Company Enforcing its Own Constitution: It’s Not That Simple

The Facts

The appellants, two companies, adopted a constitution in 2003 which provided that if a shareholder wished to sell their shares, they must sell them to the remaining shareholders in proportion to the remaining shareholders’ current shareholding (the Pre-emptive Right).

In 2009, a shareholder agreed to sell all their shares to another shareholder to the exclusion of the others, contrary to the Pre-emptive Right (Share Sale Agreement). The companies instituted proceedings in its name that the agreement was in breach of the Pre-emptive Right.

The parties to the Share Sale Agreement applied to the Court that the proceedings be dismissed or stayed as it infringed the prohibition to provide financial assistance in relation to the acquisition of its own shares.[1]

The Interpretation

In deciding whether the companies had breached this prohibition, the High Court identified three elements which must be established:

1. Financial assistance is given by the company;
2. The assistance was to “acquire” shares in the company; and
3. The assistance materially prejudiced the company’s shareholders or creditors.

The Court identified that:

• The cost of funding litigation to enforce the constitution was considered financial assistance because financial assistance includes any action which “smoothed the path to the acquisition of shares”.[2]
• If the proceedings were successful, the remaining shareholders would be able to enforce the Pre-emptive Rights, being an option to acquire shares. As “shares” includes an option to acquire shares, any action to enforce the Pre-emptive Right would constitute an acquisition.[3]
• The cost of the companies funding litigation would deprive the companies of resources which can reduce the equity of all shareholders (including those that were parties to the Share Sale Agreement). This constitutes a material prejudice to either all or individual shareholders.[4]

Conclusion

This case provides a timely reminder that although a constitution or shareholders agreement may include rights a company can enforce, such provisions do not automatically mean that the company can enforce those rights.

1. As prohibited by section 260A(1) Corporations Act 2001.
2. Connective Services Pty Ltd & Anor v Slea Pty Ltd & Ors [2019] HCA 33 [22], [33], [34]
3. Ibid [23], [35].
4. Ibid [25], [37].