5-Day Cleanse: Cleansing Notices and Cleansing Prospectuses under the Corporations Act

Corporate Update

29 Oct

Written By AGH Law

A number of recent cases have reiterated the importance of listed companies complying with the on-sale restriction (On-Sale Restriction) under section 707(3) of the Corporations Act 2001 (Cth) (Corporations Act) and, in particular, making sure they “cleanse” shares issued without a prospectus.

In this Insight, we discuss the On-Sale Restriction and the cleansing of shares, including:

an overview of the relevant law;
what you should do to avoid a breach;
what you should do if a breach occurs; and
recent examples of companies that got it wrong and how they resolved it.

What is the Disclosure Requirement?

As a general rule, companies are not allowed to offer securities (such as shares) unless a disclosure document (such as a prospectus) for the offer has been issued and lodged with the Australian Securities and Investments Commission (ASIC) (Disclosure Requirement) [1]. The Disclosure Requirement is primarily aimed at addressing the information imbalance between companies and investors.

There are, however, certain situations where a company may be able to offer securities without a disclosure document, including where the offer is made: 

under an exception in section 708 of the Corporations Act, such as:
- a personal offer that does not result in issues or sales of securities in the company comprising
- more than 20 investors and more than $2 million raised in a rolling 1 year period [2];
- an offer to a sophisticated investor, professional investor or senior manager of the company [3];
via a “low-doc”:
- rights issue under section 708AA of the Corporations Act [4]; or
- share purchase plan under ASIC Corporations (Share Purchase and Interest Plans) Instrument 2019/547) [5]; or
to a person outside Australia [3].

Exceptions to the Disclosure Requirement like these recognise that there are certain persons and certain circumstances that don’t necessarily require the protection provided by a disclosure document.

What is the On-Sale Restriction?

The On-Sale Restriction essentially provides that securities [7] issued to a person without disclosure can’t be traded or on-sold within 12 months of their issue, unless an exception applies (e.g. where securities are traded or sold to other investors that do not require disclosure under section 708).

The On-Sale Restriction acts as an anti-avoidance measure to the Disclosure Requirement by preventing a company from issuing securities to retail investors or the market generally via an intermediary investor who is exempt from the Disclosure Requirement. As part of this, the On-Sale Restriction aims to ensure that retail investors and the market are fully informed about the company at the time the relevant securities are issued.

How are shares “cleansed”?

In the case of a listed company [8], there are certain exceptions to the On-Sale Restriction which are generally referred to as “cleansing” the relevant securities, including where the company issues:

a cleansing notice in accordance with section 708A(5) of the Corporations Act (Cleansing Notice) [9]; or
a cleansing prospectus in accordance with section 708A(11) of the Corporations Act (Cleansing Prospectus).

Cleansing Notice

Broadly, a Cleansing Notice requires that:

the company’s securities have been quoted at all times in the previous 3 months;
the company has not been suspended for more than 5 days (in aggregate) [10],[11] during the previous 12 months (or such shorter period if quoted for less than 12 months);
in the 12 months before the securities are issued, ASIC has not made any determination that the company has breached certain financial reporting, continuous disclosure or other relevant provisions of the Corporations Act;
the company lodges the Cleansing Notice with its stock exchange within 5 business days of the securities being issued, with the Cleansing Notice to contain, among other things:
- a statement confirming that the company has complied with the financial reporting and continuous disclosure provisions of the Corporations Act; and
- any confidential, price sensitive information that has not been disclosed to the stock
  exchange in accordance with the applicable carve-out to its continuous disclosure rule (e.g. ASX Listing Rule 3.1A), but only to the extent that it’s reasonable for investors to find such information in a prospectus (Excluded Information). The matter of Excluded Information should be given thorough consideration and we recommend that companies adopt a documented protocol for engaging with key personnel and considering relevant matters to ensure that any Excluded Information is disclosed in accordance with section 708A(6)(e).

Cleansing Prospectus

Where the requirements for issuing a Cleansing Notice are not met, a listed company can instead issue a Cleansing Prospectus [12] to cleanse securities it issues from the On-Sale Restriction.

As a disclosure document, a Cleansing Prospectus must comply with certain disclosure requirements and must be lodged with ASIC. Therefore, they are invariably more time consuming and costly for issuing companies.

An effective Cleansing Prospectus requires that, among other things:

the Cleansing Prospectus is for an offer of securities that are in the same class as the relevant securities;
the class of securities is quoted;
the Cleansing Prospectus discloses all Excluded Information; and
the Cleansing Prospectus is lodged with ASIC either:
- on or after the day on which the securities were issued but before they are on-sold; or
- before the day on which the securities are issued where offers of the securities are still open for acceptance.

How do breaches usually occur?

The typical ways in which listed companies breach the On-Sale Restriction include:

failing to issue (as applicable):
- a Cleansing Notice in the time required; or
- a Cleansing Prospectus before the on-sale, in accordance with the Corporations Act;

issuing a Cleansing Notice in circumstances where it was not permitted to under the Corporations Act (e.g. where the company has been suspended for more than 5 days in the previous 12 months); and
issuing a defective Cleansing Notice (e.g. where a company omits Excluded Information and fails to issue a corrective Cleansing Notice).

What should be done if a breach occurs?

When a company becomes aware of breaching the On-Sale Restriction, immediate action should be taken, which may include the following:

requesting an immediate suspension of trading in the company’s securities on its stock exchange;
contacting impacted shareholders and, where possible, entering into voluntary holding locks (to the extent the shares have not already been traded);
issuing a Cleansing Prospectus to cleanse any shares which have not yet been traded;
conducting a detailed review of all previous share issues by the company to ensure there are no other prior breaches;
applying to either the Federal or Supreme Court to seek declarations and relief under section 1322(4) of the Corporations Act to validate procedural and administrative errors and grant relief from any potential civil liability (in particular, relief for any shareholders who on-sell their shares); and
once orders from the Court have been obtained, requesting the resumption of trading in the company’s securities on its stock exchange.

What does the Court process involve?

The most cumbersome step for a company rectifying a breach of the On-Sale Restriction is likely to be obtaining orders from the Court to “cleanse” the breach.

Depending on the declarations sought pursuant to section 1322(4) of the Corporations Act, the Court must be satisfied that:

the act, matter or thing, or the proceeding is essentially of a procedural nature;
the person or persons concerned acted honestly (including any persons issued the securities if the securities are on-sold);
it is just and equitable that the orders be made; and
no substantial injustice has been or is likely to be caused to any person.

It is also common for the Court to look at the surrounding circumstances of the breach, including how the officers of the company acted once they became aware of the breach and the culture of compliance within the company (and, as such, there will be a need to prepare detailed Court submissions and affidavits for all parties involved in the breach).

Courts will also have regard to the need to ensure that officers, upon becoming aware of a breach, are not deterred from seeking Court relief and, therefore, in the absence of an egregious breach, Courts have generally found it to be just and equitable to validate trades in uncleansed securities and to provide relief to on-selling shareholders who have traded in their shares in good faith.

What are some recent examples of a breach?

Re Superior Resources Ltd [2020] FCA 635 (Superior Resources)

Superior Resources Limited announced a placement on 31 July 2019 and proceeded to lodge a cleansing notice on the same day. However, the shares were not issued until 15 August 2019, with no further cleansing notice being issued (in breach of the requirement to issue a cleansing notice within 5 business days of the issue of shares in accordance with section 708A(6) of the Corporations Act). Evidence before the Court suggested that the company secretary had mistakenly believed that the cleansing notice issued on 31 July 2019 was effective.

The error was not discovered until May 2020, when the company’s solicitor, as part of due diligence for an upcoming placement and entitlement offer, advised that the company had not issued a valid cleansing notice in relation to the shares issued in August 2019. The solicitor advised the company to request immediate suspension of its shares on the ASX and to seek declarations from the Court to validate any trading of those shares that had occurred and to further relieve the shareholders who received the shares of any civil liability in trading those shares without a valid cleansing notice having been issued.

In granting the orders under section 1322, the Court made particular mention of the fact that the company, after becoming aware of the failure, had acted as promptly and appropriately as it could have to rectify the omission. The Court also noted that although the evidence suggested that the company secretary’s inattention may have contributed to the error, the fact that the company’s board had, following discovery of the error, resolved to seek legal advice for every future issue of securities, made it clear that there was not a culture of non-compliance within the company.

Re Golden Rim Resources Ltd [2019] FCA 120 (Golden Rim)

Golden Rim Resources Ltd conducted two, separate, 2-tranche placements (the 1st, announced in July 2018 and the 2nd announced in March 2019). A cleansing notice was issued in relation to the issue of the 1st tranche of each placement, however no cleansing notice was issued following issue of the 2nd tranche shares. In the case of each placement, the 2nd tranche shares were issued following receipt of shareholder approval approximately 2 months after the issue of the 1st tranche shares. It was not until late June 2019 when the company secretary noticed the failure to lodge a cleansing notice in relation to the 2nd tranche of each placement.

Approximately 1 business day following discovery of the failure to cleanse the shares, the company took action to ensure that ASX suspended the company’s shares. The company also wrote to all shareholders to advise of the breach and to advise the steps it proposed to rectify the breach. In addition, the company issued a Cleansing Prospectus approximately 2 weeks after becoming aware of the failure (in order to ensure any further trading of the shares was in compliance with the Corporations Act) and applied to the Court for declarations that any sale of the shares issued as part of the 2nd tranche of each placement which occurred prior to the date of the Cleansing Prospectus being lodged were not invalided due to the company failing to lodge the cleansing notice at the relevant times.

In granting the orders, the Court held that notwithstanding the obligation for listed companies who discover a breach to act as quickly as possible, the fact that there was a delay of 1 business day did not outweigh the factors in favour of granting the relief under section 1322. In particular, the Court acknowledged the level of detail in the company secretary’s affidavit on the steps taken following the discovery of the breach.

An additional factor which the Court noted weighed in favour of granting the orders was the possibility of liability for an unwitting breach by shareholders who had on-sold their shares, which, in the absence of the orders, would expose those shareholders to prejudice. More broadly, the Court also noted that shareholders and the company itself were likely to suffer prejudice if the company’s shares had been placed in suspension for any additional period (which, in the absence of the orders, would have been the case).

Re Poseiden Nickel Limited [2018] FCA 1063 (Poseidon)

During a period spanning 4 years, Poseiden issued shares on 40 occasions without disclosure to investors, relying on various exemptions under the Corporations Act. In relation to a number of these issues, the company either failed to release a cleansing notice following the issue of shares or released a cleansing notice in circumstances when it was not eligible to do so (for example, where the company’s shares had been suspended from trading for more than 5 days).

Upon becoming aware of these breaches of the Corporations Act, the company sought and obtained orders from the Federal Court under section 1322(4) of the Corporations Act that subsequent dealings in the issued shares were not invalidated by the contraventions. Amongst other matters, evidence before the Court was that an earlier company secretary had established practices having little regard to what was required in the context of a particular share issue and that these practices had been followed by a subsequent company secretary. Despite this,, the Court found that there was no blatant or flagrant disregard of the company’s disclosure obligations.

Interestingly, while the Court granted most shareholders who had on-sold their shares relief from civil liability, the Court declined to grant some particular investors the same relief, 1 of which was a global investment banking firm who received shares under a convertible note agreement (over the course of 18 separate issues) and the other being a nominee of an experienced stockbroking business that received shares under a subscription deed pursuant to which it was expressly contemplated that they would on-sell shares within 3 months of issue (also over the course of 18 separate issues). In refusing to grant relief to these particular investors, the Court held that these investors had an increased obligation to take active steps (including seeking advice where necessary) to ensure that the company had validly “cleansed” the issued shares and otherwise complied with the requirements under the relevant agreements and deeds.

AGH Law’s experience in seeking Court relief

During June 2019, AGH Law represented Animoca Brands Corporation Limited (Animoca) in its successful application to seek relief under section 1322(4) of the Corporations Act in relation to 5 separate share issues where Animoca either issue a defective Cleansing Notice or failed to issue a Cleansing Notice [13].

As set out below, there were 2 important takeaways from this decision.

What is the proper construction of a “day” in section 708A(5)(b) of the Corporations Act

With respect to 4 of the share issues where a Cleansing Notice was issued, Animoca’s shares had been suspended from trading for the following periods in the prior 12 months:

from 11:02am on 24 January 2018 to 10:14am on 25 January 2018;
from 9:24am on 11 July 2018 to 9:49am on 12 July 2018; and
from 9:46am on 10 August 2018 to 10:20am on 15 August 2018.

In relation to the relevant share issues, Animoca’s company secretary at the time formed the view, after consulting with colleagues experienced in the issuing of Cleansing Notices, that the shares had not been suspended for a total of 5 days on the basis that the suspensions of 14 minutes and 20 minutes on 25 January 2018 and 15 August 2018, respectively, did not each constitute a day of suspension for the purposes of the Corporations Act.

Counsel raised whether it was a necessary precondition for the Court to find that there had been a contravention of the Corporations Act or whether it was necessary only to find an arguable contravention when granting orders under section 1322. This argument, in part, depended on what the proper construction of a “day” is in section 708A(5)(b) of the Corporations Act.

Ultimately, the Court wasn’t required to address either of these points on the basis that the shares of Animoca were suspended:

in January 2018, for less than 24 hours across 2 trading days;
in July 2018, for more than 24 hours but only involving 1 trading day;
in August 2018, for more than 72 hours across 4 trading days; and
in April 2019, for more than 24 hours across 2 trading days.

In its judgement, the Court noted ASX’s view that if a company is suspended from trading for part of a trading day then this constitutes 1 day, however observed that that there is no definition of “day” or “days” in the Corporations Act and that the Acts Interpretation Act 1901 (Cth) is of limited assistance. In addition, the Court noted that the general approach adopted by the Courts is not to count parts of days [14] as full days, although this would not apply where the sequence of events on a particular day is important [15]. The Court considered, however, that without a contradictor or ASX being afforded the opportunity to appear to make submissions in support of ASX’s policy position with respect to part-day suspensions, it was not appropriate nor necessary to make any specific determination on this issue.

Accordingly, the proper construction of what constitutes a “day” in section 708A(5)(b) of the Corporations Act remains open to interpretation by the Courts and remains an important consideration for companies when calculating the number of days of suspension of their shares. As such, we suggest that companies exercise caution and determine their ability to issue a Cleansing Notice on the conservative assumption that if they have been suspended for any part of a day, that day should count as a full day when calculating whether the company has been suspended from trading for 5 or more days.

Refusal to grant relief to certain shareholders

As was the case in the Poseiden decision, the Court held that 2 particular investors (who were, notably, foreign residents with backgrounds in IT), should not be granted an order relieving them from civil liability.

This was on the basis that these investors had indicated, via email, that it was their understanding that they were not able to trade the shares in the absence of a Cleansing Notice and, as such, in the absence of further evidence to the contrary, any decision by those investors to on-sell their shares was done with actual knowledge. Accordingly, the Court indicated support for the idea that shareholders who on-sell their shares in circumstances where they have knowledge of a breach of the On-Sale Restriction should be differentiated from investors who are not aware of the breach and trade their shares in good faith.

Next steps

If you have any queries about this Insight, get in touch with our team.

Footnotes

[1] Section 727(1) of the Corporations Act.

[2] Section 708(1) of the Corporations Act (20/12 Rule). Generally, this requires: the offer is a personal offer (i.e. made to specific parties known to the company; other offers under the 20/12 Rule have been made to fewer than 20 persons in the previous 12 months; and the new offer will not result in more than $2 million being raised in the previous 12 months in reliance on the 20/12 Rule

[3] Sections  708(8)–(12) of the Corporations Act. Broadly, such persons are presumed not to need disclosure because of their financial capacity, experience, wholesale status or association with the company.

[4] In accordance with 708AA(2)(f) of the Corporations Act as modified by Australian Securities and Investments Commission (ASIC) Corporations (Non-Traditional Rights Issues) Instrument 2016/84.

[5] Including certain ASX Listing Rules.

[6] The applicable securities laws in the place(s) where the offer is made would instead apply.

[7] Importantly, the On-Sale Restriction also applies to any securities / shares issued upon the conversion of convertible securities (e.g. options, performance rights, convertible notes, etc).

[8] Which are usually required to warrant that any issued securities to be quoted on a stock exchange can be on-sold within 12 months of their issue.

[9] For a “low-doc” rights issue under section 708AA of the Corporations Act, a company must issue a Cleansing Notice within 24 hours before the offer is made. In the case of a share purchase plan under ASIC Corporations (Share Purchase and Interest Plans) Instrument 2019/547), a listed company must either issue a Cleansing Notice within 24 hours before making the offer or have previously issued a Cleansing Notice for another issue not more than 30 days before the offer is made.

[10] Although not in the Corporations Act, ASIC’s documented view in ASIC Regulatory Guide 173: Disclosure for on-sale of securities an other financial products is that "5 days" equates to 5 trading days and a company is not considered to be suspended whilst in trading halt.

[11] Until 1 January 2021, this has been extended to 10 days pursuant to ASIC Corporations (Trading Suspensions Relief) Instrument 2020/289, provided that an company’s securities had not been suspended for more than 5 days in the 12 months ending on 19 March 2020.

[12] For example, a prospectus under section 713 in relation to quoted securities.

[13] Re Animoca Brands Corporation Ltd; ex parte Animoca Brans Corporation Ltd [2019] WASC 225.

[14] Associated Beauty Aids Pty Ltd v Federal Commissioner of Taxation (1965) 113 CLR 662, 669.

[15] State of South Australia v Slipper MP [2003] FCA 1414; (2003) 203 ALR 473 [52] - [54].

Important

The contents of this publication should not be relied upon as legal advice, but instead as commentary and general information. Specific legal advice about your circumstances should always be sought separately before taking any action based on this publication.