Sept 2022 (updated Oct 2022)
From 1 October, we expect to see significant changes in the way that companies offer equity to their Australian personnel. For many businesses, new rules in the Corporations Act significantly reduce the red tape associated with offering equity to staff. However, there are some traps which both listed and unlisted companies will need to navigate carefully.
With effect from 1 October 2022, the Corporations Act has been amended to replace the existing class order relief for employee incentive schemes under which most listed companies, and some unlisted companies, have long offered equity to their directors and employees.
When the legislation was passed a few months ago, we outlined the role of these new rules and some of the major changes compared to the class orders. The below provides additional insights about how those rules are likely to work in practice, drawn from our experience planning for and advising clients on these changes in advance of the 1 October transition:
Under the new rules, Parliament has created several pathways through which companies can offer equity under an ESS.
From 1 October, there is effectively a ‘hard way’ and three ‘easy ways’ to offer equity under an ESS. The differences between them are so stark that we expect that most companies will prefer one of the easy ways in the absence of significant countervailing factors, for example, tax or a desire for consistency in ESS structures across multiple countries.
The three ‘easy pathways’ involve (among other requirements):
The offer structures in points 2 and 3 above already exist as exceptions to the disclosure document obligations under Chapter 6D of the Corporations Act. However, structuring offers in those ways will not automatically ensure that a company satisfies other obligations that sometimes apply to employee share schemes, such as financial services licensing requirements and the design and distribution obligations. The role of the new ESS rules is equivalent to the role of the old class orders: by making offers in accordance with the new ESS rules, companies can avoid the need to consider, and if necessary comply with, those other obligations. As the conditions to the ‘easy pathways’ are relatively simple, companies will generally find it attractive to make offers under the new ESS rules rather than working through those other Corporations Act requirements. This includes some companies that did not previously need to rely upon the class orders, as the ESS exemption from the design and distribution obligations in the Corporations Act has now been narrowed
Companies can rely upon a mix of the pathways. Companies could both offer equity for no monetary consideration to their general staff members, and offer equity for monetary consideration under a separate plan for senior managers.
Although the statutory requirements for the ‘easy pathways’ are generally fairly simple, there can be some nuances beyond the requirements outlined above. Companies should still take legal advice about how to offer equity after 1 October.
A particular subtlety arises for companies using trust structures in their ESSs, as the protection afforded by the new ESS rules falls away if there is any breach of the trust deed; even if the breach is immaterial and subsequently cured, and even if the trust is only used for ESS interests granted under small scale offers or offers for no monetary consideration. These companies may therefore need to assess whether certain changes to their trust deeds are desirable to reduce the possibility of such breaches.
The nuances of the ‘easy pathways’ pale in comparison to the complexities and requirements associated with offers under the ‘hard pathway’, which applies if none of the ‘easy pathways’ are available. Many of the requirements under this pathway are significantly more onerous than those presently existing in the class order relief under which companies have offered equity to their directors and employees for many years. The new aspects include:
Given the above, we expect companies going forward will generally prefer to rely upon one of the ‘easy pathways’. So apart from offers limited to senior managers or so-called professional or sophisticated investors, our expectation is that many companies will restructure their ESSs to ensure that no monetary consideration is paid on either grant or exercise, or favour traditional ‘no monetary consideration’ awards such as performance rights. The humble market-priced option will unfortunately be a casualty of the new rules, except where structured to only be exercisable on a cashless (or ‘net’) basis.
Historically, ESS participants in listed company schemes have been able to freely on-sell their ESS shares immediately after acquiring them in reliance on on-sale relief provided in the class orders. For offers made under the new rules (i.e. from 1 October) ESS participants will be prohibited from on-selling their shares within the first 12 months after acquiring them, other than to a narrow group of recipients such as other ESS participants, the senior managers of the company, and certain others who are regarded for the purposes of the Corporations Act as professional or sophisticated investors.
This will create a headache for listed companies as the ASX Listing Rules require that shares in a quoted class be freely tradeable once they are issued.
Unsurprisingly, many in the market have objected to this and just before the new rules went live, ASIC released a consultation paper regarding a potential modification to the Corporations Act (by way of a new legislative instrument) that, if implemented, would generally permit the unrestricted on-sale of shares where they are quoted on ASX (or certain overseas exchanges).
Although we expect ASIC’s proposal to receive widespread support, it is unlikely to take effect until late in 2022 or the beginning of 2023. Unless and until it takes effect, the on-sale issues described above continue to apply. Companies offering ESSs before the modification takes effect should therefore be comfortable that they can satisfy the ASX Listing Rules by other means, such as:
Whether listed or unlisted, any company offering equity incentives to its Australian personnel should, at a minimum, review its plan documentation and processes for compliance with the new ESS rules. In almost all cases, updates will be required – although the nature and complexity of the updates will depend on the structures being used.
The new ESS rules appear fairly straightforward at first blush, but there are a number of traps lurking in the detail. Our commentary above is a summary in nature, and we encourage our clients to seek specific legal advice before offering new equity to directors or employees after 1 October 2022. Please feel free to get in touch to discuss further.
 With effect from 1 October, the ESS exception to the design & distribution obligations in the Corporations Act will only apply to offers made under the new ESS rules. Therefore, companies that have historically made offers outside the class orders (i.e. by satisfying, or meeting relevant exemptions from, the financial services licensing and other Corporations Act requirements) will now need to assess whether their ESSs are caught by the design & distribution obligations. If they are caught, these companies can either switch to making offers under the new ESS rules; or else will now need to comply with the design & distribution obligations, including by making, periodically reviewing, and complying with, ‘target market determinations’.
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