In the fourth edition of Sections of the Corporations Act You May Have Missed, we step away from commercial litigation and insolvency and enter the realm of corporations law; specifically, the Four R’s (the Rarely Remembered Replaceable Rules).

Section 254D of the Corporations Act 2001 (Cth) (Act) requires company directors to offer new shares to existing shareholders before issuing them to third-party purchasers. As one of the Four R’s, section 254D is often extinguished by the provisions of a company’s constitution. As such, it is not a very well-litigated provision. However, as part of the suite of basic corporate governance rules included in the Act, its effect is important for those who have overlooked or ignored it when drafting their company’s constitution, or smaller proprietary companies with less formal and procedural modes of operation.

Rateable offering of shares – s 254D(1)

If a company has not replaced, modified or extinguished section 254D in its constitution, its directors are required, when issuing new shares of a particular class, to offer those shares first to the existing shareholders of that class. These shares must be offered rateably (proportionately) to shareholders based on their existing number of shares. For example, shareholder A, who holds twice as many ordinary shares as shareholder B, must be offered twice as many of the ordinary shares proposed to be issued as those offered to shareholder B.

Notably, public companies need not be concerned about compliance with the replaceable rule – section 254D only applies to proprietary companies. Presumably, this is because of the operational difficulties and procedural costs involved if a large corporation were required to offer new shares to the tens or hundreds of thousands of its existing shareholders.

Resolutions to bypass s 254D(1)

By way of section 254D(4) of the Act, companies are permitted to resolve, at general meetings, to authorize directors to make a particular issue of shares without complying with the general pre-emption right held by existing shareholders under section 254D(1). This does not, however, entitle a company to pass a resolution providing a standing approval of issues of shares without complying with the pre-emptive rights requirement. As highlighted in Chiu v Zhao [2004] FCA 1714, a resolution which purports to authorize directors to make “any future issue of shares without complying with section 254D(1)” is a general authorization and is invalid under section 254D(4), which only permits the authorization of particular issues of shares.

The ability of shareholders to waive their right to pre-emption via resolution may allow the company the flexibility needed to attract particular or specific investors, without having to pass the shares through existing members first. However, it should not be forgotten that such processes may be wielded oppressively, and may give rise to applications under section 233 of the Act.

Court validation of issue of shares