Offering shares to non-executive directors (‘NEDs’) is often an effective way for a company to align the NED’s interests with the interests of the company’s other shareholders. However, the way in which shares are offered to NEDs requires thought and attention to avoid any negative consequences.
One such method that a NED could receive shares in a company is via a ‘loan funded share plan’. In this blog, we explore some of the key corporate law issues that should be considered if you intend to issue shares to a NED under a loan funded share plan. This blog does not address tax issues, which are also an important consideration in structuring this type of plan.
So, what exactly is a loan funded share plan?
Simply, a loan funded share plan is an arrangement under which a company provides a loan to a participant to fund the purchase of shares (at market value) in that company. A loan funded share plan is a common alternative to more traditional incentive schemes for employees/directors (such as bonuses, or start-up option schemes or tax-deferred option schemes or performance rights plans).
One key difference is that shares are not usually issued at a discount under a loan funded share plan, whereas options or performance rights are often issued at a discount to their market value (or for no consideration) under start-up option schemes or tax-deferred option schemes or performance rights plans. As such, loan funded share plans are usually intended to fall outside of the ESS tax rules, which are enlivened when issuing securities to employees, directors or contractors at a discount.
Can a company provide loans to a person to facilitate the purchase of shares?
Under the ‘financial assistance’ provisions of the Corporations Act, a company generally cannot loan money to a person to facilitate the purchase of shares in the company or its holding company. However, there are two common exceptions to this rule:
- Where the company is satisfied that providing such a loan would not materially prejudice the interests of the company and its shareholders, or the company’s ability to pay its creditors; or
- where a company provides the loan under an ‘employee share scheme’ (as defined in the Corporations Act) that has been approved by the company’s shareholders.
A loan funded share plan can constitute an ‘employee share scheme’ under the Corporations Act if shares may be acquired under that plan by or for the benefit of employees of the company (or a related body corporate), or directors that hold ‘salaried employment or office’ in the company (or a related body corporate).
The phrase ‘salaried employment or office’ is not specifically defined in the Corporations Act, but arguably the phrase suggests that only executive directors (i.e. those directors who are directly employed by the company as a director and receive wages from the company) are eligible to participate in an ‘employee share scheme’. This appears to be the approach taken by the Commonwealth Treasury in an April 2019 Consultation Paper on Employee Share Schemes.
Based on this, we think there is a risk that offering a loan to a NED under a loan funded share plan falls outside the financial assistance exemption for ‘employee share schemes’ described above (even if the NED provides services to the company in another capacity, such as a contractor). By allowing a NED to participate in a loan funded share plan, there is also a risk that the entire loan funded share plan would not be classified as an ‘employee share scheme’ on the basis that the plan doesn’t strictly meet the definition in the Corporations Act. This would mean that any grant of shares under the loan funded share plan (even to employees) could fall outside the financial assistance exemption for ‘employee share schemes’.
To avoid any potential financial assistance issues associated with issuing loans to NEDs to fund the purchase of shares, companies should consider implementing a standalone loan funded share plan for its NEDs that sits alongside its loan funded share plan for employees and executive directors. For any grant of shares under the NED loan funded share plan, the company would then need to either:
- conclude that the loan to the NED is not materially prejudicial to the interest of the company and its shareholders, or the company’s ability to pay its creditors – although this could be argued as the loan proceeds would be immediately injected back into the company by the NED to acquire shares under the loan funded share plan, the dilutive effect of issuing those shares without receiving any new funds could potentially be materially prejudicial to other shareholders; or
- conduct a financial assistance whitewash, which will require the company’s shareholders to approve the provision of the financial assistance within certain timeframes. This step would also require certain ASIC notifications to be made.
If it isn’t clear that the ‘no material prejudice’ exemption applies in the circumstances, our recommendation would be to conduct a financial assistance whitewash before issuing any shares under a loan funded share plan for a NED.
As well as the potential financial assistance issues, issuing shares to a NED under a loan funded share plan could also raise the following issues:
- Disclosure – since a share in a company is considered a ‘security’ under the Corporations Act, an offer of shares under a loan funded share plan could invoke disclosure requirements relating to that offer (for example, Prospectus requirements). However, these disclosure requirements are not triggered if:
- the NED is considered a ‘senior manager’ of the company (that is, a person who is concerned with, or takes part in, the management of the company). A NED will likely satisfy this threshold as management of a company vests with its directors under 198A of the Corporations Act;
- the NED is considered a ‘sophisticated investor’ – this can be shown if the NED will be making at least a $500,000 investment in the company, or if the NED can produce an accountant’s certificate noting that the NED (together with companies and trusts that they control) has net assets of $2.5 million or gross income of at least $250,000; or
- a ‘personal offer’ is made to the NED which (together with any other personal offers made by the company) results in $2m or less being raised in any 12-month period from 20 or fewer investors.
- Licensing – since a share in a company is also considered a ‘financial product’ under the Corporations Act, the provision of any ‘financial services’ in respect of shares issued under a loan funded share plan (for example, advice) may need to be provided under an Australian Financial Services Licence (‘AFSL’). However, there are various AFSL exemptions (for example, in ASIC Class Order CO 14/1001) which could apply depending on the specific factual circumstances. Specific advice should be sought on the applicability of those exemptions.