Over the last couple of years there has been a significant increase in Federal Court applications being made by companies seeking orders validating secondary trading in securities that were not cleansed by a cleansing notice or cleansing prospectus.

We have sought court orders on behalf of clients in various recent matters.  It can take up to two months or more to obtain such orders. 

An offer of securities by a company will not be valid unless it is made with a prospectus, or one of the exemptions from disclosure applies. The exemptions include offers to sophisticated and professional investors, and small-scale offerings. The disclosure requirements for the issue of securities also apply to any secondary trading within 12 months of the date of issue. This is to avoid situations where securities are validly issued to a sophisticated or professional investor without a prospectus, but are then on-sold within 12 months to ordinary investors.

Companies can ensure that secondary trading within 12 months will be valid by ‘cleansing’ the securities when they are issued. This can be done by issuing a cleansing notice to ASX under s708A(5) of the Corporations Act (Act), or by lodging a cleansing prospectus with ASIC under s708A(11) of the Act.

A failure to cleanse securities when they are issued can have serious ramifications. Offers for sale and sales by shareholders will be in breach of the Act and, importantly, ASX will immediately suspend your securities from trading, and the suspensions can remain in place for extended periods.

Upon becoming aware of any secondary trading in uncleansed shares, a company should apply to the Federal Court for orders pursuant to ss1322(4)(a) and (c) of the Act validating the past trading and relieving on-selling shareholders from civil liability in relation to these sales.  The first step in dealing with the problem is for the company to issue a cleansing prospectus, which will cleanse the securities not then on-sold for future sales.

The pre-conditions for the issue of a valid cleansing notice are contained in s708A(5) of the Act. However, it is important to note that if a company re-complies with the ASX Listing Rules following a reverse takeover, the 5-trading day period does not start from the date that its securities have been (re)instated to official quotation as in an IPO. The company’s securities remain quoted during the period of suspension and as such, a company must look back a full 12 months to determine if it satisfies the 5-trading day condition.

Section 708A(6) of the Act prescribes the contents of a cleansing notice. An important requirement is that the notice must set out any excluded information as at the date of the notice. Excluded information is information that has not been included in a company’s continuous disclosure and would be relevant to investors and professional advisers when assessing the financial position of the company and the rights and liabilities attaching to the securities.  Companies should carefully consider whether the pre-conditions for the issue of a cleansing notice can be satisfied, and what must be set out in the notice.

The courts have generally found it is just and equitable for validating orders to be made. This is essentially because on-selling shareholders have traded in their shares in good faith, and the public policy of the Act would be undermined if validating orders are not made.

In some recent cases company officers have been criticised for not ensuring that securities have been cleansed upon issue, particularly in cases where there has been a repeated failure to cleanse securities upon issue.

In the recent decision of iCandy Interactive Limited [2018] FCA 533, the court gave consideration as to whether it should make an order to the effect that the company’s legal costs incurred in the application should not be paid from company funds. Such an order was made in Re Wave Capital [2003] FCA. While the court in iCandy declined to make such an order, it was made clear that there is potential in appropriate case for costs orders to be made against directors or other officers.

Please contact Steinepreis Paganin if you have any concerns about previous securities issues; unresolved issues may lead to complications when undertaking future capital raisings or other corporate actions by a company.