NSW Supreme Court confirms that ASX-listed companies and their underwriters do not owe shareholders any duty of care in the way they conduct accelerated entitlement offers.

The decision is significant since it is the first time that accelerated entitlement offers have received judicial attention and the decision affirms the appropriateness of this form of capital raising and the way it is conducted.

Over the years, a lot of ink has been spilled debating the fairness of accelerated entitlement offers given the differential treatment between institutional and retail shareholders. Several structures have been developed to overcome the potential disadvantages that can arise, with the most popular (at least from the perspective of retail shareholder advocates) being the PAITREO structure, in which retail shareholders can sell their entitlements on ASX immediately after completion of the institutional offer.

This issue was front and centre in the recent NSW Supreme Court decision in RinRim Pty Ltd v Deutsche Bank AG. The proceedings were brought by a significant shareholder who was treated as a retail shareholder in Primary Health Care’s 2008 accelerated renounceable entitlement offer. The shareholder was eligible to be treated as an institutional shareholder but wasn’t and so claimed for the difference between what its entitlements would have received had they been sold in the institutional bookbuild.

At the time of the AREO, the shareholder held 1.76% of Primary’s total shares, and was the 11th largest shareholder. The shareholder was eligible to acquire approximately $20 million worth of new shares under the AREO, or to renounce that entitlement. The shareholder was not a fund manager or institutional investor and so was not accelerated into the institutional component of the AREO, instead being invited to participate in the retail entitlement offer. The shareholder renounced its entitlements and received $400,000. Had it been invited into the institutional offer and renounced its entitlements, it would have received approximately $4.8 million due to the clearance price in the institutional bookbuild being substantially higher than in the retail bookbuild.

6 years after completion of the AREO, the shareholder brought several claims against the underwriters, as well as Primary, including a claim that the underwriters and Primary owed them a duty of care which they had failed to meet causing them loss. This duty of care was said to have required Primary and the underwriters to have invited the shareholder into the institutional offer or to have notified it that it could contact the underwriters to seek inclusion.

The shareholder was unsuccessful. The Court confirmed that neither Primary nor the underwriters owed a duty of care to any shareholders in connection with the conduct of the offer.

The key takeaways for issuers and underwriters alike are:

  1. (No right to be accelerated) provided that the terms of the offer leave it to the discretion of the issuer or the underwriters to designate a person as an “institutional shareholder”, then shareholders not have any inherent “right” to be accelerated into the institutional component of an accelerated entitlement offer (even if they are investors who are exempt from the requirement to receive a prospectus). There is no obligation to contact all institutional shareholders or to accelerate all exempt investors
  2. (No duty of care) the Court was reluctant to recognise a new form of duty for a number of reasons, including that doing so would:

a) make underwriting either more expensive or make AREOs as a form of capital raising unattractive and less obtainable. This demonstrates judicial support for the benefits of an AREO structure; and

b) be unreasonable. To require underwriters to conduct an investigation to ascertain whether each and every shareholder of an issuer was a “sophisticated investor” or “professional investor” under the Corporations Act would be unreasonable (especially having regard to the time available to conduct this exercise, whilst still complying with internal “on-boarding” requirements which are necessary for any investors who are not pre-existing clients of the underwriters).

The shareholder has filed a notice of intention to appeal and so the NSW Court of Appeal may get to consider these issues again.

Based on the decision there are a number of practices (all of which are customary) which are important to bear in mind when conducting accelerated renounceable offers:

  • Any definition of an “Institutional Shareholder” in offer documents should import a discretion on the issuer or underwriters to determine who meets that definition.
  • Offer documents and ASX announcements which explain how to participate in an offer should also include wording whereby the applicant acknowledges that the determination of eligibility of investors for the purposes of the institutional or retail components of the entitlement offer is determined by reference to a number of matters, including legal and regulatory requirements, logistical and registry constraints and the discretion of the issuer and / or the underwriters.
  • In the announcement for the offer, include language which encourages shareholders to contact the share registry or their stockbroker, accountant or other professional adviser if they have any questions about how to participate in the offer.
  • It is helpful to ensure that the underwriting agreement doesn’t impose any obligation on the underwriters (or the issuer) to ensure that all exempt investors are treated as institutional investors. Likewise, any mandate letter or underwriting agreement should expressly state that underwriters do not owe any fiduciary duties to the issuer (and it would also be useful to have the issuer acknowledge that no fiduciary duties are owed by the underwriters to any other person either).