We explain ASIC's consultation as part of a proposal to effectively prohibit the offer of scrip in proprietary companies, or public companies with a custodian holding arrangement, as consideration in a scheme or takeover.
Stub equity structures have been used on recent control transactions, particularly by private equity bidders, to offer shareholders the ability to remain directly or indirectly invested in the target company
ASIC is now consulting as part of a proposal to amend the Corporations Act to effectively prohibit stub equity structures
The proposed changes will in particular impact private equity bidders, who will be forced to re-visit the use of alternative stub equity structures, including using offshore holding companies
Use of stub equity structures
Stub equity is not a new phenomenon. In order to make an offer attractive to shareholders, bidders often need to offer shareholders some ability to retain an on-going exposure to the target company's performance.
For listed bidders this is relatively simple, as they can offer shares in the listed bidder as full or part consideration, and they can limit the control impact on the bidder by capping the number of available shares. For example, in 2015, TPG revised its offer for iiNet by adding TPG shares as a form of consideration that iiNet shareholders could elect to receive (subject to a cap).
For unlisted bidders, including private equity funds, this is more complicated. The bidder (or its holding company) will need to be controlled by the fund, and the fund needs control over its future liquidity.
To meet these aims, a practice was developed in the scheme under which an Australian proprietary company was used as the holding company (HoldCo), and target shareholders could elect to receive scrip in HoldCo (subject to a cap that retained control for the fund).
The use of a proprietary company also removes the administration required for a public company, including the more extensive governance and disclosure requirements and restrictions on related party transactions.
However, a proprietary company also cannot have more than 50 non-employee shareholders. To avoid exceeding the 50 shareholder limit, the bidder employed an arrangement under which a custodian would hold shares in HoldCo on behalf of all target shareholders who elected to receive HoldCo shares.
The use of an Australian proprietary company and not exceeding the 50 shareholder limit also has another important effect, as Australian takeover provisions only apply to public companies with more than 50 members. This means that the stub equity structure is not subject to Australian takeover provisions when the investor wants to exit its investment.
ASIC's policy position
In the Patties scheme in 2017, ASIC did not oppose the use of the stub equity structure.
The scheme under which KKR acquired Pepper in 2017 adopted a similar stub equity structure as the Patties scheme. Again, ASIC did not oppose its use.
The scheme under which Wattle Hill RHC and ROC Partners acquired Capilano in 2018 was consistent with Patties and Pepper, but added a fundraising element that was expressly permitted by the Corporations Act.
ASIC argued that the Court should not approve the scheme on the basis that it was contrary to public policy, and the specific prohibitions and legislative intent of the 50 shareholder limit, for an Australian proprietary company to offer scrip to more than 50 target shareholders, and to combine the offer with a custodian arrangement to avoid exceeding the 50 shareholder limit.
ASIC argued that these public policy concerns were not addressed by the disclosures made to shareholders as part of the scheme, which explained the fact that HoldCo would not be subject to the same governance and disclosure requirements as a public company and would not be subject to the takeover provisions.
Following the Capilano scheme, ASIC announced that it would consult with the market on prohibiting the use of such stub equity structures in Australian control transactions.
ASIC's proposed changes
ASIC has now released its consultation to effectively prohibit stub equity structures in control transactions.
ASIC's proposal is to do so by prohibiting:
- the offer of scrip in proprietary companies as part of a control transaction; and
- the use of a custodian holding arrangement to avoid exceeding the 50 shareholder limit.
The second limb of ASIC's proposed changes is important. This is because it prevents the bidder using a public company HoldCo and still avoiding the application of the Australian takeovers provisions.
How the market can respond
The market can respond by making submissions in response to the ASIC consultation paper. Submissions are due by 17 July 2019.
MinterEllison will be making submissions against the proposed changes.
The market can also respond by employing alternative stub equity structures that can achieve the commercial aims of bidders without using an Australian public company. Alternative stub equity structures that are not impacted by ASIC's proposed changes include the use of offshore companies as the holding company.