Did you get approval? The Hidden Costs of Overlooked Conditions
By Jacqueline Monk, Special Counsel, and Bilgen Bayraktar Abali, Lawyer
Many contracts list certain conditions that have to be satisfied before something else can happen. A business sale agreement may require at least 80% of existing employees to agree to stay on before the sale can go ahead. A supply agreement may require the buyer to formally test and accept materials before payment goes through. Sometimes these conditions are buried in the terms of the contract and get missed.
A recent decision by the NSW District Court (De Lorenzo v CXI Software Pty Ltd) shows how costly missing a condition can be.
What happened?
Malzo loaned $100,000 to CXI by way of a convertible note. Malzo then transferred the convertible note to its director. CXI had to meet two conditions before it could convert the convertible note into shares:
- complete a capital raising of at least $2.5million
- arrange for CXI shareholders to approve the conversion of the convertible notes to shares.
The Court found that the first condition had been met, but that there was no evidence of the second condition being satisfied.
CXI argued that a board resolution approving the conversion of convertible notes to shares meant that shareholders’ approval was not necessary. CXI reasoned that the CXI constitution gave directors full and unencumbered authority and discretion to issue shares without the approval of shareholders.
The Court did not agree with this reasoning and found that unanimous approval of shareholders was required to convert the convertible note into shares. Accordingly, the debt remained on foot and CXI was required to repay that amount to the director.
Key Takeaways
Where shareholder approval (or any other form of approval) is required as a condition in a contract, it is important to ensure that the parties properly obtain and document this approval. Conditions in contracts can come in all shapes and sizes and can require regulatory involvement or third-party engagement (such as mortgagees or, as the case was here, shareholders). It’s important that you understand these conditions when you sign a contract so that you manage cost and risk exposure later on. Walter Baden has extensive experience in advising on commercial contracts and corporate governance matters and can assist with navigating these complexities.