Waldmart Board Proposal: Bonus Shares And Increased Dividend

Legal Rules Surrounding the Issuance of Bonus Shares

Questions:

1.Does the board of Waldmart have the power to issue bonus shares and can the Shareholders at the upcoming AGM legally Compel the Board not to Issue the Share?

2.Can the shareholders stop the directors from Increasing and Paying the Proposed dividend because it is Commercially unwise to do so?

3.If Shareholders vote against the Remuneration report and a Second Strike is achieved, what will be the Consequence of Waldmart Ltd and its Director?

The board of directors at Waldmart has undertaken to issue bonus shares and to increase the dividend by 25% from the previous year’s payout. Shareholders had, during the previous year’s AGM rejected a proposed Remuneration Report; this resulted in a first strike for the company. The board believes the bonus issue and the dividend increase could convince shareholders to make the first strike a non-issue and to reconsider the remuneration report. They have issued out a separate letter outlining reasons why they believe the approval of the report is justified. Minority shareholders, led by Better Super Ltd are unhappy with the proposed bonus issue and find the dividend increase unwise due to the financial difficulties in the industry.

1.Rules: The Corporations Act 2001 gives company directors the power to issue both redeemable and non-redeemable preference shares, partly paid shares, and bonus shares.[1] Bonus shares are those whose issue does not require any consideration to be paid to the company.[2] However, shares must be issued for a proper purpose and it is the duty of directors to ensure this purpose is upheld.[3] If the exercise of this power to issue is aimed at benefiting directors and not shareholders; that is it is either by what of granting them more control or pushing their interests, then the company can invalidate it at a general meeting.[4] This duty of proper purpose is in ultimate exercise of a director’s duty as a trustee to the company and shareholders as highlighted in s 181 of the Act.[5] A civil penalty can be imposed on directors found to be in breach of this duty.

In Howard Smith Ltd v Ampol Petroleum Ltd[6] Millers Company had a large number of shareholders with majority shareholding. Additionally, there was another bunch interested in purchasing shares in Millers. The board of directors did not want the shareholders to have majority as it would lead to a possible replacement of the board, they, therefore, issued out more shares to dilute the majority shareholding. The court, after analysing the power held by the directors, both by law as well as the company articles identified that the directors did have power. The court thereafter analysed the primary purpose of the issue and realised that the directors acted in self-interest and as such contravened their fiduciary duty as well as the duty of improper purpose. The decision could, therefore, be invalidated.

Application: The Corporations Act 2001 gives Waldmart directors the power to issue bonus shares as discussed above. Additionally, this is reiterated in the Waldmart’s constitution which gives directors the same powers; as such, legally the directors of the supermarket have the legal capacity to issue bonus shares. However, the Act also provides that any issue of shares must be for the proper purpose; usually to raise more capital. As outlined in the Howard v Ampol[8] case although the directors had issued the shares to raise further capital, they had also resolved to do so in order to dilute shares held by the majority shareholders; the primary action of directors in this case, therefore, was not proper. Similarly, with Waldmart, the directors could argue that the bonus issue is to raise more capital, however, it is believed that this resolution is an attempt to please shareholders into making the first strike a non-issue. Therefore, the issue does not fall in line with the ‘proper purpose’ test; it seems to be in the interest of the directors. Shareholder on these grounds can, therefore, challenge the resolution, they can refuse to validate it at the meeting or seek legal recourse in court.

Proper Purpose of Share Issuance

Tentative Conclusion: The directors at Waldmart have the power to issue bonus shares, however, shareholders can legally compel them not to or invalidate a resolution passed to do so.

2.Rules: The standard practice is that a company’s constitution will outline how dividends are paid subject to relevant legal provisions.[9] Guided by law a company can only declare dividends if it satisfies some conditions.[10] Firstly, prior to the declaration of the dividends, the company’s assets must exceed their liabilities and the excess amount should suffice to cover the dividend. Secondly, the payment should equitable and sensible to all shareholders; although there are no regulations outlining how to determine what is fair and reasonable.[11] Finally, the issue should not harm the organisation’s capacity to pay off creditors. In ICM Investments Pty Ltd v San Miguel Corporations and Anor (2014),[12] Justice Vickery outlined that in the payout of dividends it is important to consider whether the profits available are sufficient; directors should justify that the dividend would be truthfully and reasonably relevant and the profits are sufficient to cover it.[13]

Another issue to consider in the declaration of dividends is the duty of all director’s to prevent insolvent trading. The Act provides that a director would be in breach of this duty if they are aware or suspect that their action or inaction would lead to the company incurring debt, or if a reasonable person under similar circumstances would deem it so.[14] The Act outlines the paying or declaration of a dividend as one of the circumstances to consider[15]; the contravention of this provision elicits a civil penalty.[16] A court would issue a declaration citing contravention where there is proof that the breach is serious and would be of detriment to the company, shareholder interests or creditors.[17] This is in line with their trust imposed duty as directors to act for the best of the company.

In general, directors owe a fiduciary duty to the company; that is they must act for the benefit of the organisation.[18] Although the duty is generally owed to the company as a whole;[19] it is only the company that can sue in breach, Dyson Heydon (QC) noted that to act in good faith for the company would include acting to advantage the company, shareholders and other stakeholders with interest in the company.[20] Woodhouse J in Coleman v Myers (1977)[21] outlined that, holding the position of a director in the company does not exclude one for upholding their fiduciary duty to the shareholders of the same company. As such, in making their decisions, directors should consider their fiduciary duty to act in the best interest of the company, its shareholders and any other stakeholders who may be affected. Where they contravene this duty they will be held liable and subject to penalty under the Corporation Act 2001 s 1317E the maximum of which is $200,000.

Application: The law give power to directors to determine whether dividend can be paid, the amount to be paid, the mode of payment, and when it should be paid.[22] Guided by this provision it is evident that Waldmart’s directors have the legal capacity to increase and declare dividends. However, as mentioned above, this duty is subject to the provisions of s588 of the Act which require that a director not engage the company in insolvent trading. Therefore, if the payout of dividend or its declaration is likely to render the company insolvent or unable to pay the debt then it would be a contravention. Waldmart directors are tasked with ensuring any dividend paid or declared can be covered by the company profits and does not in any way detriment the company’s activities or the interest of other stakeholders such as creditors. For Waldmart, the increase of dividends was first and foremost in the interest of the company’s director. Secondly, as raised by Better Super Ltd, the company is facing certain unstable financial time, if the dividend serves to detriment the company and its stakeholders either by making it insolvent or is an amount that cannot be sufficiently catered for by the current profits, then the shareholders can challenge the resolution.

Waldmart's Power to Issue Bonus Shares

Tentative Conclusion: Waldmart Directors have the power to increase dividends, however, this decision is not to the benefit of the company and shareholders can legally challenge it.

3.Rules: Amendments in 2011 saw the introduction of the two-strike rule in Australia; under this new law, where a proposed remuneration report received 25 percent or more votes against it in two years straight then the board of directors could be re-elected.[23] The purpose of the introduction of this rule was to restrain executive compensation which had become an issue raising public anger and scrutiny in the recent past.[24] Previously, this right to reject remuneration reports through voting had no consequences on the directors or the company. Where a previous AGM led to the first strike, the company at the second AGM must give shareholders the option to spill where 50 percent of the shareholders in question are in support; a spill meeting is then held, if the 50 percent threshold is attained, within 90 days. Where the 50 percent threshold is unattained then the directors will not stand for re-election.[25] The managing director or the CEO will be allowed to continue running the company in their position where shareholders decide on a re-election; this law is an accountability measure.[26]

Application: As aforementioned, the object of the ‘two-strike’ rule is to see to it that directors can be held accountable for their decisions especially with respect to the remuneration of executives. After the first strike, directors are expected to provide an explanation for their proposed actions disclosing why they believe the report is justified and if any remuneration consultants were contacted.[27] Waldmart directors rightfully issued a letter to shareholders citing the reasons they believed would justify the report. This report must be explained at the next Waldmart AGM meeting; the remuneration report in the next AGM will include a response to the comments raised, evidence of steps taken with regard to the comments or where no action was taken, an explanation of the same. The session should demonstrate a willingness to engage and dialogue with shareholders. If a second strike is achieved on the same report then the Waldmart Directors will have to organise a ‘spill meeting’ in 90 Days and present themselves for re-election; the threshold for the second strike is 50 percent shareholding.

Conclusion

In conclusion, Waldmart directors have the legal authority to increase dividend and issue bonus share, however, these decisions are subject to the underlying fiduciary duty to act to the benefit of Waldmart. Shareholders can rely on this duty to challenge the decision. Additionally, the consequence of a second strike would be the re-election of directors.

References

Carole Hemingway ‘What is the Duty to Act in Good Faith in the Best Interests of the Company?’ Legal Vision (25 August 2016) https://legalvision.com.au/what-is-the-duty-to-act-in-good-faith-in-the-best-interests-of-the-company/

Chris Walker, ‘Bonus shares- what’s really in a bonus?’ Finance Nine.Com (28 November 2010) https://finance.nine.com.au/2016/10/07/10/26/bonus-shares-whats-really-in-a-bonus

Damian Reichel & Michael Garry ‘New Dividend Payment Rules’ Johnson Winter & Slattery (August 2010) https://www.jws.com.au/en/legal-updates-archive/item/153-new-dividend-payment-rules

George Wilkins, ‘What is the ‘two-strikes’ rule?’ The Sydney Morning Herald (8 October 2012) https://www.smh.com.au/business/agm-season/what-is-the-twostrikes-rule-20121008-278us.html

Legal Challenges to Bonus Share Issuance

Heydon JD, ‘Directors Duties and the Company’s Interests’ in Finn PD (ed), Equity and Commercial Relationships (LBC 1987) 

Ian Tunstall ‘Duty to prevent insolvent trading’ Find Law Australia https://www.findlaw.com.au/articles/616/directors-duty-to-prevent-insolvent-trading.aspx

Michelle Milligan and Mirela Leko, ‘Did you receive a strike or comments on your remuneration report in 2011?’ Minter Ellison (29 February 2012) https://www.minterellison.com/Pub/NL/20120301_CHQa/

Nicholas Bourne, Essential Company Law (Cavendish Publishing, 3^rd ed, 2000

Paul Redmond Corporation and Financial Markets Law (LBC, 6^th ed, 2013)

Professor Bob Baxt ‘Is it time to reform our dividend law?’ AICD (1 February 2015) https://www.companydirectors.com.au/director-resource-centre/publications/company-director-magazine/2015-back-editions/february/directors-counsel-is-it-time-to-reform-our-dividend-law

Reza Monem and Chew Ng, ‘Australia’s ‘two-strikes’ rule and the pay-performance link: are shareholders judicious?’ (2013)  December Journal of Contemporary Accounting & Economics

Russell Hinchey & Peter McDermott Company Law (Pearson Education, 1^st ed, 2005)

Roman Tomasic, Stephen Bottomley & Rob McQueen, Corporations Law in Australia (The Federation Press, 2^nd ed, 2002)Cases

Coleman v Myers [1977] 2 NZLR 225

Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821

ICM Investments Pty Ltd v San Miguel Corporations and Anor [2014] VSCA 246

Lorenzi v Lorenzi Holdings Ltd [1993] 12 ASCR 398

Whitehouse v Carlton Hotel Pty Ltd [1987] 162 CLR 285, [1987] 5 ACLC 421

Legislation

Corporations Act 2001 (Cth)

Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Act 2011

Other

Governance Institute of Australia, Guidelines for Managing the Requirements of a Second Strike (2014)

Corporations Act 2001, s 245A (1) (Cth)

Chris Walker, ‘Bonus shares-what’s really in a bonus?’ Finance Nine.Com (28 November, 2010) https://finance.nine.com.au/2016/10/07/10/26/bonus-shares-whats-really-in-a-bonus

Russell Hinchy & Peter McDermott Company Law (Pearson Education, 1^st ed, 2005) 3.5

Nicholas Bourne, Essential Company Law (Cavendish Publishing, 3^rd ed, 2000) 67, See Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821.

Corporations Act 2001, s 181 (1) (Cth).

[1974] AC 821.

See Whitehouse v Carlton Hotel Pty Ltd [1987] 162 CLR 285, [1987] 5 ACLC 421; Lorenzi v Lorenzi Holdings Ltd [1993] 12 ASCR 398; Paul Redmond Corporation and Financial Markets Law (LBC, 6^th ed, 2013) pp 7.215-7.305.

Ibid n 6

Corporations Act 2001 s 254U

Corporations Act 2001, s 254T

Damian Reichel & Michael Garry ‘New Dividend Payment Rules’ Johnson Winter & Slattery ( August, 2010) https://www.jws.com.au/en/legal-updates-archive/item/153-new-dividend-payment-rules

ICM Investments Pty Ltd v San Miguel Corporations and Anor [2014] VSCA 246

Professor Bob Baxt ‘Is it time to reform our dividend law?’ AICD (1 February, 2015) https://www.companydirectors.com.au/director-resource-centre/publicationsCorporations Act 2001 s588G (2).

Ibid s 1A

Corporations Act 2001 s588G (2) (b)

Ian Tunstall ‘Duty to prevent insolvent trading’ Find Law Australia https://www.findlaw.com.au/articles/616/directors-duty-to-prevent-insolvent-trading.aspx

Carole Hemingway ‘What is the Duty to Act in Good Faith in the Best Interets of the Company?’ Legal Vision (25 August 2016) https://legalvision.com.au/what-is-the-duty-to-act-in-good-faith-in-the-best-interests-of-the-company/

Roman Tomasic, Stephen Bottomley & Rob McQueen, Corporations Law in Australia (The Federation Press, 2^nd ed, 2002) 320

Heydon JD, ‘Directors Duties and the Company’s Interests’ in Finn PD (ed), Equity and Commercial Relationships (LBC 1987)  120-36

Coleman v Myers [1977] 2 NZLR 225

Corporations Act 2001 s254U (1).

Corporations Amendment (Improving Accountability on Director and Executive Renumeration) Act 2011

Reza Monem and Chew Ng, ‘Australia’s ‘two-strikes’ rule and the pay-performance link: are shareholders judicious?’ (2013)  December Journal of Contemporary Accounting & Economics 3

Governance Institute of Australia, Guidelines for Managing the Requirements of a Second Strike (2014) 2

George Wilkins, ‘What is the ‘two-strikes’ rule?’ The Sydney Morning Herald (8 October 2012) https://www.smh.com.au/business/agm-season/what-is-the-twostrikes-rule-20121008-278us.html

Michelle Milligan and Mirela Leko, ‘Did you receive a strike, or comments on your remuneration report in 2011?’ Minter Ellison (29 February 2012) https://www.minterellison.com/Pub/NL/20120301_CHQa/