One of the most difficult issues that arises in a scheme of arrangement (whether used to acquire control of a company or to effect a demerger) is the determination of whether any group of shareholders should be treated as a separate class for the purpose of voting on the scheme. 

The consideration of class is critical because an incorrect determination will likely result in queries from ASIC and the Court and opposition by target shareholders, none of which will assist smooth completion of the deal. Further, if the proposer of the scheme does not provide all necessary information to the Court to allow a proper assessment before convening the scheme meeting, it could jeopardise final approval of the scheme.

As call options granted by a target shareholder to a bidder have become increasingly popular as deal protection devices in schemes, this question of class will arise more frequently. Are the terms such that the parties to the call option form a separate class? A series of recent court decisions have examined schemes, call option agreements and the question of 'class'.

The question of 'class'

The starting point for any determination of class is Sovereign Life Assurance Co v Dodds [1892] 2 QB 573, where the Court distinguished between a class of creditors whose insurance policies had matured and a class of creditors whose policies had not matured. Bowen LJ stated:

The word 'class' is vague ...   It seems plain that we must give such a meaning to the term 'class' as will prevent the section being so worked as to result in confiscation and injustice, and that it must be confined to those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest.

More recently, Ferguson J, in Re Foster's Group Limited [2011] VSC 93, said:

In more recent times, the courts have observed that the test laid down [in Sovereign Life Assurance] is not one of identical treatment but rather one of community of interest. As Santow J has noted, 'divergent commercial interests extrinsic to share membership are ordinarily not a factor which should differentiate classes.' The courts are also mindful that if there is more than one class, each will have a power of veto.

In Re Foster's Group Limited, the Court found that no separate class was required, for:

  • foreign shareholders who would receive a cash payment, rather than the shares in Treasury Wine Estates Limited which would be issued to Australian shareholders, under the proposed demerger; or
  • partly paid shareholders, who would receive the same number of fully paid shares in Treasury Wine Estates Limited as fully paid shareholders would receive. The Court noted that the economic relativities required that such an approach be adopted and, further, that holders of fully and partly paid shares already meet together at the company's annual general meeting.  

This decision is a good example of the approach the Courts take to determine whether the rights and interests of any group of shareholders are so different to that of the main body of shareholders to require a separate class.

The MAC Services Group Limited 1

In this scheme, Oil States International (OSI) entered into a scheme with MAC Services Group Limited (MSL), which would result in MSL becoming a wholly-owned subsidiary of OSI.  In addition OSI entered into a call option agreement with Marley Holdings Pty Ltd (Marley) which held 52% of the MSL shares.  Under the call option agreement OSI could purchase 19.9% of MSL's total issued share capital from Marley if:

  • a third party made a competing proposal for the acquisition of shares in MSL; and
  • OSI, in turn, then publicly announced a counter-proposal which the board of MSL determined in good faith was more favourable to MSL shareholders than the third party's competing proposal.  

Barrett J noted that Marley had an interest in the emergence of a third party competing proposal that differed from that of other shareholders because Marley would receive an increased price for its 19.9% holding subject to the call option agreement at the announcement of a matching proposal by OSI, while other shareholders would only receive the increased price if OSI's counter-proposal was carried through to completion.

However, despite this divergence in interests, Barrett J held that the rights of Marley and the way in which those rights were to be affected by the proposed scheme of arrangement were not so different from those of the other shareholders to require the creation of an additional class.

Cellestis Limited 2

Cellestis Limited (Cellestis) entered into a scheme with QIAGEN Australia Holding Pty Limited (QIAGEN), by which QIAGEN would acquire all of the ordinary shares in Cellestis.

In addition to the ordinary shares in Cellestis there were unlisted employee options which were to be cancelled for consideration, under a separate but interconditional agreement. Further, two directors of Cellestis who collectively held 23.8% of the issued shares in Cellestis granted QIAGEN call options over 19.9% of their shareholding. Thus, the Court needed to decide if potential additional classes were required for:

  • the employee option holders (some of whom were also shareholders); and
  • the two directors who had granted QIAGEN call options over their own shares.  

The Court concluded that neither the rights of the employee option holders nor the two directors were too dissimilar to the rights of the other Cellestis shareholders to constitute separate classes.

Davies J found that the employee option holders did not constitute an additional class because:

  • the scheme related to shares in Cellestis and any shares held by the option holders would participate on the same basis and receive the same scheme consideration as shares held by all other Cellestis shareholders who were not option holders - that is, all shareholders were treated equally under the scheme;
  • the scheme related to the transfer of ordinary shares and therefore the proposed cancellation of the options was not part of the scheme but part of the broader transaction;
  • the consideration to be paid for the cancellation of the options was derived using the Black-Scholes valuation methodology which was a commonly used methodology for valuing unlisted or thinly traded options and the extent of any difference in the consideration to be paid to the option holders and the scheme consideration was a product of the Black-Scholes valuation methodology; and
  • not all of the option holders were shareholders in Cellestis.

Davies J also concluded that the two directors who granted QIAGEN call options were not a separate class for the following reasons:

  • the event triggering the right to exercise the call options was the emergence of a competing proposal;
  • the two directors would receive the same consideration as the other shareholders;
  • the two directors had recommended the scheme to the other shareholders and stated their intention to vote in favour of the scheme in the absence of a superior proposal;
  • the call option deeds expressly provided that nothing in the deed restricted the ability of the directors to exercise the votes attached to the option shares; and
  • the directors held another parcel of shares not covered by the call option which would be participating in the scheme.

Call options are here to stay

The decisions in The MAC Services Group Limited and Cellestis Limited show that call option agreements do not necessarily create a separate class. While call option agreements will continue to need careful consideration, the mere fact that a shareholder potentially receives some commercial benefit as opposed to other shareholders does not automatically constitute a separate class.

Given the strong desire for bidders to have some deal protection mechanisms, these decisions will give comfort that call options can be granted without necessarily complicating the scheme process by creating a separate class of shareholder.