Jurisdiction - Australia
Regulatory & Compliance
Ashurst

15 January, 2013

 

Legal News & Analysis – Asia Pacific – Australia – Regulatory & Compliance

 

Corporations Legislation Amendment (Remuneration Disclosures and Other Measures) Bill 2012

 

WHAT YOU NEED TO KNOW

 

  • On 17 December 2012, the exposure draft of the Corporations Legislation Amendment (Remuneration Disclosures and Other Measures) Bill 2012 was released.
  • The Bill is intended to clarify the operation of the dividend test in section 254T of the Corporations Act 2001 (Cth), but in the process may have destroyed the original rationale for that new test.
  • The Bill also effects the Government’s further reforms to disclosure of executive remuneration, with proposals to require listed companies to disclose details of their “remuneration governance framework” and the total amounts paid to key management personnel (“KMP“) during the financial year attributable to past pay or present pay or remuneration granted during the year but payable in future years. The Bill also includes the Government’s proposal around disclosures relating to the “claw back” of remuneration where there has been a material misstatement or omission in financial statements for prior years.
  • The deadline for submissions on the exposure draft is 15 March 2013.

 

Dividends

 

The current section 254T was introduced into the Corporations Act by the Corporations Amendment (Corporate Reporting Reform) Act 2010 (Cth). With effect from 28 June 2010, it replaced the former section which provided that a dividend could be paid only out of profits. The current section 254T prohibits a company paying a dividend unless:

 

  • the company’s assets exceed its liabilities immediately before the dividend is declared and the excess is sufficient for the payment of the dividend; and
  • the payment of the dividend is fair and reasonable to the company’s shareholders as a whole; and
  • the payment of the dividend does not materially prejudice the company’s ability to pay its creditors. Assets and liabilities are to be calculated in accordance with the accounting standards in force at the relevant time.

 

The Bill proposes that the current section 254T be replaced with a new section 254T. Proposed subsection (1) of the new section relates to the declaration of dividends and subsection (2) to paying a dividend without a declaration. They are in similar form (the words in square brackets are the words used in subsection (2)):

 

A company must not declare [pay] a dividend unless, immediately before the dividend is declared [paid]:

 

a) the company’s assets exceed its liabilities, and the excess is sufficient for the payment of the dividend; and

 

b) the directors of the company reasonably believe that the company will, immediately after the dividend is declared [paid], be solvent.

 

The proposed new section 254T recognises that it is common practice for directors of companies to determine to pay a dividend, rather than declare a dividend. The current section 254T appears to assume that all dividends are declared before they are paid.

 

The second and third limbs of the current section 254T are dropped from the proposed new section 254T:

 

  • The second limb, namely, that payment of the dividend must be fair and reasonable to shareholders as a whole, is dropped entirely.
  • The third limb, that the payment of the dividend must not materially prejudice the company’s ability to pay its creditors, is replaced with the more specific and less onerous requirement that the directors must reasonably believe that the company will, immediately after the dividend is declared [paid], be solvent. This aligns section 254T with the requirements of section 588G of the Corporations Act (director’s duty to prevent insolvent trading).

 

If there is no doubt about a company’s solvency, then the proposed new section 254T will, in effect, simply prohibit a company declaring/paying a dividend unless the company’s assets exceed its liabilities by an amount sufficient for the payment of the dividend. But if the excess is sufficient, can the company pay the dividend notwithstanding that it has no profits from which to do so? In that situation, where the dividend is being paid out of capital, must the company satisfy the requirements (including shareholder approval) for a reduction of capital? Apparently, yes. The draft explanatory memorandum (“EM“) to the Bill states that:

 

The new dividends test does not displace the existing requirements in relation to conducting share capital reductions and share buy-backs under Part 2J of the Corporations Act. These provisions will continue to apply under the new dividends test. (at paragraph 1.16)

 

This seems to be at odds with Parliament’s previous clear intention to do away with the profits test. It is also inconsistent with previous statements made by Treasury (most recently in its discussion paper Proposed Amendments to the Corporations Act released in November 2011) where it was stated that the “Treasury considers that the test for paying a dividend in section 254T of the Act is a circumstance where a reduction in capital is ‘otherwise authorised’ by the law.”

 

It is not now easy to discern any rationale for replacing the profits test contained in the original section 254T. A dividend paid other than out of profits, will be subject to the rules governing capital reductions in Part 2J.

 

The proposed new section will at least clarify that assets and liabilities for the purpose of the test are to be calculated in accordance with accounting standards only where a company is required to prepare a financial report. Otherwise, the calculation can be made in accordance with the company’s financial records.

 

Executive remuneration

 

The additional reforms to executive remuneration disclosure will, if enacted, apply to remuneration reports for financial years starting on or after 1 July 2013. The changes contemplated by the Bill are likely to increase the amount of disclosure in listed companies’ remuneration reports. It remains to be seen whether the proposals, in particular those relating to disclosures about “remuneration governance frameworks” and “remuneration outcomes” (described below), will address complaints that remuneration reports are overly complex and lengthy.

 

The proposed reforms to executive remuneration are summarised as follows:

 

Proposed reform Comment
Description of the company’s “remuneration governance framework”

The remuneration report must include a description of the company’s process (the remuneration governance framework) for determining remuneration of KMP for the company (or if applicable, the consolidated entity).

 

Alternatively, if the framework is set out in the financial report or in another section of the directors’ report, the remuneration report must contain details of where it is set out.

 

(new section 300A(1)(aa))

 

The Bill does not mandate the content of the disclosure about a company’s “remuneration governance framework”.

 

The draft EM to the Bill notes that a description of the remuneration governance framework could include:

  • qualifications and experience of each member of a company’s remuneration committee;
  • length of time the chair of the committee has served in that capacity;
  • changes in the composition of the committee since the last remuneration report;
  • management advice to the committee;
  • conflicts of interest that may have arisen and how they were managed; and
  • general “wrap up” information, namely any other information that a shareholder would reasonably require to make an informed assessment of the remuneration governance framework of the company.

 

Remuneration outcomes

The remuneration report must include, for each KMP, the total amount of remuneration that was:

 

  • granted before the start of the year and paid to the person during the year;
  • granted and paid to the person during the year; and
  • granted during the year (whether or not payment is dependent on satisfaction of a performance condition), but that is not to be paid until after the end of the year.

 

(new section 300A(1)(ca))

This change is intended to ensure companies disclose KMP remuneration information in a manner that will enable shareholders to distinguish between present pay, future pay and pay that has been received due to past pay being crystallised.

 

The amounts to be disclosed for “past pay” and present pay” are those amounts actually paid.

 

This change is aimed at giving readers information on “take home” pay of KMPs. It is in addition to the KMP remuneration disclosures currently included in remuneration reports, describing the various components of total remuneration. Disclosing the remuneration outcomes for all KMPs will add to the length of remuneration reports (eg additional tables of data). Listed entities might also consider including explanations of how the “past pay”, “present pay”, disclosures etc are reconciled to the full remuneration disclosure.

Options

If options granted to a KMP as remuneration lapse during the year – the number of those options and the year in which they were granted must be disclosed in the remuneration report.

 

(new section 300A(1)(e)(iv))

 

The requirement to disclose the percentage of the value of the person’s remuneration for the year that consists of options is to be repealed (current section 300A(1)(e)(vi))

 

This change will remove the requirement to report on the value of “lapsed” options.

 

Item 15 of Corporations Regulations 2M.3.03 will continue to require disclosure of the number and value of any options that have been granted during the reporting period and the number of options that have vested during that period.

Benefits on termination

The remuneration report must contain for each KMP details of:

 

  • the benefits to be given by the company or a related body corporate to the person in connection with the person’s retirement from an office or position of employment in the company, if a failure to give the benefit would constitute a contravention of a law in Australia or elsewhere (otherwise than due to a breach of contract or trust);
  • the benefits to be given by the company or a related body corporate to the person in connection with the person’s retirement from an office or position of employment in the company, if the above paragraph does not apply to the benefit; and
  • any other benefits to be given to the person, or arrangements entered into or to be entered into with the person, by the company or a related body corporate, that relates or that will relate to a period beginning after the person’s retirement from an office or position of employment with the company (whether or not the benefit is required to be given or the arrangement required to be entered into under a contract or in accordance with any law).

 

A reference to a benefit given in connection with a person’s retirement from an office or position of employment with a company has the same meaning as in section 200A. (new section 300A(1)(ea) and (5))

This change will require companies to disclose details of non-contractual payments made to a KMP “in connection with” the person’s retirement. This will include amounts paid that reflect statutory and other accumulated payments, amounts paid specifically for termination, and a summary of post-severance arrangements (eg consulting services provided by the executive post termination).

 

The draft EM states that the definition of “benefit” is given by section 200A. Strictly, section 200A defines circumstances when a benefit is given in connection with a person’s retirement. Section 200AB defines “benefit” for the purpose of the termination benefit provisions in Part 2D.2. Otherwise, section 9 defines benefit to be “any benefit”.

 

Therefore, benefit, as used in the proposed new disclosure requirement, is broader than that which applies for the termination benefit provisions in Part 2D.2. On this basis, payments that are not benefits for Part 2D.2 (eg see those items in Corporations Regulation 2D.2.02(2)), may nevertheless be benefits for disclosure purposes.

 

 

 

Claw back where material misstatement or omission in financial reports

If the company becomes aware during the financial year of a “material misstatement or omission” in the financial statements in relation to the company in any of the previous 3 financial years, the remuneration report must include details for each KMP:

 

  • of any reduction, repayment or other alteration of the person’s remuneration made, or to be made, because of the misstatement or omission; or
  • if a reduction, repayment or alteration of the person’s remuneration has not been made, and will not be made, because of the misstatement or omission – an explanation of why.

 

A misstatement or omission in the financial statements for a financial year is a material misstatement or omission if the misstatement or omission is material within the meaning of the accounting standards.

 

(new section 300A(1)(i))

 

Rather than proposing prescriptive rules about the claw back of prior years’ remuneration following a material misstatement of a prior year’s financial report, the Bill proposes a disclosure-based approach.

 

If a material misstatement or omission arises, the company’s response in respect of KMP remuneration must be disclosed. Shareholders will then be able to consider that disclosure when they come to vote to adopt the remuneration report and the spill resolution, etc.

 

The disclosure obligation only relates to action taken in respect of people who were KMPs during the year being reported on. The proposed sub-section, as drafted, does not require disclosure of actions taken in respect of former KMPs.

 

For the concept of material misstatement or omission, the draft EM refers to AASB 1031: “omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. The size or nature of the item, or a combination of both, could be the determining factor.”

 

As an aside, if a listed company discovers a material misstatement or omission in its financial report for a prior year, changes to remuneration payable to KMPs will be one of a number of issues the company may need to respond to.

 

Other changes The Bill also proposes to:

 

  • relieve unlisted disclosing companies from the obligation to prepare a remuneration report. Rather, the obligation will apply only to listed companies; and
  • relieve companies limited by guarantee with annual revenue less than $1 million from the requirement to appoint an auditor;
  • transfer the remuneration setting responsibility for the offices of the Financial Reporting Council, the Australian Accounting Standards Board and the Auditing and Assurance Standards Board to the Remuneration Tribunal.

  

  

For further information, please contact:

 

Corey Lewis, Ashurst

corey.lewis@ashurst.com

 

Geoff Hone, Ashurst

geoff.hone@ashurst.com

 

 

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