- Financial need is not a sufficient justification for a rights issue which is likely to have a substantial impact on control of an entity.
- Where an existing shareholder may acquire a substantial increase in voting power as a result of the rights issue, the full range of dispersion strategies, including sub-underwriting arrangements, provision for oversubscriptions, shortfall facility or back-end book build, should be carefully considered.
The Takeovers Panel has provided a timely reminder to market participants that a need for funds is not of itself sufficient to justify a rights issue which would result in a person obtaining a substantial increase in voting power and control. In undertaking a rights issue it remains critical to carefully consider whether all reasonable available steps have been taken to mitigate any control effect on an entity seeking to raise funds by way of a rights issue.
In March 2012, the Panel made a declaration of unacceptable circumstances in relation to a rights issue by Real Estate Capital Partners USA Property Trust (RCU) on the basis that the rights issue was likely to have a substantial impact on the control of RCU.
The potential for the rights issue to bring about a change in control of RCU was due to the structure of the capital raising, as there was no dispersion strategy to deal with any shortfall units acquired by the sole underwriter, who was also a substantial holder in RCU.
The Panel’s Reasons for Decisions1 is a practical reminder of the principles set out in Guidance Note 17–‘Rights Issues’ (GN17). The mere fact that control is affected by a rights issue does not of itself give rise to unacceptable circumstances. However, where the control effect exceeds what is reasonably necessary for the fundraising purpose, it will constitute unacceptable circumstances. Unacceptable circumstances were found in the RCU matter because there was no facility for unit holders to take up units in excess of their entitlement, no sub-underwriting arrangements, limited inquires were made by the responsible entity for RCU, Real Estate Capital Partners Managed Investments Limited (RE) to source potential underwriters or sub-writers and high fees were to be paid to the underwriter.
The Panel’s orders in this matter show a pragmatic, and ultimately commercial, response to the issues facing RCU. The orders balance RCU’s needs for funds and inability to raise funds through other means such as an asset sale, against the principles in Chapter 6, as set out in section 602 of the Corporations Act 2001 (Cth) (Corporations Act).
On 1 March 2012, RCU announced a 0.98 for 1 renounceable rights issue at 40 cents a unit.
The rights issue was fully underwritten by Frost Holdings Pty Ltd (Frost), which, prior to the capital raising, had voting power of 19.82% in RCU. There was the potential for Frost’s voting power to increase to 59.51%, if no unit holder took up their entitlement under the rights issue (and obtain control of RCU), based on the structure of the rights issue.
The structure of the rights issue did not contain any dispersion strategy that may have reduced the potential control impact of Frost acting as sole underwriter, such as sub-underwriting arrangements, provision for oversubscriptions, a shortfall facility or a back-end book build. The only features in the rights issue which sought to mitigate its control effect was its renounceability and that it was priced at a discount.
Information was provided to the Panel that Frost had actively discouraged the RE from implementing dispersion strategies for the rights issue, other than allowing the rights issue to be renounceable (noting that Frost had initially required it to be a non-renounceable rights issue).
A substantial holder of RCU (Applicant) made an application to the Panel seeking a declaration of unacceptable circumstances on the basis that (amongst other things):
- the underwriting arrangements would provide Frost with the opportunity to substantially increase its voting power in RCU, and
- the rights issue was contrary to principles in section 602 of the Corporations Act.
Panel’s decision and the reasons for the decision
The Panel concluded all reasonable steps to mitigate the control effect of the rights issue on RCU were not taken. The Panel made a declaration of unacceptable circumstances and made orders (among other things) requiring Frost to:
- divest the units it received as underwriter so that unit holders who were originally entitled to participate in the rights issue are offered as many units as necessary to take up their full entitlement and may apply for units in excess of their entitlement, and
- pay the costs of the dispersion strategy.
As stated above, the Panel’s handling of this matter reveals a pragmatic response balancing the interest of RCU and the policy considerations of section 602 of the Corporations Act. This is shown with the following statement by the Panel:
‘Our orders do not detract from the Rights Issue being successful but reduce the potential control effect of the underwriting. They provide unitholders with an opportunity to reduce the underwritten amount, by applying for additional units in the shortfall.’
The Panel was clear that its role was to ‘remedy the unacceptability of the arrangements which the RE negotiated’ while at the same time permitting RCU to access the funds that it required. This was despite attempts by the Applicant seeking interim orders that would have had the effect of preventing the rights issue from proceeding and final orders that sought the Panel to consider an alternative underwriting proposal.
By the Panel refusing to be drawn into considering these matters, it displays a pragmatic and ultimately commercial response to the issue at hand—the rights issue was allowed to proceed, giving RCU access to the funding that it needed, with all RCU unit holders being given a reasonable and equitable opportunity to acquire any shortfall units that were not taken up as part of the original entitlement offer.
*At the date of this article, RCU had completed its rights issue entitlement offer. Frost had acquired 24,265,937 units as underwriter of this offer, resulting in a voting power of 43.87 per cent in RCU. On 13 April 2012, the RE, on behalf of Frost, announced an offer to sell the units acquired by Frost, in accordance with the Panel’s orders. This offer closed on 27 April 2012.