The Corporations Act 2001 (Cth) (Act) generally prohibits a company from providing financial assistance to any person (as that term is defined in the Act) in connection with the acquisition of shares in itself or in its holding company unless certain conditions are met.

The rationale behind the prohibition, when first introduced into the United Kingdom, was to provide protection against the abuse of the rights of the company’s creditors and shareholders, particularly minority shareholders (see Great Britain, Board of Trade, Report of the Company Law Committee (1962) Cmnd 1749 (‘the Jenkins Committee’) at 62 [173]; Dempster v National Companies and Securities Commission (1993) 9 WAR 215 at 267. See also Austin and Ramsay, Ford, Austin and Ramsay’s Principles of Corporations Law, 17th ed (2018) at 1813 [24.670]). The protection includes preventing a company from eroding its own capital base, or prejudicing its creditors and minority shareholders, by financing transactions that may not be in the company’s best interests (see Connective Services Pty Ltd v Slea Pty Ltd [2019] HCA 33). The intention of the financial assistance provisions is to ensure that if an exemption to financial assistance is to be sought and achieved, all shareholders have prior notice of it and a chance to approve or vote the proposal down.

What might constitute financial assistance is broad and extends beyond monetary payments to any action by a company that helps a person to acquire shares in the company or in its holding company.

Companies (and directors) providing financial assistance to prospective shareholders must consider their obligations under the Act.

While the Act does not define "financial assistance", Australian courts have given the term a broad commercial meaning.

The High Court in Connective Services Pty Ltd v Slea Pty Ltd [2019] HCA 33 held that "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”" (see Connective Services Pty Ltd v Slea Pty Ltd [2019] HCA 33).

A common and well understood example of financial assistance is the company providing a loan to the prospective shareholder so that he or she may acquire the shares. The loan is then paid off via cash instalments or "foregone bonuses or commissions".

There are also other common examples of financial assistance, however these are less understood as being caught by the Act:

• the company giving a guarantee and indemnity and security in favour of a lender for a loan used by a prospective shareholder (the borrower) to acquire shares in the company or its holding company

• gifting funds or assets

• reducing the purchase price of shares.

It is also important to remember that financial assistance includes assistance given before or after the acquisition of the relevant shares.

Section 260A of the Act provides that a company may financially assist a person to acquire shares in itself or in its holding company 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 (No Material Prejudice Test) (see section 260A(1) of the Act)

• the assistance is approved by shareholders under section 260B of the Act, commonly referred to as a "whitewash" (whitewash, discussed below)

• the assistance falls within specific exemptions listed in section 260C of the Act.

This exemption hinges on whether a company will be in a worse position to pay creditors. In Connective Services Pty Ltd v Slea Pty Ltd (see [2019] HCA 33 at para 26), the High Court stated:

"The issue of material prejudice to the interests of the company or its shareholders or creditors requires an assessment of and comparison between the position before the giving of the financial assistance and the position after it to see whether the company or its shareholders or its ability to pay its creditors is in a worse position."

What "worse position" means is not a clear‑cut or objective rule. As the Explanatory Memorandum to the 1998 amendments to the equivalent exemption said, the question of material prejudice is fact‑intensive and that:

"it will not be possible to determine whether the transaction involves material prejudice merely by reference to arbitrary rules, such as the percentage impact the transaction will have on the company’s profit" (see Australia, House of Representatives, Company Law Review Bill 1997, Explanatory Memorandum at 1 [1.2]).

It is generally not advisable for a company to rely on the No Material Prejudice Test, even if it first undertakes an involved analysis to determine whether no material prejudice exists. In the event that such a determination is contested (by an unhappy shareholder who did not have notice of the proposed assistance), a court may still find that the financial assistance provided failed the test.

Rather than go to the time and expense of running an analysis and still not knowing if the proposed financial assistance is certain to be exempt, companies and their advisers should first carefully consider whether the assistance falls within an exemption under section 260C of the Act or ensure compliance with the process set out in section 260B of the Act. Usually there is a cost benefit to doing so.

Section 260C of the Act sets out circumstances where the prohibition against financial assistance does not apply.

General exemptions to the prohibition apply where the financial assistance is given in the ordinary course of commercial dealing and consists of:

• acquiring or creating a lien on partly paid shares for the amounts payable

• entering into an agreement whereby a person may make payments for shares to the company by way of instalments.

Section 260C also lists specific exemptions which apply to certain entities or in certain transactions, including:

• financial institutions or subsidiaries of debenture issuers

• where the transaction is a reduction of share capital or a share buy-back in compliance with the Act (see Part 2J.1 of the Act).

A company may proceed with giving financial assistance to a person if it obtains shareholder approval through the process prescribed in section 260B of the Act. This notice and approval is known as the "whitewash".

The whitewash procedure requires the company to obtain shareholder approval for the giving of financial assistance by way of special resolution or by ordinary resolution approved by all ordinary shareholders by:

• issuing a notice of meeting to its members which includes a statement setting out all the information material to the decision on how to vote on the resolution (Notice) (see section 260B(4) of the Act)

• prior to the Notice being issued to members, lodging the Notice and accompanying documents with ASIC (see section 260B(5) of the Act)

• if a special resolution is reached, notifying ASIC within 14 days after it is passed (see section 260B(7) of the Act)

• once shareholder approval is given, notifying ASIC that financial assistance has been approved in accordance with section 260B of the Act (see section 260B(6) of the Act).

A whitewash ensures that shareholders are properly informed of the proposed financial assistance and have the opportunity to approve or reject it, thereby requiring corporate transparency with the intention of protecting minority interests and reducing the risk of oppression.

Where a company provides financial assistance in breach of section 260A of the Act, the transaction itself remains valid and the company is not guilty of an offence. However, any person involved in providing the financial assistance (including, for instance, company officers, legal advisers, accountants and lenders) may be liable and subject to civil penalties or, where dishonesty is involved, criminal penalties.

As set out above, generally a company may provide financial assistance in compliance with the Act if it qualifies for a defined set of exemptions. Obtaining shareholder approval through the whitewash is generally the preferred approach as it tends to cover all circumstances, is a matter of running a recognised process and removes the costs and uncertainty about whether the assistance has the benefit of the No Material Prejudice Test.

Commercially and operationally, we find that business, directors and non-legal advisers get frustrated with the time and cost of going through the whitewash procedure (and for that reason many run the risk of not doing so). This is especially the case if such parties are aware that the UK removed the requirements for whitewash procedures for private companies well over a decade ago.

In single shareholder companies, or in companies with a small shareholder cohort who naturally communicate such corporate activity with each other ahead of time, this can be considered a compliance burden. However, again, the prohibition and exemption regime is designed to ensure disclosure to shareholders ahead of time, so their interests may be protected. This is likely the key reason why the whitewash requirement has not been repealed in Australia.

For further information relating to financial assistance, please contact the Corporate & Commercial team.