As the Australian credit market has not yet returned to the buoyant state enjoyed prior to the global financial crisis, companies continue to explore rights issues as a way of raising funds. Given the potential change of control impacts associated with a rights issue, listed companies need to consider how to structure any underwriting of a rights issue to avoid an application to the Takeovers Panel (the Panel) to prevent the transaction.
In its only decision relating to a rights issue so far this year, the Panel approached the factors described in Guidance Note 17: Rights Issues (GN 17) in a manner consistent with its application of those factors in prior decisions relating to underwritten rights issues. By following the principles set out in GN 17 relating to the choice of underwriter, structure of the rights issue and disclosure, listed companies can conduct an underwritten rights issue, with some assurance that they will be able to withstand a claim to the Panel.
- In December 2010, Mintails Limited (Mintails) issued convertible notes to an investor and one of its unlisted subsidiaries also issued convertible notes to a second investor. The terms of the convertible notes were not disclosed at the time of issue. Further notes were issued in April 2011. During the Panel application, it became apparent that, on conversion of the convertible notes issued by its subsidiary, Mintails would be required to execute a further agreement to exchange the subsidiary's newly issued shares for shares in Mintails.
- Mr Harbour, a 38.7% shareholder, had made an on-market bid for shares in Mintails in March 2011 and, in April 2011, requisitioned a shareholders meeting to replace two of the directors.
- One week prior to announcing the rights issue, Mintails disclosed in a Target's Statement that its subsidiary's convertible notes were to be assigned to an unnamed third investor, who may underwrite a possible rights issue.
- Mintails announced a proposed 1 for 4 rights issue which was to be underwritten by one of its shareholders, Trinity Asset Management (Pty) Limited (Trinity), for a 6% fee. During the Panel application, it was disclosed that the third investor who would acquire the convertible notes (and so potentially acquire shares in Mintails) was an associate of Trinity.
- Trinity's participation as underwriter, together with the shares that could be acquired by its associate on conversion of the convertible notes could result in Trinity obtaining a 30% interest in Mintails - a 25.13% increase on its existing 4.87% interest.
- Over the two days following the announcement, Mr Harbour offered to underwrite the rights issue for a more competitive fee and then for no fee but Mintails proceeded to enter into a binding underwriting agreement with Trinity.
- Mr Harbour then lodged an application with the Panel claiming that the potential impact of the underwriting by Trinity on control of Mintails, combined with inadequate disclosure by the company about the convertible notes, gave rise to unacceptable circumstances.
Mintails then restructured the rights issue so it was not underwritten, but included a $2 million minimum subscription condition and a shortfall facility. It also agreed to substantial further disclosure and other requirements relating to shareholder approval for the issue of Mintails shares on exercise of the convertible notes. Based on these changes, the Panel considered Mr Harbour's concerns to have been sufficiently addressed, so it was unnecessary for the Panel to conduct proceedings. A win for shareholders of Mintails, but it didn't result in Mr Harbour achieving his initial goal of participating in the underwriting as a permitted way of increasing his stake in Mintails.
Structure of the rights issue
Identity of the underwriter
An important issue in structuring a rights issue is whether it is underwritten by a professional underwriter or sub-underwriter, a related party or a major shareholder. GN 17 makes it clear that failing to seek alternatives to a major shareholder or related party as underwriter will increase the prospects of unacceptable circumstances existing. Further, in Vesture Limited 02  ATP 15 (Vesture), the Panel indicated that in circumstances where one major shareholder is participating in an underwriting, all major shareholders should be offered an opportunity to participate.
Mintails' conduct prior to Mr Harbour lodging his application appears to run contrary to the principles set out in GN 17 and the Vesture decision. However, as Mintails abandoned the underwriting after the application was lodged, the Panel's reasons provide no further guidance on the importance of the underwriter's identity.
In Vesture, the Panel declined to require that a 43.96% shareholder be allowed to participate as an underwriter, when it was clear that the shareholder was seeking control of Vesture. It is not known whether part of Mintail's motivation in appointing Trinity alone as underwriter was to avoid delivering control of Mintails to Mr Harbour, but that may well have been a contributing issue.
Another important factor which will be considered by the Panel is whether the rights issue includes a dispersion strategy, as this decreases the possibility of any one person increasing control through a rights issue. While items 10 and 13 of section 611 of the Corporations Act 2001 (Cth) allow an increase in voting power above 20% which results from an acquisition of shares under a rights issue or by an underwriter or sub-underwriter, the Panel and ASIC are both alert to the potential for such acquisitions to have an unacceptable effect on control. Including a dispersion strategy, such as a shortfall facility, in a rights issue will mitigate the risk of any one person increasing voting power and so reduces the prospect of unacceptable circumstances being found.
Mintails' restructured rights issue replaced the underwriting with a shortfall facility. Under the shortfall facility, shareholders taking up their full entitlement under the rights issue could also apply for shortfall shares up to a 20% threshold. If the shortfall facility was oversubscribed, the applications would be scaled back in proportion to each applicant's shareholding as at the record date of the offer. The shortfall allocation process would be repeated until all of the shortfall applications were satisfied.
Mintails' decision to utilise a rights issue with a shortfall facility open to all existing shareholders rather than an underwriting by one single shareholder provided an appropriate safeguard to mitigate potential control effects of the rights issue, consistent with the Panel's approach in GN 17.
Effect of the rights issue
An aspect considered by the Panel in GN 17 is the need for adequate disclosure of the potential control effects of the transaction. The level of disclosure to shareholders is expected to be proportionate to the extent of the potential control effects. Further, under GN 17, the Panel considers that shareholders will be able to make an informed decision where all of the possible control scenarios are specifically disclosed.
Harbour submitted that insufficient information had been disclosed by Mintails to enable shareholders to assess the effect of the Trinity underwriting and the transfer of convertible notes to an associate of Trinity.
Based on its initial review of the information disclosed by Mintails about the convertible notes, the Panel considered that it was unclear when the convertible notes could be exercised and whether shareholder approval was required for the issue of Mintails shares on exercise of the conversion notes. The Panel was concerned that other relevant information about the convertible note terms had not been disclosed, with the result that Mintails' shareholders could not have appreciated a significant control impact of the proposed transaction - that by not participating in the rights issue, the likelihood of Trinity and its associates gaining a controlling interest in Mintails would increase.
The Panel required Mintails to include in the offer document relating to the restructured rights issue, the possible maximum voting power of each of the large shareholders and investors (including Trinity and its associates, Harbour and the other holder of the convertible notes issued by Mintails) in the various scenarios that may flow from the rights issue. The form of disclosure had been agreed with Mintails and was attached to its undertaking to the Panel – it appears nothing was being left to chance. The Panel also required Mintails to agree that the issue of any Mintails shares on exchange for shares in its subsidiary would be subject to shareholder approval.
While this situation is somewhat unusual, the point for listed companies and their advisers to note is that they need to consider disclosure of all possible control effects, in a rights issue, not just the changes flowing directly from the rights issue.
A final comment
The Mintails decision reinforces the Panel's approach to rights issues, as set out in GN 17 and its prior decisions on rights issues. To implement a rights issue in a way that is likely to be acceptable:
- select a structure that minimises the control impact to the greatest extent possible in the circumstances – such as using professional underwriters or sub-underwriters or offering a shortfall facility; and
- make complete disclosure about any aspects of the company's business or capital structure potentially affecting the control of the company so that shareholders can make a fully informed decision whether or not to participate.