Introduction
The COVID-19 pandemic is not only a global health crisis, but also a global economic crisis. There is no doubt that apart from home-gym equipment suppliers and toilet paper manufacturers, many companies are experiencing unprecedented financial difficulties as a result of the outbreak, a symptom that may not be life-threatening, but is certainly livelihood-threatening. Directors are spending long hours formulating operational and financial action plans in order to sustainably navigate their company through uncertain times, in accordance with their directors’ duties and in the best interests of the company. Companies need their directors now more than ever, but the elephant in the room is how a company will remunerate directors at a time where balance sheets are starting to cause concern. Directors may agree to deferred fee payments, but given it is not known how long this pandemic will last and the extent of the consequences well after life returns to “normal”, companies may wish to consider alternative compensation options available to them to remunerate directors during uncertain times.
Equity-based remuneration
Companies have the ability to issue shares in the capital of the company in lieu of making cash payments to directors. In addition to conserving the company’s cash reserves, issuing shares to directors may also have the benefit of further aligning the interest of directors with that of the company’s shareholders through directors having direct ownership in the company.
The equity-based payments can be achieved as a “one-off” measure by obtaining approval from the company’s shareholders to issue securities with a certain value in lieu of the relevant director’s fees. This method is a somewhat short-term option. Alternatively, the company may consider implementing a director fee equity plan (Director Fee Equity Plan), whereby directors can elect to sacrifice all or a portion of their fees to acquire shares in the company over a certain period. In this case, approval is sought from shareholders to approve the Director Fee Equity Plan and issue shares under the Director Fee Equity Plan.
There are a number of commercial and regulatory considerations a company must take into account when proposing the equity based remuneration alternative. Accordingly, in this article Partner Michele Muscillo outlines how listed entities may implement these share-based payment alternatives from a legal perspective, in order to remunerate directors reasonably and appropriately.
Step 1: Review your constitution, letters of appointment and service agreements
It is important that the Board turns its mind to the company’s constitution, each individual director’s letter of appointment and/or service agreement. This is an important step to determine the ability of the company to issue securities to directors, as well as confirming the maximum aggregate amount the company may pay to its non-executive directors (this amount may only be amended by obtaining shareholder approval under rule 10.17 of the ASX Listing Rules (Listing Rules), so it is also important to determine the current approved director fee pool).
Step 2: Formulate your Director Fee Equity Plan (if desired)
This sounds a lot more exciting than what it is in practice. As mentioned above a company can obtain approval from shareholders to make a “one-off” issue of a certain number of shares to directors in lieu of paying a certain portion of director fees in cash. The approvals required in this regard are set out below.
Alternatively, the company may wish to have the ability to issue shares in lieu of fees (if elected by a director) over a period of time which can be achieved through a shareholder approved Director Fee Equity Plan (whilst contemporaneously obtaining approval from shareholders for the maximum number of shares under the plan over a period).
Some features of a Director Fee Equity plan include:
- providing a process for directors to elect to receive shares in lieu of some or all of their director’s fees;
- permitting shares to be issued directly to the director or their nominee;
- including a mechanism for determining the issue price of the shares; and
- setting the maximum number of shares to be issued under the plan.
Step 3: The approval process
Given issuing shares to a director (regardless of whether these are being issued in lieu of fees or not) constitutes a transaction between the company and a related party of the company, the company is required to comply with Chapter 2E of the Corporations Act 2001 (Cth) (Corporations Act) and Chapter 10 of the Listing Rules in order to issue shares to directors and if desired, implement a Director Fee Equity Plan.
Chapter 10 of the Listing Rules deals with transactions between an entity and persons in a position to influence that entity. Specifically, Listing Rule 10.11 provides that, unless an exception applies, the company must not, without the approval of shareholders, issue or agree to issue equity securities to a related party of the company. Accordingly, the company will be required to convene a meeting of its shareholders to obtain approval pursuant to Listing Rule 10.11 to issue shares to directors in lieu of paying fees.
Where the company also proposes to implement a Director Fee Equity Plan, its adoption also requires approval pursuant to Listing Rule 10.14.
In conjunction with obtaining shareholder approval under Listing Rule 10.11 and 10.14 (as applicable), the company should also seek approval for the issue of the fee shares as an exception to the company’s available 15% placement capacity under Listing Rule 7.1 (pursuant to Listing Rule 7.2 Exception 14). This means that any fee shares issued to the directors will not count towards the company’s 15% placement capacity. ASX has recently amended the Listing Rules to provide a temporary uplift to placement capacity under Listing Rule 7.1 to 25%. Further details regarding this change and other amendments designed to assist companies during COVID-19 can be foundhere.
At a high level the notice of meeting must include, amongst other matters, details of:
- who will be receiving the securities;
- the number of shares to be issued (where a plan is being implemented, companies will often obtain approval to issue the maximum number of shares under the plan);
- details of the relevant director’s total remuneration package;
- the date or dates on which or by which the shares will be issued to the director. Where approval is being obtained under Listing Rule 10.11 the securities must be issued no more than one month after the date of the meeting;
- the purpose of the issue;
- issue price of the securities; and
- a voting exclusion statement.
Where a Director Fee Equity Plan is being implemented, the material terms of the plan and if applicable, the number of securities previously issued to the director under the plan must also be included.
As noted above, it is also important to consider the shareholder approved non-executive fee pool limit as this will cap the number of shares that can be issued.
Chapter 2E of the Corporations Act prohibits a public company from giving a financial benefit (such as shares) to a related party (which includes a director) of the public company unless providing the benefit falls within a prescribed exception. It is therefore important that the Board consider the provisions in Chapter 2E of the Corporations Act to confirm the issue of shares to directors in lieu of fees constitutes reasonable remuneration negotiated on an arm’s length basis. If there are any concerns around this aspect, the company should also obtain shareholder approval for the purposes of Chapter 2E of the Corporations Act.
Step 4: Points to consider
Additional points that a company may need to consider are:
- The application of the ASX Corporate Governance Council’s Corporate Governance Principles and Recommendations (4th Edition) (Corporate Governance Principles). Relevant Recommendations include:
- recommendations 2.3 and 2.4 – a listed entity should disclose the names of directors it considers to be independent, and a majority of the board should be independent directors. A relevant factor in considering independence is whether the director receives performance-based remuneration or participates in an employee incentive scheme of the entity;
- recommendation 8.2 – a listed entity should separately disclose its policy and practices regarding the remuneration of non-executive directors and executive directors and other senior executives. The Corporate Governance Principles suggest that non-executive directors should not receive performance-based remuneration as it may lead to bias in their decision-making and compromise their objectivity.
A company should therefore ensure that it only issues ordinary shares to non-executive directors and refrain from issuing options with performance hurdles, if it wishes to maintain their independence in compliance with the Corporate Governance Principles.
- Ensuring the company continues to comply with its continuous disclosure requirements in accordance with Chapter 3 regarding notification of director’s interests in the company.
If you require further advice or assistance with implementing share-based remuneration for directors, please contact our Corporate Advisory team.