The Federal Court has clarified the proper application of ASX Listing Rule 7.1 (known as the “15% rule”) and the limitations of ASX Listing Rule 7.2, Exception 2, (known as the “underwriters’ exception”). Companies, underwriters and advisers should take note that the underwriters’ exception to the 15% rule does not extend to securities issued to the underwriter as part of its fee.
The effect of the decision is that securities issued to an underwriter will only be exempt from the 15% rule where the securities are shortfall securities (being the “rump” taken up by an underwriter where the shareholders have not taken up their full entitlements).
ASX Listing Rule 7.1 provides that a listed company must not, without shareholder approval, issue or agree to issue more securities in one year than would represent 15% of its issued capital. Listing Rule 7.1 protects shareholders against dilution of their holding, except in limited circumstances expressed as exceptions to the Rule in Listing Rule 7.2. The first of those exceptions is a pro rata issue of securities, as shareholders can protect against the dilution by taking up their entitlements. The second exception (Exception 2) is an issue of securities “under an underwriting agreement to an underwriter of a pro rata issue to holders of ordinary securities”.
In October 2012, Oil Basins Limited (OBL), a shareholder of Bass Strait Oil Company Limited (BAS), claimed that:
- BAS had not taken into account in its 15% calculation for a share placement in 2012 certain options issued to an underwriter of a previous share placement in 2011;
- specifically, BAS had increased the number of securities it could issue by failing to deduct from the 15% calculation the options issued to the underwriter in 2011 as part of its fee;
- BAS’s reliance on Listing Rule 7.2 as a basis for exemption was based on an erroneous interpretation of that Rule;
- the Listing Rules must be interpreted in accordance with their spirit, intention and purpose, as the Rules themselves clearly specify; and
- because the only interpretation of Listing Rules 7.1 and 7.2 consistent with their spirit, purpose and intention was the interpretation OBL advocated, BAS had issued more securities than it was entitled to issue in the 2012 share placement.
BAS argued a more rigid, black letter view of the Listing Rule, noting that as Exception 2 refers to an issue of securities to an underwriter under an underwriting agreement, and there is no stated restriction on the purpose for which those securities may be issued, it was permissible to exempt the securities paid as fees to an underwriter pursuant to an underwriting agreement.
The Federal Court agreed with OBL, relying on the spirit and intention of the Listing Rules in reaching its conclusion. The Court found that the issue of securities for the purpose of fees is akin to a placement, where existing shareholders have no involvement in the underlying issue of securities, and therefore no way of protecting themselves against dilution of their voting and economic interests in the existing securities. The Court found that if the issue of fee securities fell within Exception 2 and therefore the 15% rule did not apply to those securities, a company would be free to issue as many securities as it wished to an underwriter as payment of its fee, with the effect of diluting the other shareholders (noting that the underwriter could then assign them to a nominee, as BAS did in this case). The Court concluded that this would allow a company to impermissibly circumvent Listing Rule 7.1.