The Victorian Supreme Court has found no unfairness or unreasonableness resulted from a proposal to borrow $25 million to fund a return of capital to preferred shareholders, despite the fact that previous management had adopted a less risky strategy with the intention that the return of capital would be paid from earnings rather than borrowings.
KGD Investments Pty Ltd (KGD) owned approximately 24% of the shares in Placard Holdings Pty Ltd (Placard Holdings). The remaining 76% of shares were owned by external investors and members of Placard Holdings’ senior management team (Investors and Management) and carried preferred rights to receive dividends or other distributions until the Investors and Management had recovered the amount paid for the shares.
The Placard Group CEO proposed to borrow an additional $29 million from Bankwest, of which:
- $25 million would be used to pay a special dividend, by virtue of which the Investors and Management would recover the balance of the amount paid for their shares, with the rest to be divided amongst all shareholders on a pro rata basis; and
- the remaining $4 million would be allocated to working capital (Proposal).
KGD opposed the Proposal on the following bases:
- it would be contrary to the interests of the members of Placard Holdings as a whole and/or oppressive to, unfairly prejudicial to or unfairly discriminatory against KGD in contravention of section 232(d) and 232(e) of the Corporations Act 2001 (Cth) (Act) respectively; and/or
- it was not fair and reasonable to the Placard Holdings’ shareholders as a whole within the meaning of section 254T(1)(b) of the Act.
It was not disputed in expert evidence that increased borrowings will decrease profitability or affect the liquidity of Placard Holdings to the extent of the increased interest expense, or that debt will increase resulting in higher leverage and reduced equity. However, Almond J in the Supreme Court of Victoria rejected KGD’s claims on the basis of expert evidence which included the following:
- the debt was predicted to be repaid due to high revenue forecasts for the next 4 years;
- the risk that customers would terminate, or not renew, their contracts simply as a result of the additional debt was low;
- the proposed new Bankwest facility would include more favourable terms such as lower amortisation payments and a lower interest rate;
- replacing equity with debt is likely to be beneficial to Placard Holdings;
- after making allowance for permitted dividend distributions, the cash position under the proposed new BankWest facility would be higher than under the status quo; and
- the Proposal would not have an adverse effect on any future sale of Placard Holdings.
Almond J further held that:
- there was some permissible lopsidedness introduced into the management of Placard Holdings because the Investors and Management were entitled to a preferential return of capital;
- just because a changed management style adopts a higher risk strategy with the company becoming more leveraged and susceptible to a significant downturn of business (under the previous CEO, the Placard Group did not have significant borrowings with the intention being that the return of capital would occur progressively though earnings, rather than a lump sum borrowing) does not mean that the Proposal provides grounds for an order under section 233 of the Act, or contravenes section 254T of the Act; and
- the Proposal, viewed objectively, was commercially justifiable and made due allowance for risk.