Oh No – Have I Allotted Shares for an Improper Purpose?
Directors possess the fiduciary power to allot shares and they must exercise this power in accordance with their fiduciary obligations arising at common law and under statute.
Directors must not allot shares for an improper, extraneous or ulterior purpose, for example, to maintain the control of the company in the hands of the directors and their associates.
The power to allot shares is conferred on directors primarily to enable capital to be raised, but the courts recognise that this is not the only valid purpose for which shares may be issued by a company, if the reasons relate to a purpose that benefits the company as a whole.
In simple terms, directors must allot shares for a proper purpose.
Principles
In the case of Re Pacific Springs Pty Ltd [2020] NSWSC 1240, the NSW Supreme Court outlined the key principles as to what does and does not constitute a ‘proper purpose’ for allotting and issuing shares:
- The ultimate question is whether the allotment of shares was made honestly in the interests of the company as a whole.
- Directors cannot exercise a fiduciary power to allot shares for the purpose of defeating the voting power of existing shareholders by creating a new majority.
- As fiduciary agents of the company, the power conferred upon directors cannot be exercised in order to obtain some private advantage.
- Directors are generally not considered to have breached their fiduciary obligations in circumstances where they issued shares for a purpose authorised by the company’s constitution and/or shareholders.
Liability implications
Shareholders can bring derivative actions to contest allotments by directors who, for example, were motivated by a desire to consolidate their own power instead of advancing the interests of the company. The liability implications for directors in this regard can be significant. For example, directors may be ordered to pay damages to the company and may be subject to penalties under the Corporations Act 2001 (Cth).
Key takeaways
If you are a company director, it is essential you understand your fiduciary obligations when it comes to allotting and issuing shares. Ask yourself:
- Does the company’s constitution identify any purposes for which the power to allot shares may be, or may not be, exercised?
- Does the board intend to allot shares in accordance with one of those authorised purposes? If not, why not?
- Is it practical to obtain the consent of the company’s shareholders to the proposed share allotment? The law recognises that there can be no complaint about the exercise of the power to allot shares if what was done was with the consent of the existing shareholders of the company.
- Will the proposed share allotment advance a genuine commercial interest of the company?
- Will the proposed share allotment increase your own control of the company or otherwise financially benefit you, whether in your capacity as a shareholder or otherwise?
If you have any doubts as to the validly of a proposed share allotment, you should promptly seek legal advice.
Queries
If you have any questions about this article, please get in touch with an author or any member of our Corporate & Commercial team(s).
Disclaimer
This information is general in nature. It is intended to express the state of affairs as of the date of publication. It does not constitute legal or financial advice. If you are concerned about any topic covered, we recommend that you seek your own specific legal and financial advice before taking any action.