There have recently been a number of significant developments in relation to schemes of arrangement. These include:
- the Federal Court refusing to make orders convening a meeting of CSR’s shareholders to vote on a demerger proposal by way of scheme, on public policy and commercial morality grounds relating to CSR’s potential asbestos liabilities
- the Government’s corporate law advisory body recommending significant reforms to the scheme regime, and
- developments regarding ‘hostile schemes’.
Each of these developments is discussed below.
Federal Court stops CSR’s proposed demerger by scheme
- The Federal Court declined to make orders convening a meeting of CSR’s shareholders to vote on a demerger proposal by way of scheme.
- The court considered that the demerger proposal was not commercially moral or consistent with public policy.
- Given the special circumstances, the decision is expected to have little impact on other demerger proposals.
The Federal Court has refused to convene a meeting of CSR Ltd’s shareholders to vote on a proposed scheme of arrangement under which CSR Ltd’s sugar and renewable energy business would be demerged into a new company (to be known as Sucrogen Limited), leaving CSR Ltd (New CSR) as a building products and aluminium business.
ASIC and a number of other parties appeared before the court and expressed their concern with what they argued was the potential prejudice to persons who currently had, or in the future may have, a claim for compensation from CSR Ltd for injury sustained from exposure to asbestos products supplied by CSR Ltd.
Justice Stone stated that a critical issue was that there was considerable uncertainty as to New CSR’s provision for asbestos claimants after the demerger. Her Honour concluded that the court could not be satisfied that the provisions made for the asbestos liabilities were consistent with public policy or commercial morality or that the demerger would not involve an unfair or oppressive result. Her Honour’s decision was made in light of the facts that:
- New CSR would be the repository of all CSR Ltd’s liabilities in respect of asbestosrelated claims both present and future
- New CSR would suffer a significant reduction in the capital available to meet such claims, and
- there was uncertainty with the actuarial estimates and other expert opinion on the quantum of the asbestos liabilities.
What does this mean for future demergers?
The decision is expected to have little impact on demergers going forward and should be confined to its own special and unique factual circumstances. Although every demerger will have some impact on the ability of the entity that is the subject of the demerger to meet the claims of creditors, as Justice Stone noted, that of itself ‘does not indicate any unfairness or conflict with public policy’.
Justice Stone stressed that the position of future asbestos claimants should not be equated with every other category of current and future creditor. Her Honour noted that the interest of the future asbestos claimants arose ‘not from some future dealing with CSR but from their involuntary exposure to asbestos products supplied by CSR’.
Unlike, for example, normal commercial creditors of an entity, the future asbestos claimants were involuntary creditors, and there were in her Honour’s view, strong and clear public policy grounds for seeking to ensure that those exposed to asbestos products are not denied appropriate compensation in the future.
On 10 February 2010, CSR announced that it had sought leave to appeal the Federal Court’s decision.
CAMAC proposes reforms to schemes
- The Government’s corporate law advisory body has recommended a number of significant reforms to the scheme of arrangement regime.
- The reforms include supporting a due diligence defence for directors, removing the takeover avoidance provision and abolishing the head count approval requirement.
- The reforms are a welcome development and remove a number of features of schemes which create unnecessary completion risk.
The Government’s Corporations and Markets Advisory Committee (CAMAC) has published its final report setting out its recommended reforms to the scheme of arrangement regime. CAMAC’s proposed reforms are a welcome development. The reforms would remove many features of schemes which create unnecessary uncertainty and completion risk for transactions whilst having no adverse effect on the many shareholder protections inherent in the scheme regime.
Schemes of arrangement have been used in Australia for several decades as a means of effecting changes of control of widely held companies. Today, around 46 per cent of friendly or recommended change of control transactions are effected by way of scheme (the remaining 54 per cent being effected by way of takeover bid).
However, unlike the takeover provisions which have been subject to significant amendment, overhaul and refinement over the years, the scheme provisions have, in the main, hardly been touched since they were first enacted in the United Kingdom back in the 19th century. Not surprisingly, the scheme provisions contain some outdated and unhelpful features.
CAMAC’s key recommendations are:
- Repeal of takeover avoidance provision—s411(17)(a) of the Corporations Act provides that a scheme cannot be approved if it was proposed for the purpose of avoiding the takeover provisions. This provision creates unnecessary uncertainty and completion risk for schemes. CAMAC has recommended the repeal of s411(17)(a).
- Directors’ liability—in takeovers and many fundraising contexts, directors who cause the issue of the relevant disclosure document have due diligence defences to liability. There is no equivalent defence in schemes. CAMAC has acknowledged the need for changes to the liability regime in schemes and has recommended a broader review of the liability regimes applicable to all disclosure documents.
- Extension of schemes to managed investment schemes—this would mean the scheme of arrangement procedure could be used for deals involving property and infrastructure trusts as an alternative to a takeover bid or a ‘trust scheme’.
- Head count test—CAMAC has recommended the removal of the anachronistic head count test that requires a majority of shareholders by number to approve a scheme, in addition to the approval threshold of 75 per cent of votes cast. The head count test provides an incentive for share splitting and has the potential to result in the blocking of a scheme even where the holders of the overwhelming number of shares have voted in favour.
- Approach to classes and extrinsic interests—CAMAC has recommended that the court be given a curative power to approve a scheme even if the classes were wrongly constituted or if extrinsic interests exist that might otherwise result in the court overturning the scheme vote.
- Size and content of scheme booklets—CAMAC has made a number ofrecommendations to try and reduce the size of scheme booklets, including advocating a requirement that booklets should be presented in a ‘clear, concise and effective’ manner, removing the checklist of technical disclosure requirements and allowing incorporation of documents by reference.
A number of other proposed reforms were considered, but ultimately not endorsed by CAMAC, most notably:
- Hostile schemes—CAMAC considered it impracticable and unnecessary to amend the scheme provisions to facilitate hostile schemes (that is, schemes of arrangement which are not supported by the target company).
- Eggleston principles—CAMAC rejected the need to mandate the application of the Eggleston principles in s602 of the Corporations Act to schemes, noting that they were not necessary in the context of schemes.
- Convertible securities—CAMAC did not consider legislative change was necessary to accommodate noteholders and optionholders, noting that they could continue to be dealt with under creditors’ schemes.
- It is generally thought that it is too difficult to use a scheme of arrangement to effect a hostile transaction.
- Two recent transactions serve as a reminder that, despite this general view, there may well be commercial circumstances which make a hostile scheme worth pursuing.
It is generally thought that a scheme of arrangement can only be used to effect an ‘agreed’ or ‘friendly’ transaction, unlike a takeover bid which can also be used to effect a ‘hostile’ transaction. This is essentially because of the central role that the target company must play in driving the scheme of arrangement process.
However, this has not stopped speculation as to whether it might still be possible to implement a scheme of arrangement which is not supported by the target company. The Corporations Act permits a shareholder of the target to make an application to the court for orders convening a scheme meeting and so does not, in theory anyway, leave the door completely shut on hostile schemes.
There have been a number of examples in Australia of ‘bear hug’ style announcements where a potential bidder announces a proposed scheme of arrangement conditional on the support of target directors. One example of this was QBE’s approach to IAG in 2008. However, there has not, to date, been an example in Australia of a potential bidder going one step further and seeking to initiate the scheme process.
As mentioned above, CAMAC considered whether the scheme provisions should be amended to facilitate hostile schemes and concluded that they should not. However, two recent overseas examples provide some interesting insights into hostile schemes.
In the United Kingdom, Goldshield Group was recently the subject of a hostile scheme. The hostile scheme was proposed by an entity backed by the private equity fund HgCapital and certain members of Goldshield’s management team who collectively held 11.36 per cent of the shares in Goldshield. This is the first hostile scheme attempted in the UK since 1981 when Trust House Forte proposed a hostile scheme for Savoy Hotel—on that occasion the hostile scheme was ultimately abandoned.
The proposed hostile scheme involving Goldshield was noteworthy as the announcement went beyond the mere ‘bear hug’ style of announcement that we have seen in Australia and contained a statement from the bidder that it would apply to the court for orders convening the scheme meetings. Interestingly, the announcement also stated that, if the scheme failed due to a technical or procedural problem arising as a result of the transaction proceeding by way of a hostile scheme, the bidder would implement the transaction by way of a takeover bid.
Unfortunately for those wanting to find out whether a hostile scheme is more than a mere theoretical possibility, HgCapital’s proposal was ultimately recommended by the independent directors of Goldshield and the transaction proceeded by way of a recommended scheme of arrangement.
The other recent example occurred in Bermuda (Bermudan law in this regard being very similar to other common law jurisdictions). In that instance, Validus Holdings announced a hostile scheme to acquire IPC Holdings which is in the reinsurance business. Validus acquired 100 shares in IPC and applied to the court for orders convening a scheme meeting to vote on the proposed scheme. The court noted it remained an unprecedented course to embark on a scheme in the face of the opposition of the target board and that there were ‘severe practical difficulties in piloting such a scheme’. Despite this, the court stressed it did have the power to order the convening of the meeting.
However, the court ultimately decided that it was not appropriate to convene the meeting in this case as there was no ‘real and solid indication of independent shareholder support sufficient to show that [the hostile scheme had] some reasonable hope of success’.