Schemes of arrangement are subject to discretionary Court approval. The Court recently declined to approve CSR's demerger scheme.

With respect, the Court's reasoning is sparse. No doubt the Court was sensitised by the controversy which followed James Hardie's scheme to quarantine its asbestos liabilities. The CSR decision has been appealed.

It should be emphasised that CSR has always transparently managed any liabilities arising out of claimants' exposure to asbestos products, which were made by CSR many years ago. It was not a purpose of CSR's proposed demerger to quarantine or limit such claims. Post demerger, asbestos claimants would continue to have recourse to the substantial balance sheet of the main CSR entity (New CSR). The sugar and alternative energy spin-off entity (Sucrogen) would be free of the claims only as an incidental effect of the demerger scheme. The scheme was proposed for strategic business reasons to maximise shareholder value, not to seek to quarantine or limit asbestos claims.

The key concern of ASIC and other objectors to the scheme was that the proposed demerger would split the assets of CSR between Sucrogen and New CSR, so that only the assets of New CSR would be available to meet CSR's current and future asbestos liabilities. CSR was mindful of this issue and had engaged specialist actuaries to 'stress-test' its capacity to meet the claims of all of its creditors including future asbestos related liabilities following the demerger. Grant Samuel, the independent expert, determined that on the basis of the actuaries' analysis, it would not be unreasonable for CSR to conclude that the demerger would not have a materially adverse impact on New CSR’s ability to continue to pay its creditors, including future asbestos related claims.

ASIC and the other objectors had engaged their own experts to highlight the uncertainty involved in any actuarial assessment of future asbestos liabilities. They argued that the Court should not approve the scheme unless it was clearly satisfied that the asbestos claimants would be no worse off after the demerger than before. This submission was based on the decision in Stork, where the Court adopted this standard.

Justice Stone was not persuaded the Stork standard was the correct standard to apply in assessing the exercise of the Court's discretion to convene a scheme meeting. Instead her Honour drew upon the principles outlined by Justice Emmett in Re Central Pacific Minerals and concluded that unless the Court is satisfied that the scheme is not consistent with public policy and commercial morality, or does not provide adequate disclosure, it should convene the scheme meeting.

While the Court acknowledged that there was never any guarantee that a company would be able to pay its future creditors, the Court considered that future asbestos claimants had a unique status. The claimants' interest arose not from some future dealing with CSR but from their involuntary exposure to asbestos products supplied by CSR before the demerger even if, in some cases, exposure would not occur until after demerger.

Justice Stone rested her decision not to convene the scheme meeting on the fact that New CSR would bear all present and future asbestos claims, in circumstances where it would have undertaken a significant reduction of capital.

The Court said that the significance of these '…two factors increases with the uncertainty of the actuarial estimates and other expert opinion…'. The Court said that in these circumstances the Court could not '…be satisfied that the provisions made are consistent with commercial morality or that the Scheme, if given effect, would not involve an unfair or oppressive result…'. Further, Justice Stone stated that '…these same issues lead me to conclude that the material in the explanatory statement cannot provide adequate disclosure to CSR shareholders of New CSR's ability to meet these future liabilities…'.

Much is uncertain in the world and in business life. General uncertainty should not impugn a proposed scheme. With respect, what is missing from the Court's reasoning is an explanation of why the uncertainty in this case was sufficiently material to render the transaction immoral, unfair or oppressive, or the disclosure in the scheme booklet inadequate. The demerger was not going to denude New CSR of assets, just reduce them. The coverage of the asbestos liabilities was still very substantial. While unknowable unknowns, particularly in the context of human suffering, make everyone uncomfortable it cannot be that, despite consideration genuine effort, the existence of these unknowns force CSR into some kind of corporate rigor mortis. Taken to an absurd extreme, the same issue would call into question even the payment of a dividend in the ordinary course by CSR.

In our opinion, the controversy surrounding James Hardie's redomicile to The Netherlands and its efforts to quarantine its asbestos related liabilities continues to cast a long shadow. The James Hardie transaction used a scheme approved by the Supreme Court of New South Wales. The asbestos liability estimates before the Court in that case were subsequently found to have been very conservative, so that the quarantined asbestos liability fund was inadequate. As explained above, the CSR case is fundamentally different.

CSR has now been granted leave to appeal to the full Federal Court. No doubt the outcome of the appeal will be observed with interest not just by all CSR stakeholders, but also entities whose operations generate potential environmental or product liability claims.

James Philips, Partner
T:+61 2 9921 4945
james.philips@minterellison.com

Schemes of arrangement continue to be a popular method of structuring friendly takeovers. Schemes are also a conventional mechanism for accomplishing internal reconstructions such as demergers, demutualisations and changing the principal listing or jurisdiction of incorporation of a company (so-called 're-domicile' schemes). Given the prevalence of schemes in the Australian market, it is timely to consider the impact of recent reforms proposed for schemes.

On 28 January 2010, the Commonwealth Government released a report by the Corporations and Markets Advisory Committee (CAMAC) on schemes of arrangement. CAMAC's report sets out a number of recommendations for reform to the scheme rules. This article considers those reforms proposed by CAMAC which are likely to be of practical relevance to listed entities and their advisers contemplating a friendly takeover scheme.

Before considering those reforms, it is worth noting that CAMAC ignored calls from some critics who have lobbied over recent years against the use of schemes to effect friendly takeovers. CAMAC's position is that schemes have a legitimate place as an alternative to a Chapter 6 takeover bid for change of control transactions. This is consistent with ASIC's policy. Minter Ellison shares CAMAC's view that the statutory framework for schemes, including the ASIC review process and judicial oversight, is sound and provides appropriate protections to ensure that changes of control through schemes take place in an efficient, competitive and informed way.

Which leads to the key reforms proposed in CAMAC's report that are likely to be of most interest to market participants. In our view, there are three such proposed reforms.

Repealing the 'headcount test' for shareholder approval of schemes

At present, a scheme requires the approval by a company's shareholders under the following two tests: 

• first, a simple majority in number (i.e. at least 50% plus one) of each class of shareholders who vote at the scheme meeting (either in person, by proxy or otherwise) must vote in favour of the scheme – this is the so-called 'headcount test', and
• secondly, the resolution in favour of the scheme must be passed by at least 75% of the total number of votes cast by the shareholders in each class – this is the so-called 'voted shares test'.

The effect of the headcount test is that each participating shareholder has one vote on the scheme, regardless of the number of shares they hold. The rationale for the headcount test is that it provides a check on the ability of large shareholders to determine the outcome of the scheme vote, and otherwise reduces the possibility of schemes being used to oppress minority shareholders or ignore their interests. However, the headcount test is susceptible to manipulation in that it allows parties who oppose a scheme to engage in share splitting. This occurs where one or more shareholders transfer off-market small parcels of shares to a large number of other persons willing to vote in accordance with the wishes of the transferor. By splitting shares to increase the number of members voting against the scheme, an individual or small group opposed to the scheme may cause the scheme to be defeated. This may occur even though a special majority is achieved under the voted shares test (being the second limb of the current shareholder approval requirements for a scheme).

CAMAC has recommended the removal of the headcount test for the approval of schemes, on the basis that it gives small shareholders disproportionate power and potentially enables them to defeat a scheme. CAMAC considers that decisions on a fundamental corporate matter such as a scheme proposal should be determined by the number of shares voted, rather than the number of shareholders who vote, and that the interests of small shareholders in schemes are already adequately protected.

We support this reform recommendation and note that a stand-alone scheme approval test of 75% of shares voted would be consistent with the voting threshold for other important corporate proposals that may fundamentally affect shareholders. These include changes to a company's constitution and other proposals that call for approval by special resolution.

Abolishing the takeover anti-avoidance requirement

If a scheme is approved by the requisite majority of shareholders, the next step is to seek court approval for the scheme. One aspect of court approval of schemes that has attracted considerable attention over many years is the operation of s411(17) of the Corporations Act. This section provides that the court must not approve a scheme unless:

(a) it is satisfied that the scheme has not been proposed for the purpose of avoiding the takeover provisions in Chapter 6, or

(b) ASIC provides a statement that it has no objection to the scheme.

Both matters do not have to be satisfied: an ASIC no objection statement under paragraph (b) precludes the court from exercising its power under paragraph (a). But if ASIC does not provide its no objection statement under paragraph (b), the proponents of the scheme must satisfy the court that no substantive takeover avoidance purpose exists. Even if ASIC does provide a 'no objection' statement under paragraph (b), the Court can still take into account any avoidance purpose in exercising its discretion whether to approve the scheme.

Section 411(17) has been interpreted by the courts, and applied by ASIC, in a manner that does not preclude the use of schemes to achieve a change of control. Therefore, a party seeking to acquire control of a publicly listed company may choose a scheme over a conventional takeover bid, provided there is some commercial justification for that choice and the target company's board supports the change of control proposal.

However, the precise operation of s411(17), in particular paragraph (a) of that subsection, has not been definitively tested. Consequently, it remains a source of uncertainty. Although schemes have to date survived various challenges over the years in relation to alleged takeover avoidance, this may not always be the case. The possibility remains that a properly funded party will successfully challenge a takeover scheme on the basis that the scheme structure has been chosen to avoid the operation of the takeover provisions of Chapter 6. This is particularly the case given ASIC's unofficial policy of withholding its s411(17)(b) 'no objection' statement at the second court hearing in relation to a takeover type scheme where an objector wishes to argue 'avoidance' of the takeover provisions in Chapter 6 at the approval hearing. For these and other reasons, the existence of s411(17) has for a long time presented a completion risk to a friendly takeover scheme.

CAMAC has recommended the repeal of the takeover avoidance provision in section 411(17)(a). CAMAC notes that this section dates back to the 1970s and early 1980s when the takeover laws in Chapter 6 as we know them today were being formulated. Back then, there was a question mark as to whether schemes were an appropriate alternative structure to takeover bids for achieving a change of control. The concern at that time was that the scheme provisions were never drafted with takeovers in mind. Accordingly, s411(17) was introduced as a statutory safeguard. However, over the past 25 years, the courts have consistently stated that a scheme of arrangement is an appropriate alternative mechanism for effecting a change of control transaction. Accordingly, CAMAC considers that section 411(17)(a) no longer fulfils any real purpose.

CAMAC recommends that section 411(17) be recast so that:

• section 411(17)(a) is repealed
• ASIC retains the right to provide the court with a statement of objection or no objection in relation to the proposed scheme, and
• the court retains the ultimate power to approve or reject a scheme, irrespective of whether or not ASIC provides a 'no objection' statement.

We support this reform recommendation, as we believe that the repeal of section 411(17)(a) removes the current uncertainty and completion risk associated with a potential challenge to the scheme on takeover avoidance grounds.

Extending the scheme provisions to listed managed investment schemes

Listed managed investment schemes form a significant portion of the market for ASX listed securities. For example, listed property trusts represent approximately 10% of the ASX index. The growth in the number and market capitalisation of listed managed investment schemes is partly attributable to the growth of superannuation funds, as well as to the emergence of 'stapled' entity structures involving a combination of shares in a listed company stapled to units in a listed managed investment scheme. At present, the scheme provisions cannot be utilised by listed managed investment schemes. Consequently, the restructuring of listed managed investment schemes is usually more complicated and involves compliance with a combination of trust and corporate laws. In contrast, the takeover bid provisions were amended in March 2000 to allow for takeovers of listed managed investment schemes, as well as companies.

CAMAC recommends the extension of the scheme provisions to both listed and unlisted managed investment schemes. This would allow changes of control or other reorganisations of managed investment schemes to be undertaken in a simpler, more transparent and streamlined way, rather than the current approach whereby unitholders are required to pass a special resolution amending the constitution of their managed investment scheme to authorise a cancellation or transfer of units, as well as a separate resolution to permit the intending controller to acquire more than 20% of the units. It would also provide greater certainty of outcome, particularly in the case of stapled structures, as the scheme meetings of the company and the managed investment scheme would potentially run simultaneously. Extending the scheme of arrangement provisions to listed managed investment schemes will also better protect the interests of unitholders, including through ASIC involvement and court review of a proposed scheme.

Conclusion

Other reforms proposed by CAMAC include streamlining and simplifying the disclosure requirements for scheme explanatory statements so that information is presented to shareholders in a clearer and more concise manner. The aim is to discourage companies from including extraneous or only marginally relevant information that results in voluminous and less comprehensible scheme documents, in the belief that potential liability is minimised by including more rather than less material.

CAMAC has also acknowledged the anomaly in directors having due diligence defences in takeover and fundraising documents but not for scheme documents. CAMAC supports a principle of harmonising the liability and due diligence defences across all disclosure documents and explanatory materials produced by listed entities, whether for fundraising, takeovers or schemes.

Overall, the reforms proposed by CAMAC are sound and are generally well supported. The reforms will assist in strengthening the important role that schemes play in the Australian market for control of listed entities.

For further information please contact:

Alberto Colla, Partner
T:+61 3 8608 2754
alberto.colla@minterellison.com

Investments or acquisitions in convertible notes and options are now subject to the same approval requirements as investments or acquisitions in shares.

The monetary thresholds applicable to private business investment have been raised with effect as of 1 January 2010 to total assets of the investee of A$231m and, for U.S. investors, A$1004m.

The changes do not target Chinese acquirers, but Chinese acquirers remain concerned about the Australian foreign investment approval process.

Convertible notes and options

On 12 February 2010 the Foreign Acquisitions and Takeovers Amendment Bill 2010 received Royal assent (2010 Act), and therefore came into operation. The legislation applies retrospectively to proposals received from 12 February 2009, when the proposed Bill was announced by the Commonwealth Treasurer.

The 2010 Act amends the Foreign Acquisitions and Takeovers Act 1975 by expanding the concept of 'voting power' to include a new concept of 'potential voting power'. Other amendments are to similar effect. This means that securities conferring a contingent right to receive voting shares will now be treated, for the purposes of the 2010 Act, in substantially the same way as voting shares. Relevantly, as noted above, investments or acquisitions in convertible notes and options are now subject to the same approval requirements as investments or acquisitions in shares. In the language of the 12 February 2009 announcement: '… the amendments will ensure that any investment, including through instruments such as convertible notes, will be treated as equity for the purposes of the Act.'

As a result of the 2010 Act, the position now is that a party must notify the Treasurer (through FIRB) if:

• the party is acquiring securities which will takes its holding in the entity that issued the securities through the 15% (or 40% when aggregated with the holdings of associates) threshold calculated on a diluted basis (i.e. treating any convertible securities as though they were shares), and
  
• the investee entity is over the applicable threshold in size (see below).

Equity investments structured using convertible securities will now in effect be treated as though the conversion event had already occurred. Of course, the previous rules also continue to apply so there is no avoiding notification of a non-convertible acquisition just because other people hold convertible securities.

The changes to the thresholds give effect to indexation for inflation.

The thresholds:

• are calculated on the basis of the gross assets of the business or corporation in which an interest is being acquired, not, for example, the net assets or (in some circumstances) value of or imputed by the relevant acquisition,
  
• do not apply to acquisitions by sovereign wealth funds or state-owned entities. Such acquirers do not have the benefit of any threshold, and must seek approval for acquisitions in businesses or corporations with gross assets below or above the thresholds.

Minter Ellison is actively assisting potential acquirers of Australian assets from the People's Republic of China to understand and successfully work through the Australian foreign investment approval process. An article in our November 2009 Mergers and Acquisitions note (Finding consistent messages in FIRB’s approach to Chinese investment) addressed this topic. We have published several bilingual guides and a number of case studies on the topic: www.minterellison.com.cn

For further information please contact:

James Philips, Partner
T:+61 2 9921 4945
james.philips@minterellison.com

The tightening of the credit market in Australia has led a significant number of companies to explore raising further capital by issuing additional equity to new or existing holders. Unlike taking on additional debt, the issue of new equity by a company can result in a change of control. Where the company is listed on the Australian Securities Exchange (ASX), this may give rise to various issues under both the Corporations Act and the ASX Listing Rules.

The basic position established by section 606 of the Corporations Act is that a person cannot acquire a relevant interest in 20 percent or more of a listed company, or an unlisted company with more than 50 members except in certain narrowly defined circumstances. The two exceptions to this prohibition that are most relevant to an entitlement offer are those described in section 611, item 10 (relating to interests acquired via rights issues) and section 611, item 13 (relating to interests acquired via the underwriting of a public capital raising). The Takeovers Panel emphasised in Guidance Note 17: Rights Issues that entitlement offers falling within item 10 or item 13 of section 611 could give rise to unacceptable circumstances depending on their structure. ASIC also stated in Regulatory Guide 159: Takeovers, compulsory acquisitions and substantial holding notices that it will consider making an application to the Panel if it considers that these exceptions are being abused.

The Takeovers Panel recently had the opportunity to consider its approach to these issues in the context of proceedings concerning a 178:1 pro rata non-renounceable entitlement offer by the Multiplex Prime Property Fund (MAFCA) administered by its responsible entity, Brookfield Multiplex Capital Management Ltd (BMCM). MAFCA had announced the entitlement offer as a means of raising capital to remedy breaches of loan to valuation covenants with its financiers. These breaches had been waived for several months but MAFCA advised the Panel that the waiver would not be extended any further.

Structure of the entitlement offer

The entitlement offer was to be wholly underwritten by a related entity, Brookfield Multiplex Capital Securities Ltd (BMCS) in its capacity as the trustee of another Brookfield Multiplex fund. The entitlement offer also included a 'cash-out' facility under which BMCS would buy units in MAFCA from existing holders at 0.1 cent per unit. A waiver was required from ASX to allow the entitlement offer to proceed in its proposed form, because ASX Listing Rule 7.11.3 prohibits the ratio of securities offered under a non-renounceable issue being greater than 1:1.

As initially proposed, the entitlement offer did not include a shortfall facility or a bookbuild. This meant that any units not taken up by existing unitholders would be taken up by BMCS in its capacity as the underwriter of the offer. Given the 178:1 ratio of the offer, it was likely that unless a large number of current unit holders took up their entitlements, BMCS would become the holder of a significant, perhaps even controlling, interest in MAFCA.

Applications to the Panel

While preparations for the entitlement offer were continuing, Australian Style Investments Pty Ltd (Australian Style) and Grocon Investment Management Pty Ltd (Grocon) were making their own moves to acquire interests in MAFCA. Australian Style attempted to make an on-market takeover bid for MAFCA units, but the Panel found that the bid was coercive and could not proceed (see the November edition of Mergers & Acquisitions for an overview of the Panel decision). Grocon had put a number of alternative recapitalisation proposals to MAFCA in the months leading up to the announcement of the entitlement offer, but these had each been rejected by the BMCS board.

Both Australian Style and Grocon lodged applications with the Panel seeking declarations of unacceptable circumstances soon after MAFCA released the booklet containing the terms of the entitlement offer to the ASX. Among other things, both applications claimed that structure of the entitlement offer had an unacceptable control effect on MAFCA. The Panel quickly announced (see Multiplex Prime Property Fund 04 [2009] ATP 21) that it would not be proceeding with Grocon's application because it had been made late, and because the only matters raised in it that the Panel considered to be substantive were also raised in the application lodged by Australian Style to which Grocon had also been made a party.

Control issues

The Panel decided to conduct proceedings on the application by Australian Style in relation to whether the structure of the entitlement offer and further actions taken by MAFCA mitigated any potential control impact of the entitlement offer (see Multiplex Prime Property Fund 03 [2009] ATP 22). The Panel noted that the factors to be taken into account when assessing the offer included ratio, pricing, renounceability, underwriting and the dispersion of any shortfall.

Ratio, pricing and renounceability

The Panel noted that normally a massively dilutive rights issue of the kind proposed would not be acceptable. However, because it appeared to be the only way for MAFCA to obtain the funding that it required by the deadline set by its financiers, the Panel was prepared to accept the decisions made by MAFCA regarding the ratio, pricing and renounceability of the offer.

Underwriting

Australian Style had complained in relation to the underwriting arrangements between MAFCA and BMCS that it appeared that the entitlement offer had been structured so as to effect a change of control in favour of BMCS without BMCS having to undertake a formal takeover bid. The Panel noted BMCS's submission that, given MAFCA's financial distress, it was unlikely that any other entity would be willing to act as underwriter. BMCS also argued that it was not interested in taking control of MAFCA but wanted to protect the Brookfield Multiplex group's investment in MAFCA from the prejudice that it might suffer if MAFCA was wound-up. The Panel did not find that the underwriting arrangements were unacceptable.

Shortfall

The Panel was not prepared to accept a structure that did not have some measures in place to minimise the potential consequences of the entitlement offer on the control of MAFCA. To address these concerns, BMCM agreed to institute a shortfall facility for existing unitholders and a bookbuild to deal with any shortfall before it was allocated to the underwriter. BMCM further undertook to remove certain conditions it was initially minded to place on the use of these measures including that:

• there would be no allocation of units to a person under the offer if to do so could cause that person's voting power in MAFCA to exceed 20%, and
  
• a person would only be allocated units in excess of the amount required to give that person a 'substantial holding' in MAFCA if the person made a public statement that the they intended to retain the units for a certain period of time, and demonstrated to BMCM that they had the financial ability to pay all further calls that might be made on the MAFCA units.

Following the offer's close, BMCM announced to the ASX that, through a combination of applications under the offer and the shortfall facility, 51.6% of the new units on offer were taken up by existing unit holders. BMCM announced on the following day that a further 3.34% of new units had been taken up in the institutional bookbuild, with BMCS taking up the remaining 45% of new units in its capacity as the offer's underwriter.

Conclusion

The Panel decided that the structure of MAFCA's entitlement offer did not warrant the declaration of unacceptable circumstances – a decision subsequently upheld by a further review Panel (see Multiplex Prime Property Fund 03R [2009] ATP 23). The Panel made it clear that this was almost entirely due to the extreme state of financial distress that MAFCA found itself in, and the lack of any realistic alternative course of action other than defaulting on its financial covenants and being wound-up. Even in these circumstances, the Panel was reluctant to find that a non-renounceable entitlement offer resulting in massive dilution of holders that did not take up their entitlement was acceptable. It would still have refused to accept the structure proposed without the addition of the shortfall facility and bookbuild. The lesson flowing from the Panel's approach is that the potential control impacts of entitlement offers can no longer be brushed aside as unavoidable 'side effects', but are key considerations that must be addressed by issuers to avoid Panel action..