In the summer of 2014, we wrote about the regulatory limits on major shareholders supporting rights issues (see the alert titled “Getting your rights issue right”). This followed a series of Takeovers Panel decisions which provided greater clarity on the Panel’s tolerance for control impacts flowing from major shareholders providing sub-underwriting support.

Since then (and particularly in recent months where there has been a tightening in equity markets and a need for a number of companies, particularly in the energy and resources sector, to recapitalise), these regulatory settings have again been tested. Although ASIC and the Panel’s policy guidance in this area remains unchanged, the recent decisions of the Panel provide valuable insights into the various factors that the Panel will consider when determining whether unacceptable circumstances arise. This alert summarises these recent decisions and the key factors to consider when designing rights issues.

Key take-aways

  • Where a shortfall facility is adopted as a control mitigation mechanism, the Panel is critical of directors reserving for themselves a wide discretion to scale back applications for shortfall shares. The Panel is generally of the view that shareholders should participate in the shortfall in priority to underwriters and sub-underwriters.
  • The Panel has taken a dim view of sub-underwriting fees paid to major shareholders over the entire amount of the sub-underwriting commitment, without any reduction for the amount of the sub-underwriter’s own entitlement. Fees of this nature are problematic because the sub-underwriter is accruing a benefit not available to other shareholders, without assuming additional risk.
  • Where possible, underwriters should be independent of major shareholder sub-underwriters and make genuine, good-faith attempts to identify alternative sub-underwriters. Priority arrangements, whereby major shareholders take preference over other sub-underwriters in the allocation of shortfall shares, should be avoided.
  • Preferably, where the potential control effect is significant, pricing of the issue should be set at a level that encourages broad participation from shareholders to limit any potential shortfall. The Panel will look for evidence that appropriate pricing levels were tested with financial institutions in order to find alternative underwriters and sub-underwriters.
  • Shareholder approval of a rights issue is not a complete answer to an application for unacceptable circumstances, where the disclosure in the relevant notice of meeting is defective.
  • Disclosure to shareholders in the relevant offer document (and notice of meeting where shareholder approval is sought) must be clear and specific regarding the material terms of the proposal, the maximum control effect of the proposal, shareholder dilution under various scenarios and how shortfall shares will be allocated.

Summary of recent Panel decisions

Regal Resources Limited

Decision

Control implications

Key influencing factors

The Panel made a declaration of unacceptable circumstances.

The Panel considered that the scaling back of shortfall shares by Regal Resources Limited (Regal) was inconsistent with disclosure in Regal’s notice of meeting and prospectus.

The Panel made an order requiring Regal to make a new offer of shares to those shareholders whose shortfall applications were scaled back (New Offer).

The Panel ordered that shares held by Ndovu Capital VI, B.V (Ndovu), the underwriter, be cancelled in a number equivalent to the number of shares issued by Regal under the New Offer. This ensured there was no additional dilution to other Regal shareholders as a result of the New Offer.

Ndovu, the underwriter, was a 13.23% shareholder in Regal. Regal obtained shareholder approval for Ndovu’s voting power to increase to a maximum of 68.03% as a result of the underwriting of the rights issue and a related placement and conversion of convertible loan.

Following completion of the rights issue, Ndovu’s actual shareholding as a result of its underwriting was 63.16%.

Item 7, section 611 approval

Regal obtained approval under item 7, section 611 of the Corporations Act 2001 (Cth) for the underwriting arrangement.

The Panel rejected Regal’s submission that the item 7 approval was a complete answer to the application. The Panel noted that unacceptable circumstances could still occur where the acquisition by the underwriter occurs in circumstances that are not in accordance with the terms of the shareholder approval.

Shortfall facility

Eligible shareholders were invited to nominate to subscribe for additional shares under a shortfall facility. Despite this, Regal accepted applications for less than two thirds of the number of shortfall shares applied for, and issued the remaining shortfall shares to Ndovu.

The fact that, in the notice of meeting issued to shareholders, Regal retained a discretion with respect to the allocation of shortfall shares was not sufficient to overcome the broader impression created by Regal’s disclosure. The Panel considered that the language and context of the disclosures in the notice of meeting conveyed that the shortfall facility was being made available as a mechanism to mitigate the control effect of the rights issue. The market has an expectation that, where shortfall facilities are held out as a control mitigation mechanism, shareholders would be allocated in priority to underwriters and sub-underwriters, and that any discretion reserved for directors should be used sparingly.

The Panel determined that clear and specific language would be required to reserve a broader discretion not to allocate shortfall shares to applicants and instead issue the shortfall to an underwriter. The language in the notice of meeting indicated that priority would be given to applications by eligible shareholders. The notice of meeting implied that the discretion reserved to Regal was limited to the kind necessary to prevent contravention of takeovers thresholds and issues to related parties.

Decision

Control implications

Key influencing factors

The Panel consented to a request by Dominet Digital Corporation Pty Ltd (Dominet), the applicant, to withdraw its application following an agreement that Freshtel Holdings Limited (Freshtel) would make further disclosure.

The Panel was satisfied that the further disclosure addressed the concerns raised in the application.

The rights issue was underwritten by Patersons Securities Limited (Patersons), a professional underwriter.

The rights issue was fully sub-underwritten by six parties.

Prior to the rights issue, Patersons was not a shareholder of Freshtel. As a result of the underwriting arrangements, Patersons’ shareholding in Freshtel could have reached 25%.

Control impact

The rights issue prospectus disclosed the offer as being “fully underwritten” and stated that the underwriter would not have voting power in excess of 20% after the issue of the shortfall. The prospectus did not disclose the potential for Patersons’ voting power to increase to 25% if there was no take-up of entitlements and all sub-underwriters defaulted on their obligations.

Freshtel agreed to release a supplementary prospectus clarifying this point.

The Panel was satisfied that the sub-underwriting arrangements entered into were sufficient to reduce the risk that the potential control effect would have.

Shortfall facility

Although the rights issue included a shortfall facility, shareholders were advised not to apply for shortfall shares unless instructed to do so by the directors. The directors reserved the right to issue securities under the shortfall facility in their absolute discretion.

Freshtel initially informed Dominet that it could not participate in the shortfall offer.

The Panel required Freshtel to make further disclosure regarding the application shortfall shares. Freshtel also agreed to allow Dominet to participate in the shortfall offer (in priority to the sub-underwriters).

ABM Resources NL

Decision

Control implications

Key influencing factors

The Panel made a declaration of unacceptable circumstances.

The Panel considered that all reasonable steps to minimise the potential control impacts of the rights issue were not taken.

The Panel decided that ABM Resources NL (ABM) was not allowed to proceed with the rights issue and was required, within 2 business days, to make an announcement to the market confirming this.

However, the Panel indicated that it would consider a variation of this order to allow a restructure of the rights issue in a way that addressed the Panel’s concerns. The Panel also indicated that it would be prepared to vary its order if shareholder approval for the rights issue was obtained.

The rights issue was to be sub-underwritten by Pacific Road Capital Management Pty Ltd (PRCM), who was a 19.85% shareholder of ABM.

If no other shareholders took up their rights, PRCM would obtain voting power of up to 49.91% of ABM as a result of the sub-underwriting arrangement.

ABM’s expectation was that take up under the rights issue would be “reasonably low”.

Pricing

The rights issue was priced at a relatively small discount. This was likely to discourage participation and increase the consequential shortfall available to the underwriter and sub-underwriter.

There was no evidence that appropriate pricing levels in order to find alternative underwriters and sub-underwriters were tested with any financial institutions.

Non-renounceability

The Panel considered that, in accordance with its guidance on rights issues, the non-renounceability of the offer was a factor weighing in favour of unacceptability.

Underwriting / sub-underwriting

The Underwriter, Key Pacific Advisory Partners Pty Ltd (KPA), was nominated by PRCM. The Panel found that in appointing KPA, ABM knew that it was engaging an underwriter that would not seek to pass the risk to various sub-underwriters, as would usually occur.

Based on the available evidence, the Panel concluded that it was not satisfied that ABM made any genuine attempt to find additional sub-underwriters, or to accommodate an underwriter that would do so, despite advice from its legal advisers to do so.

Sub-underwriting fee

The sub-underwriting fee payable to PRCM was 6% of the total amount raised, without any reduction for new shares subscribed for by PRCM and its associates under the rights issue. The Panel concluded that this was problematic because PRCM was accruing a benefit for taking up its entitlement for no risk, which was not available to other shareholders.

Decision

Control implications

Key influencing factors

The Panel declined to make a declaration of unacceptable circumstances.

The Panel indicated that although it was minded to make a declaration of unacceptable circumstances, it would not do so if Celamin Holdings NL (Celamin) made additional disclosure in relation to the rights issue.

The rights issue was partially underwritten by Patersons (the same underwriter as in the Freshtel example above).

African Lion 3 Limited (African Lion) and Polo Resources Limited (Polo), both major shareholders, agreed to take up their entitlements under the rights issue and act as priority sub-underwriters for up to $3 million each.

African Lion was a 12.73% shareholder of Celamin and could increase its shareholding to 34.98% if no other shareholders took up their entitlements. Polo was a 12.11% shareholder and its shareholding could increase to 34.88% if no other shareholders took up their entitlements.

Priority sub-underwriting arrangements

Under the terms of the sub-underwriting arrangements made by Patersons, Polo and African Lion would have their sub-underwriting commitments filled in priority to other general sub-underwriters.

It was submitted by the applicant that this unnecessarily and unfairly made the acquisition of control by Polo and African Lion highly likely.

The Panel concluded that although the arrangement was unusual, it was proposed by Patersons as professional, independent brokers and did not, on its own, constitute unacceptable circumstances. However, the Panel noted that this may not necessarily always be the case.

Sub-underwriter fees

The sub-underwriters were entitled to fees (including options) in respect of the sub-underwritten shares, including shares taken up as part of their own entitlements.

The Panel raised concerns about shareholder sub-underwriters receiving a fee for the portion relating to their own entitlements, because they were assuming no risk.

Although critical of the fee arrangement, the Panel decided not to declare this unacceptable because both sub-underwriters’ commitment extended to over $1.8 million of funding in addition to their own entitlement.

Shortfall dispersion

Although the rights issue included a separate shortfall facility, the directors retained complete discretion as to allocation.
The Panel raised concerns about an unfettered discretion to allocate shortfall shares. The Panel noted that, whilst a general discretion may be required for listing rule purposes, disclosure should be made of the manner in which directors propose to exercise the discretion.

Celamin was required to make disclosure confirming that the directors’ discretion would only be used to ensure an applicant’s voting power did not exceed the takeovers threshold.

Disclosure of shareholder dilution

The Panel considered that disclosure in the offer document of the shareholder dilution under various scenarios had caused confusion. Supplementary disclosure was required, clarifying the circumstances in which a shareholder will be diluted.

Gondwana Resources Limited

Decision

Control implications

Key influencing factors

The Panel made a declaration of unacceptable circumstances.

The Panel considered that all reasonable steps to minimise the potential control impacts of the rights issue were not taken.

In lieu of orders, the Panel accepted undertakings from Gondwana Resources Limited (Gondwana) that if it proceeded with the rights issue, it would, among other things:

  • increase the minimum subscription to allow the applicant, Ochre Group Holdings Limited (Ochre), to subscribe for its full entitlement;
  • offer shareholders the opportunity to participate in any shortfall; and
  • make further disclosure regarding the rights issue in the prospectus in a form approved by the Panel.

The rights issue was to be partially underwritten to 50% by Bellatrix Pty Ltd (Bellatrix).

Bellatrix was an 11.84% shareholder in Gondwana. As a result of the rights issue, Bellatrix’s interest in Gondwana could have increased to a maximum of 43.75%, depending on the level of shareholder participation.

Non-renounceability

The rights issue was non-renounceable, reducing the likelihood that the offer would be fully subscribed.

Alternate proposals

Gonwana had rejected an offer from Ochre to underwrite a rights issue before the rights issue was announced and also rejected a similar offer made after the rights issue was announced.

Allocation of shortfall shares

Although there was a shortfall facility, it was limited. The prospectus stated that shareholders holding more than 20,000 shares were not to apply for shortfall securities unless directed by Gondwana’s directors.

Disclosure in prospectus

The prospectus issued in relation to the rights issue did not adequately disclose:

  • Gondwana’s need for funds;
  • how the directors proposed to exercise their discretion to allocate any shortfall under the entitlement offer; and
  • the potential effect on control of Gondwana that a proposed issue of new shares and new options would have.

Gondwana agreed to submit to ASIC a draft replacement prospectus for ASIC’s approval.

Conclusion

While there is nothing new in the Panel’s (or ASIC’s) policy approach, these Panel decisions illustrate how the regulatory settings invariably get pushed when there is a need to raise funds.

The basis for calculation of sub-underwriting fees, as well as the discretions exercised by directors in allocating shortfall shares, have been two areas of particular focus.

It is critical that sufficient regard is had to ASIC and the Panel’s guidance when structuring a rights issue, to minimise the possibility of regulatory intervention. A critical fundraising need is not a ‘safe harbour’, nor is shareholder approval if the disclosure is lacking. As always, effective dispersion mechanisms and clear and specific disclosure of control effects remain the key ingredients. Let’s see what 2017 brings.