- The use of contingent consideration results in target shareholders bearing some risk in relation to the bidder performing its obligation to pay the contingent consideration, unless some form of security is provided by the bidder.
- There has only been one recent example of the bidder providing security (by putting funds into an escrow account) for its obligation to pay contingent consideration.
- In a recent scheme of arrangement, the court has indicated that it will not require a bidder to give some form of security for the payment of the contingent consideration provided the risks associated with the contingent consideration are fully and fairly disclosed.
As highlighted in recent editions of our Merger & Acquisitions Update, there has been a significant rise in the number of schemes of arrangement which have involved an element of contingent consideration.
An issue related to contingent consideration is the question of whether it is appropriate for target shareholders to bear any risk in relation to the bidder performing its obligation to pay the contingent consideration? This is particularly relevant if the obligation to make payment does not arise until a considerable period after implementation of the scheme.
There are various methods which could be used to overcome any perceived performance risk. For example, the bidder could place funds into an escrow account or it could provide a bank guarantee.
Such security arrangements are, of course, costly (which costs may end up, directly or indirectly, being passed on to target shareholders). In addition, in the case of bidders that are prudentially regulated, such security arrangements could impact on their regulatory capital position.
Despite the numerous examples of deals involving contingent consideration, so far as the authors are aware, the only example of a bidder actually providing security was in the 2012 Reco Ambrosia / Charter Hall Office REIT trust scheme (in that scheme, the bidder paid funds into an escrow account). This approach is consistent with what would happen in a takeover bid, where no such security is required.
Bupa Australia’s acquisition of Dental Corporation*
The question of whether it was appropriate for a bidder to provide some form of security in relation to contingent consideration was recently considered by the court as part of the scheme of arrangement under which Bupa Australia acquired all the shares in Dental Corporation Holdings Ltd (an unlisted public company).
Under that scheme, the majority shareholder (Fortis Healthcare) and financial investors formed one class for the purposes of the scheme and were entitled to receive $2.347 per Dental Corporation share. Members of management and dentists formed a second class for the purposes of the scheme and were entitled to receive an upfront payment of $0.9388 per Dental Corporation share (representing 40% of $2.347) plus the right to receive three potential annual earn out payments over the next three years. The actual amount of these three potential earn out payments will be determined by reference to the adjusted EBITDA of Dental Corporation in each of the 12 month periods ending 31 May 2014, 31 May 2015 and 31 May 2016 and the adjusted net debt of Dental Corporation as at 31 May 2014, 31 May 2015 and 31 May 2016. The right to these potential future payments was treated as a ‘debenture’ for the purposes of Chapter 2L of the Corporations Act2001 (Cth). Bupa Australia’s three potential future earn out payment obligations were not secured.
At the first court hearing, Dental Corporation made extensive submissions as to why the court should not be concerned about performance risk in relation to Bupa Australia making the three potential future earn out payments. Those submissions included:
- a trustee had been appointed in accordance with the requirements of the debenture provisions in Chapter 2L of the Corporations Act 2001 (Cth) and that trustee was empowered to take action against Bupa Australia if it failed to pay any of the earn out payments
- if the trustee failed (for whatever reason) to take action against Bupa Australia for failing to pay any of the earn out payments, the shareholders could enforce their rights directly by suing under the scheme deed poll
- the covenantors under the scheme deed poll included an entity in the Bupa Group of significant financial standing
- the risk of non-payment had been prominently disclosed in the scheme booklet, and
- the affected shareholders formed a separate class for the purposes of voting on the scheme – if they did not agree to the scheme, it would not proceed.
After considering the submissions, and despite noting that there was no security for the earn out payments, Justice Robson did not raise any concerns about the performance risk issue relating to the earn out payments.
Justice Robson noted that it was not for the court to decide whether it was a good transaction for the affected shareholders, rather the threshold question for the court was, in his Honour’s view, whether the court was satisfied that there was proper disclosure (including of the relevant risks) for the affected shareholders. At the first court hearing, his Honour stated in his exchanges with Counsel:
‘They need proper disclosure. That’s all I’m looking for. I’m not suggesting it’s a bad or good deal. I’m saying where is the disclosure?’
After being taken through the relevant disclosures in the scheme booklet relating to the earn out payments, Justice Robson noted (of the disclosures):
‘It’s pretty cautious. […] There is an opportunity for the [affected shareholders to receive in] absolute terms an aggregate amount exceeding $2.347. So it’s […] an opportunity.’
In response, Counsel remarked:
‘That’s what it is. If it were put any higher than that, Your Honour, it wouldn’t be true.’
Justice Robson then proceeded to make the orders convening the scheme meetings.
On the basis of the approach taken by the court in the Dental Corporation scheme, and in the various precedent transactions, the question of whether some form of security is required for the payment of contingent consideration in a scheme of arrangement appears to have been put to rest.
However, both the target and the bidder will, as always, need to ensure, and the court will want to be satisfied, that target shareholders have received full and fair disclosure of the risks (including the risk of non-payment) associated with any contingent consideration.