In brief

  • The law and market practice relating to pre-scheme call option agreements continues to evolve as bidders seek to push the envelope in terms of deal protection in schemes.
  • A pre-scheme call option agreement in the context of a two-tiered consideration structure, where the call option was exercisable merely upon the scheme becoming effective and at a lower price than the consideration provided to other shareholders, was found not to create a separate class.
  • It now seems clear that the emergence of a competing proposal is not a mandatory condition precedent to the exercise of a pre-scheme call option agreement, in the sense that, without such a condition, the grantors of the call option would be in a separate class for voting purposes.

In our February 2011 article, ‘Latest developments on pre-scheme option and voting agreements’1, we discussed the then-latest developments on pre-scheme call option agreements. We noted that we expected to see such agreements start to edge towards their purest (bidder friendly) form, namely a simple call option to acquire target shares at a fixed price, irrespective of what happens in the scheme (eg whether or not an auction develops).

The recent Cellestis scheme of arrangement involved a pre-scheme call option agreement which marked yet another step closer towards that end point.

In that scheme, the bidder, QIAGEN, entered into a pre-scheme call option agreement with two directors of the target, Cellestis, in respect of 19.9% of the target shares (the directors held a 23.8% stake in aggregate).

As originally entered into, the bidder was entitled to exercise the call option if:

  • a competing proposal was made and the bidder matched or bettered that proposal, or
  • a competing proposal was made and the bidder reasonably formed the view that the competing proposal was likely to be successful if the option shares participated.

At the first court hearing, the court concluded that the agreement did not require the directors to be placed in a separate class for voting purposes. The court’s reasons included:

  1. the event triggering the exercise of the call option was the emergence of a competing proposal
  2. the two directors would receive the same consideration as other shareholders
  3. the two directors had recommended the scheme and stated their intention to vote in favour, and
  4. the directors held additional target shares that were not subject to the call option.

After the first court hearing, in the face of a vocal shareholder group opposing the scheme, the bidder increased the offer price from $3.55 to $3.80 per share. However, the two directors who had granted the call option agreed to forgo the increase in consideration and to receive the initial offer price of $3.55 per share in respect of the option shares. To achieve this, the call option agreement was amended to also enable it to be exercised merely upon the scheme becoming effective (that is, upon the court’s approval orders having been lodged with ASIC), whether or not a competing proposal had emerged, at the original offer price of $3.55 per share.

The amendments to the call option agreement were drawn to the court’s specific attention at a hearing to approve the changes to the structure of the scheme. The court concluded that the amendments did not cause the two directors to be in a separate class. In reaching this conclusion, the court reiterated 2 of the 4 original factors set out above, being that both directors:

  • recommended the scheme and stated their intention to vote in favour, and 
  • held additional target shares that were not subject to the call option.

Before this decision, market practice, based on the pre-scheme call option agreements which had recently been subjected to judicial scrutiny (being the agreements in the Mitchell Communications and MAC Services schemes of arrangement), was trending towards the inclusion of an exercise condition that a competing proposal had emerged – indeed, the original form of the Cellestis agreement contained such a condition.

However, in light of the Cellestis decision, it seems clear that the emergence of a competing proposal is not a mandatory condition precedent to the exercise of a pre-scheme call option agreement, in the sense that, without such a condition, the grantors of the call option would be in a separate class for voting purposes. On this basis, we can expect to see more such agreements without this requirement (noting, however, that for commercial reasons such a condition may still be requested or required by the relevant target shareholders who grant the call option).