Insights + Resources

August 9, 2019

Blocking the exits: Directors’ rights to decline share transfers

The power to refuse to register share transfers

The default position under Australian corporate law is that:

  • transfers of shares by existing shareholders of a company are not effective until the transfer is registered by directors; and
  • directors may refuse to register transfers of shares in the company for any reason.

Both of the above rules are “replaceable rules” that automatically apply to all companies registered after 1 July 1998. Companies may replace part or all of these through their own Company Constitution. The above rules therefore apply to all companies that have not duly replaced them, and in practice are extremely typical in most Australian Constitutions.

On its’ face, these are powerful rights vested in directors, who can frustrate the ability of a shareholder to transfer their shares and liquidate their investment.

Limits to the power

There are however limits on directors’ powers to refuse transfer of shares. Directors must not breach their fiduciary duties and they must not oppress minority shareholders.

Possible ways of contravening these obligations are outlined below. In considering the exercise of their rights to refuse to register transfers of shares, directors must have regard to these legal principles.

Duty to act in good faith and proper purpose 

Directors of companies have a range of fiduciary duties. One of the most applicable to registering transfers of shares is the duty under section 181 of the Corporations Act (‘the Act’): to act in good faith for the best interests of the corporation and for a proper purpose. Refusing a transfer of shares will breach this duty if the refusal is done for an improper purpose. Acting purely in a director’s own interests, for instance by preventing liquidation of a shareholder’s investment or the acquisition of shares by other entities, would be an impermissible purpose.

An exercise of the power will be proper if the driving purpose behind it is the best interests of the company. When considering the best interests of the company, the directors must consider the company as a whole, including all present and future shareholders and creditors. While directors are not necessarily obliged to make the best economic decisions, the relative commercial merit of a decision is a good basis for the test that directors believe in good faith and in the best interests of the company.

Conversely, the duty to act in good faith may sometimes compel directors to reject share transfers. For example, where the proposed transfer price is below fair value, directors should consider whether they are obliged to exercise their discretionary power to decline to register the transfer pursuant to the company’s Constitution.

Breaches of directors’ duties are serious offences under the Corporations Act 2001 (Cth) and can result in fines of up to $1.05m or 3x the value of any benefit derived from the breach. Further, if the breach is deemed serious enough, disqualification from managing a company or up to 5 years imprisonment.[1]

Shareholder oppression

Where a director’s refusal to register a share transfer is oppressive, unfairly prejudicial, or unfairly discriminatory to the shareholder, a claim for shareholder oppression may arise under section 232 of the Act.

In order to avoid liability and uphold the refusal of a share transfer, a director will need to show that a hypothetical, reasonable director would have thought that the decision was fair in advancing the interests of the company. It is not enough that the rejection of a share transfer is prejudicial or discriminatory to a particular shareholder. It must be oppressive or unfair given the context of the company and its shareholders. 

Shareholders, including minority shareholders, that have been oppressed in this way may make a claim under this section and seek damages from the directors, or potentially a court-ordered transfer of the shares.

Concluding remarks

In many companies, directors are empowered to refuse the transfer of shares. While this power is broad on its face, it is underpinned by rules of law and equity. Directors must take care not to breach their duties to act in the best interests of the company. Further, if they make decisions that are oppressive to shareholders, including minority shareholders, they can be personally liable. Directors are therefore well-advised to be mindful in exercising their powers with respect to share transfers, and to be aware of the potential pitfalls associated with it.

The information above is general in nature. If you would like more information about share transfers and the right to refuse, please contact us below.

[1] However, we are not aware of cases where improperly blocking share transfers has led to these kinds of serious sanctions.

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