Related party participation in placements: section 208 and Listing Rule 10.11 are not the same approval

A director wants to take part in the placement. It is usually a good signal and it is usually straightforward. It also engages two separate approval regimes with different tests, different exceptions and different notice requirements, and satisfying one does not satisfy the other. The most common error in small-cap raisings is treating a Listing Rule 7.1 approval as if it answers the related party question.

The two regimes

• Chapter 2E. Section 208 of the Corporations Act 2001 (Cth) prohibits a public company giving a financial benefit to a related party unless member approval is obtained under Chapter 2E or an exception applies. Related party is defined in section 228 and includes directors, their spouses and certain relatives, entities controlled by them, and entities that control the company.
• Listing Rule 10.11. A listed entity must not issue equity securities to a related party without the approval of holders of ordinary securities, unless an exception in Listing Rule 10.12 applies. The Listing Rule definition of related party picks up the Corporations Act definition and adds to it, so a person can be a related party for Listing Rule purposes without being one for Chapter 2E purposes.

They overlap. They are not co-extensive. Run both.

Listing Rule 7.1 does not answer either question

This point is worth being blunt about. A resolution approving an issue under Listing Rule 7.1, or a ratification under Listing Rule 7.4, deals with placement capacity. It says nothing about whether the entity was permitted to issue securities to a related party. Conversely, an issue approved under Listing Rule 10.11 is excluded from Listing Rule 7.1 by an exception in Listing Rule 7.2, so it does not consume capacity and does not need ratifying.

The practical consequence is that a director’s participation in a placement generally needs a Listing Rule 10.11 approval, a Chapter 2E analysis, and a separate capacity resolution for the unrelated tranche. Three questions, not one.

Working through Chapter 2E

The analysis has a fixed order. Do not skip to the exception.

• Is the recipient a related party under section 228? Include the look-forward and look-back limbs. A person who was a related party in the previous six months is still one, and so is a person who has reasonable grounds to believe they will become one.
• Is a financial benefit being given? Section 229 requires the benefit to be identified broadly, disregarding whether there is consideration and looking to the economic and commercial substance. An issue of securities is a financial benefit.
• Does an exception apply? The one that usually matters is section 210: a benefit given on terms that would be reasonable if the parties were dealing at arm’s length, or on terms less favourable to the related party. Where a director subscribes on identical terms to the institutional book, at the same price, at the same time, for the same securities, the arm’s length exception is available and is the ordinary answer. It stops being available the moment the terms differ: a discount, attaching options the book did not get, a different settlement date, or an allocation in a book everyone else was scaled out of.
• If no exception applies, get member approval. Section 219 sets out what the explanatory statement must contain, and the material must be lodged with ASIC before it is sent to members.

Working through Listing Rule 10.11

Listing Rule 10.11 is not disapplied by the arm’s length exception. That exception belongs to Chapter 2E. Listing Rule 10.12 has its own list of exceptions, and the ones that come up in practice are a pro rata issue in which the related party participates on the same basis as everyone else, an issue under an underwriting arrangement in specified circumstances, and an issue under a court approved arrangement.

So a placement to a director on arm’s length terms is exempt from section 208 and still requires approval under Listing Rule 10.11. That asymmetry is the single most common misstep in small-cap raisings. It is also why a director’s participation is normally structured as a separate conditional tranche, approved at a subsequent meeting, rather than allotted alongside the book.

Where approval is sought, the Listing Rules set out the notice requirements, and the voting exclusion in Listing Rule 14.11 excludes the related party and their associates from voting.

The structure that works

• Split the raising. Tranche one to unrelated investors within Listing Rule 7.1 or 7.1A capacity, allotted immediately. Tranche two to the related parties, conditional on approval, allotted after the meeting.
• Announce it that way. The announcement should make clear that the related party tranche is subject to shareholder approval, and should not present the aggregate as settled.
• Diarise the allotment deadline. A Listing Rule 10.11 approval carries a period within which the securities must be issued. Missing it means going back to shareholders.
• Do not allot first and approve later. Listing Rule 10.11 is a prohibition on issuing without approval. There is no ratification equivalent. An issue made in breach is a Listing Rule breach and a matter for ASX.

The points that catch people

• Substantial holders with board representation. A holder of 10 per cent or more that has a nominee on the board can be caught. Check the register and the board composition, not just the deed.
• The six month look-back. A person who ceased to be a director four months ago is still a related party for Chapter 2E.
• Underwriting or sub-underwriting by a related party. A director or a related entity underwriting a shortfall is receiving a benefit and may be receiving an issue. Both regimes engage, and the fee needs the same arm’s length analysis as the price.
• Conversion of a related party loan. Converting a director’s loan to equity is an issue of securities to a related party and a financial benefit. The fact the money is already in the company does not change either answer.
• Employee incentive securities. Securities issued to a related party under an incentive scheme have their own treatment under Listing Rule 10.14, which is distinct from Listing Rule 10.11. See our article on ASX’s revised approach to employee incentive scheme securities.

How Luma Legal can help

We structure related party participation in placements for ASX-listed entities, prepare the Chapter 2E and Listing Rule 10.11 analysis and the notices of meeting behind them, and advise boards on the arm’s length assessment. The question to settle before the bookbuild opens is whether the director’s tranche is going in conditional and separate, because that decision is difficult to unwind once the announcement has been released.