The Federal Court has recently approved a scheme in which the votes of an acquirer’s parent company and its associate were instrumental in securing passage of a scheme under which the acquirer acquired all the shares in the scheme company. Traditionally, acquirers (and their associates) have either refrained from voting on an acquisition scheme or have voted in a separate class given their potentially differing interests in the outcome of the scheme.
The traditional approach – acquirer’s and their associates shouldn’t vote
A Court cannot approve an acquisition by scheme of arrangement unless a majority of members present at the scheme meeting, as well as 75% of votes cast at that meeting, are in favour of the scheme.
It is essential that those members meeting to consider approving a scheme are able to consult together with a view to a common interest. To the extent that the legal rights (and interests arising from those rights) of particular members against the scheme company are so different as to make it impossible for them to come together in a single meeting to debate and consider the merits of the proposal for the group as a whole, the scheme company is obliged to convene separate meetings of each class of members. The voting thresholds must be met at each class meeting.
In addition, if a member has divergent commercial or other interests that the Court determines are more of an influence on the exercise of their vote than their rights as a member of that class, the Court can “tag” the votes (ie, have them specifically marked and reported to the Court at the second Court hearing) and may discount those votes in determining whether the scheme ought to be approved.
In a scheme of arrangement where the acquirer (or its associate) holds shares in the target, the traditional approach has been to quarantine the votes of the acquirer (or its associate) either by obtaining their agreement not to vote on the scheme, excluding those shares from operation of the scheme or even convening a separate class meeting. This approach reflects an expectation that the Court, in assessing whether to approve the scheme, will elect to disregard the votes of the acquirer and its associates due to their interest in successful completion of the scheme transaction.
The decision in Kumarina Resources
Given that view, the approach taken by the acquirer and target in determining voting eligibility in the scheme approved in Kumarina Resources, was risky.
Kumarina Resources proposed a scheme of arrangement with its shareholders pursuant to which shareholders would receive one Zeta Resources Limited share for every four Kumarina shares plus one Zeta option for every five Zeta shares issued. Once implemented, Kumarina’s shareholders would become shareholders of Zeta, and Kumarina would become a wholly-owned subsidiary of Zeta. The resolution to approve the scheme was passed by 79.07% of shareholders who voted at the scheme meeting.
Two dissenting shareholders objected to approval of the scheme and asserted that three shareholders (who, between them, held just under 40% of all shares on issue at the time of the scheme meeting, all of which they voted in favour of the scheme) should be treated as being in a separate class or otherwise should have their votes disregarded by the Court, for the following reasons:
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Dealing first with the question of whether those shareholders ought to have been treated as being in a separate class, the Court found that the legal rights of all shareholders in Kumarina (including Utilico, ICM and Mr Sullivan) were identical under the proposed scheme.
The Court determined that the Sale Agreement and the Investment Management Agreement were independent of the scheme, and noted that they had each been assessed by the independent expert to be at arm’s length. Accordingly, the consideration that Utilico received under the Sale Agreement and that ICM would receive under the Investment Management Agreement would not result in Utilico or ICM receiving a right or benefit under the scheme that was different to other shareholders and therefore the benefit could not give rise to a class issue.
In respect of Mr Sullivan, the Court found that the increase in directors fees was immaterial and that the mere fact Mr Sullivan would continue to act as a director of the merged group was unexceptional for transactions of this kind. Neither basis justified treating Mr Sullivan as being in a different class.
There is nothing exceptional in those conclusions, which are consistent with the well understood principles of class definition in schemes of arrangement.
Of potentially more far reaching significance is the Court’s refusal to take into account the relationship between the acquirer, its parent company and ICM in determining whether to approve the scheme.
The Court referred to the general principle that a court may decline to approve a scheme if it is not satisfied that the scheme is “at least so far fair and reasonable, as that an intelligent and honest man, who is a member of that class, and acting alone in respect of his interest as such member, might approve it” (from Re Challenge Bank Ltd (1995) 19 ACSR 421 at 422, our emphasis). The Court must find that the objective “intelligent and honest” member would consider the scheme “fair and reasonable” having regard solely to that member’s “interest as such a member” and not any other interest. Were the success of a vote to depend entirely on votes of members whose approval of the scheme was actuated by their extraneous commercial interests, there may be cause for concern about the overall fairness of the scheme.
The Court found that the scheme was “fair and reasonable from the viewpoint of an intelligent and honest person” because:
- the independent expert had concluded that the scheme was fair and reasonable and in the best interests of Kumarina’s shareholders;
- a large majority of Kumarina’s shareholders voted in favour of the scheme. This was so even if the votes of Utilico and ICM were to be excluded;
- there was no reason for considering that the votes cast at the scheme meeting were not representative of the views of Kumarina’s shareholders;
- the objectors, although they held large parcels of shares, were very much in the minority; and
- Kumarina shareholders are plainly the best judges of whether a scheme is fair and reasonable.
The Court had also earlier observed that ASIC had raised no objections to the scheme at either the first or the second Court hearing (it is unclear what weight the Court attached to this, if any).
For those reasons, the Court declined to disregard the affected votes and approved the scheme.
In coming to this decision, the Court does not appear to have considered whether Utilico’s and ICM’s approval of the scheme may have been influenced by the fact the acquirer was a wholly-owned subsidiary of Utilico and therefore had an interest in the scheme being successful (separately to any interest it would have had as a result of it being a member of the company). The judgment is also silent on the nature of the relationship between ICM and Utilico (and in particular, why they considered themselves to be associates of one another). Unlike the acquirer’s parent company, Utilico, ICM’s votes were not tagged. The Court’s appraisal of those parties’ interests was limited to their rights under the Sale Agreement and Investment Management Agreement, respectively, which arguably did not go far enough. Had the votes of Utilico and ICM been discounted, the scheme would not have passed the 75% test.
In Re Hellenic & General Trust Ltd  1 WLR 123, the Court rejected the scheme because the 53% shareholder ought to have been placed into a separate class for voting purposes since it was a wholly-owned subsidiary of the acquirer. The Court in Kumarina Resources distinguished this decision since the current scheme was not a “buy out” by Utilico of all shares it did not already hold and was instead a merger in which all Kumarina shareholders would become shareholders of the acquirer. Whilst this rationale may justify Utilico (and ICM) not being treated as being in a separate class, it ignores the wider point made in Re Hellenic & General Trust that there are serious difficulties in target shareholders being able to meet to discuss their common interest together with shareholders who are the driving force behind the scheme (or their associates).
Given this, it is difficult to reconcile this outcome with past decisions and statements by various courts in Australia and the United Kingdom and customary practice in Australian schemes of arrangement.
At its broadest, this decision could be taken as an indication that Courts will not discount votes of the acquirer or its associates in favour of a scheme in which the acquirer will acquire the target where there is significant support from non-aligned shareholders for the scheme.
This could have significant implications for the Australian M&A market as potential acquirers would be freed from the concern that stakes that they acquire in the target (or any voting agreements they enter into with major shareholders of the target) may make it harder for the statutory voting approval thresholds to be met. Potential acquirers may be more inclined to acquire pre-bid stakes or to enter into voting lock-ups over large numbers of shares (relying on shareholder approval under section 611 (item 7) where these arrangements would infringe the 20% takeovers threshold).
Since the ramifications of the decision are potentially significant, we would expect ASIC to be more attune to this issue were it to arise on a future scheme. It is also open for other courts not to follow this decision, or to confine it to its specific facts.
That said, an acquirer already in possession of a pre-bid stake (either itself or through its associates) may on the strength of this decision choose not to take the usual approach of quarantining those votes in order to test this principle further (provided that they are reasonably confident the scheme will be widely supported by non-aligned shareholders).