The Background: In RBC Investor Services Australia Nominees Pty Limited v Brickworks Limited  FCA 756 (10 July 2017) ("Brickworks case"), a large institutional investor sought to dismantle a cross shareholding arrangement between two publicly listed Australian companies on the basis that the cross shareholding was oppressive to minority shareholders. It was alleged that the cross shareholding entrenched the incumbent boards, depressed both companies' share prices and disenfranchised minority shareholders.
The Result: The Federal Court of Australia emphatically dismissed the claim, holding that reasonable directors would not, in this situation, consider maintenance of the cross shareholding to date to be unfair or oppressive. On the contrary, the court held that directors of both boards had diligently discharged their obligations to act in the best interests of the company, and the cross shareholding had facilitated long-term strategic decision-making and commercial stability. The claimant failed to establish that the founding family of one of the companies (the Millner family) exercised the alleged level of control or influence over the companies' boards, that the cross shareholding had negatively impacted the companies' share price or that the unwinding of the cross shareholding would necessarily deliver value for shareholders.
Looking Forward: In an environment of increased shareholder activism in Australia, the decision will serve as a cautionary tale to would-be activists that the court's role is not to step into the shoes of directors to make commercial decisions about matters where reasonable minds may differ. The judgment serves as an endorsement of long-term and well-documented commercial planning, notwithstanding the challenges presented by shareholder activists.
The cross shareholding arrangement was entered into by Brickworks Limited ("Brickworks") and Washington H Soul Pattinson and Company Limited ("Soul Pattinson") in 1969. At the time of the Court's decision, each of Brickworks and Soul Pattinson was the largest shareholder in each other, with Brickworks owning approximately 43 percent of the shares in Soul Pattinson, which, in turn, had an interest of about 44 percent in Brickworks.
In the 1980s, one of Australia's largest fund managers, Perpetual Limited, through its custodian's nominee, RBC Investor services Australia Nominees Pty Limited ("Perpetual"), acquired shares in both Brickworks and Soul Pattinson. When the proceeding was commenced in 2014, Perpetual owned approximately 9 percent of the shares in Brickworks and 6.5 percent of the shares in Soul Pattinson.
From 2011, Perpetual sought to dismantle the cross shareholding through a range of means in order to unlock what it saw as untapped value in the companies for the minority shareholders. Failed proposals to unwind the cross shareholding put by Perpetual to the boards of Brickworks and Soul Pattinsons included:
- The proposed appointment of Mr Robert Fraser as an independent director to Soul Pattinson in about December 2011;
- In early 2012, a proposed in specie distribution of all of Brickworks' shares in Soul Pattinson to the shareholders of Brickworks, which would remove the cross shareholding. (Ultimately, it was common ground among the parties that the taxation consequences of this proposal made the proposal unworkable);
- In July 2012, a nil premium merger, whereby the shareholders in Soul Pattinson would be issued shares in Brickworks in exchange for their Soul Pattinson shares, and Brickworks would cancel the shares in it held by Soul Pattinson;
- The cancellation of all shares held by Brickworks in Soul Pattinson in exchange for consideration paid by Soul Pattinson and the appointment of Ms Elizabeth Crouch as an independent director of Brickworks. (This proposal failed to obtain a favourable tax ruling, and Ms Crouch was not appointed a director at the annual general meeting in November 2015); and
- Variants of the nil premium merger proposal put forward in 2012.
None of the above proposals found favour with either board. Perpetual relied on this fact as further evidence of control by the Millner family and oppression.
In essence, Perpetual's case was that the entrenchment of the Millner family in the boards of both companies served to disenfranchise other shareholders and depress the value of shares in both entities. The failure of either board to dismantle the cross shareholding was said to not be in the interests of members as a whole, unfair or oppressive.
For Perpetual's oppression suit to succeed, the Court had to be satisfied that reasonable directors would consider the conduct complained of by Perpetual to be unfair. Proof of mere prejudice to, or discrimination against, a member is insufficient to establish oppression. The test is objective and looks to the effect of the impugned acts, not the motives behind such acts. Her Honour Justice Jagot explained the test and its rationale as follows (emphasis added):
The touchstone of oppression, that conduct be so unfair that reasonable directors who consider the matter would not have thought the conduct or decision fair, may appear circular but is designed to reinforce that the role of the court is not to step into the shoes of the directors and unilaterally decide what it thinks to be in the best interests of the company as a whole. The courts recognise that it is the responsibility of the directors to weigh the competing considerations with which they will be routinely confronted and determine what is in the best interests of the company as a whole. They recognise also that as the task of the directors is evaluative it is necessarily one about which reasonable minds may differ. In performing its own evaluation, accordingly, the courts do not merely substitute what appears to them to be the preferable commercial decision.
The evaluative exercise in this case concerned the dismantling of the cross shareholding and the risks of not doing so. In dismissing the claim, her Honour took into account the following matters (among others):
- At the time Perpetual acquired its shares, the cross shareholding existed, and Perpetual presumably understood the implications of it;
- It was not apparent that the cross shareholding had caused any related party or improvident transaction, nor that it had affected the share price of either company;
- The cross shareholding had provided each company with material benefits as a result of diversification which had reduced earnings volatility;
- There was insufficient material to establish that any proposal dismantling the cross shareholding would yield material longer-term financial benefits to shareholders of either company;
- Perpetual failed to prove that there was an agreement, arrangement or understanding between members of the Millner family or members of the boards of each company to maintain the cross shareholding in order to entrench control of the companies by the incumbent boards and thus the Millner family;
- The evidence established that the directors of Brickworks and Soul Pattinson had given diligent consideration to the cross shareholding structure consistent with their obligations to act in the best interests of the company. There was good reason to infer that the directors would continue to do so in the future; and
- There was no suggestion that either board had underperformed. Rather, both boards had performed well and the companies were well managed, suggesting that the cross shareholding had facilitated stability and a capacity for long-term decision-making.
Implications of the Decision
In putting to the boards of Brickworks and Soul Pattinson its various proposals for the unwinding of the cross shareholding arrangement, Perpetual was able to bring great pressure to bear by invoking relevant provisions of Australia's corporations law. In its capacity as a shareholder (of both companies) with at least five percent of the votes that could be cast at a general meeting, Perpetual was able to:
- Requisition a general meeting of Brickworks, at Brickworks' expense;
- Convene a general meeting of Soul Pattinson at Perpetual's own cost; and
- Require resolutions to be put to the general meetings, including resolutions for the appointment of directors to both boards.
Four Key Takeaways
- Australia's corporations law can be utilised to great effect by shareholder activists to disrupt a company's agenda and generate the attention of the media and the market.
- In this emerging era of robust shareholder activism, boards should be prepared for greater scrutiny of their decision-making by shareholders and the public alike.
- Directors should diligently consider proposals put to them by shareholder activists, consistent with their obligations to act in the best interests of the company. Such decision-making should be carefully documented with a view to demonstrating that the directors have discharged their duties.
- This approach by directors is important because, in an oppression suit, the court will not second-guess commercial decisions made by the board. Rather, the court will consider, through the lens of reasonable directors, whether the impugned conduct was unfair.