- The Federal Court recently allowed the votes of a related body corporate of the acquirer to count towards the shareholder approval thresholds for a scheme of arrangement.
- The decision is difficult to reconcile with the generally accepted position that votes of the acquirer and its related bodies corporate should be disregarded by the court on the grounds of their extraneous commercial interest in the outcome of the scheme.
- We expect the decision to be confined to its facts in future schemes.
In a merger by scheme of arrangement, it is generally accepted that any target shares held by the acquirer (or any of its related bodies corporate) should be disregarded when determining whether the member approval thresholds are met. This is on the grounds that the acquirer and its related bodies corporate have an extraneous commercial interest in the outcome of the scheme.
However, in a surprise decision, the Federal Court (Court)recently, in approving the scheme between Kumarina Resources Ltd (Kumarina) and its members, allowed the votes of a related body corporate of the acquirer to count towards the shareholder approval thresholds.
The scheme proposed by Kumarina
With the goal of forming a broader resources group, Zeta Resources Ltd (Zeta) and Kumarina agreed to implement a scheme under which Zeta would acquire all the shares in Kumarina for scrip consideration in the form of shares in Zeta.
At the scheme meeting, only 79.07% of the votes were cast in favour of the scheme.
ASIC provided its standard ‘no objection’ letter in respect of the scheme, but two members appeared at the second Court hearing to object to the scheme. The objectors argued, among other things, that Utilico Investments (the parent company of the acquirer Zeta) and ICM (Utilico’s investment manager) should have voted in a separate class or, alternatively, that their votes should be disregarded by the Court in determining whether the member approval thresholds were satisfied.
Utilico held 10.13% of the Kumarina shares and ICM held 9.84% of the Kumarina shares. The objections raised in relation to ICM are not relevant to this article. If Utilico and ICM’s votes were excluded, the scheme would have fallen just short of satisfying the 75% approval threshold. If only the votes of Utilico were excluded, the scheme would have just satisfied the 75% approval threshold.
The Court’s reasoning
Justice Gilmour rejected the objections and approved the scheme.
His Honour noted that the test for whether there are separate classes of members turns on whether there are members whose legal rights, as opposed to commercial interests, are sufficiently different such as to make it impossible for them to consult together with the other members with a view to their common interest.
In his Honour’s opinion, the rights of Utilico were no different from the rights of other Kumarina members and so they could vote in the same class as the other members. As Utilico was to receive the same consideration under the scheme as all other members and its rights were to be affected by the scheme in the same manner as for all other shareholders, his Honour’s conclusion on classes is uncontroversial.
Disregarding Utilico votes on the grounds of extraneous commercial interests
Although Utilico did not form a different class, there remained the very real question as to whether the Court should, nevertheless, have completely disregarded its votes in determining whether the member approval thresholds were satisfied on the grounds that they have an extraneous commercial interest in the outcome of the scheme.
The principle that a court should completely disregard the votes of the acquirer and its related bodies corporate on the basis of their extraneous commercial interest is well-accepted. Justice Gilmour’s reasoning does not clearly address this issue. However, his Honour sought to factually distinguish a case concerning a creditors’ scheme where the court had declined to approve the scheme on similar grounds.
His Honour also considered the Court’s residual discretion to decline to approve the scheme and decided not to exercise this discretion because:
- the scheme was ‘overwhelmingly approved by members’, even if the votes of Utilico and ICM were excluded,
- there was no reason to consider that the votes were not representative of the views of Kumarina’s members,
- ASIC was kept fully and thoroughly informed throughout the process,
- shareholders will receive substantial benefits from the scheme, and
- the independent expert’s report concluded that it is in the best interests of members and is fair and reasonable.
It is interesting to note that the objectors also lost on costs and their submissions were criticised as being obscure and without substance.
If the decision is regarded as establishing a principle that an acquirer’s related bodies corporate can vote in favour of a scheme, it would be a significant change to the law and practice of schemes of arrangement. Acquirers would be free to use related bodies corporate to acquire target shares (subject to the usual restrictions such as the 20% takeover threshold and, if applicable, FIRB approval requirements) and then vote them in favour of a scheme – equivalent to buying up a pre-bid stake in a takeover bid.
However, our expectation is that the decision will be confined to its facts and will not be seen by future courts as standing for such a general principle.
Absent unusual circumstances, we do not expect ASIC to provide a ‘no objection’ letter in future cases if it is aware that related bodies corporate of an acquirer voted in favour of the scheme and the approval thresholds would otherwise not have been satisfied.