various options are available to a company seeking to raise funds via
either equity (shares) or debt (debentures or debt securities):
• However, availability and choice of source depends on:
• Size and status of company
• Objectives and financial position
• Choice
• Consequences
• Quite onerous disclosure obligations in some cases, both at outset
and on-going
• These are imposed by legislation, regulation and where relevant, the
ASX

• The most likely reason for a company’s affairs coming under scrutiny
is financial failure/difficulties – and that scrutiny is most likely to come
from large creditors (depending on the size of the company) or blocs
of shareholders (and sometimes even one if that shareholder holds a
large number/proportion of shares)
• A highly geared company (one carrying a lot of debt) is often seen as
risky
• However, shareholders may raise awkward questions as well about
how a company is being run – this also can lead to problems
• Ultimately, this scrutiny may lead to legal consequences, including
action by creditors or others to recover their money – and this is
the focus of the last topic.

Topic Five Financing Corporations_5b6e9f04a38566cba2c82f5b978bce26.pptx

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