Several features of Australian corporate law have implications where a company seeks to be able to claw back scrip consideration. In this article, we detail how novel structuring and proper care can achieve security for payment in scrip transactions.
In Australia, the concept of treasury shares does not exist; if a company repurchases its own shares those shares are cancelled. Special procedures are required for such a selective share buy-back including 75% approval by shareholders. Moreover, in Australia a company cannot take security over its own shares. These features of Australian corporate law have implications where a company seeks to be able to claw back scrip consideration. While in some jurisdictions it is relatively straightforward to claw back scrip consideration, in Australia this is more complicated. For example, the recipients of the scrip consideration may vote against a buy-back of their shares; also, entry into a buy-back agreement results in a suspension of the rights attached to the relevant shares. We explain how a full or partial unwinding can be achieved in scrip transactions by having them sold back and cancelled upon a particular event. As a result, with novel structuring and proper care, security for payment can be achieved in scrip transactions.
Security for payment
If a contracting party does not want to take a credit risk on its counterparty, then security for payment can be a material consideration. For example
(a) a buyer may seek recourse in the event it needs to make a warranty claim against a seller.
(b) a seller may want comfort that any contingent future payments will ultimately be paid by the buyer.
(c) a contractor may seek security for a termination payment (or an asset put option) under a services agreement.
In all of these cases, a mere payment obligation may not give a contracting party sufficient comfort that they will be paid, and they may want some form of security to ensure payment is forthcoming.
Where cash is involved, this security for payment may take the form of an escrow account, cash retention, or possibly a bank or parent company guarantee. In certain circumstances, it may also be possible to outsource the risk by obtaining an insurance bond or insurance cover.
But what about instances in which the consideration for the underlying transaction takes the form of a share issue, and where there is insufficient financial headroom to also provide a guarantee or other security? In difficult times, entities are keen (or obliged) to preserve cash and pay with equity – but they also want to be sure that they are covered against downside risk.
The use of a company’s equity as consideration can provide a number of benefits, but also presents some challenges. While the ‘capital maintenance’ rules have been watered down to some extent, they have not been removed altogether, which means that share capital, once issued, is hard to payback or extinguish. If the consideration payable under a transaction is shares rather than cash, it is not easy to unwind the transaction. One solution to this may be to defer payment. This may include
- issuing the consideration shares in tranches – as value is earned,
- issuing some form of converting or convertible securities – which carry limited rights but convert into ordinary equity as (or when) value is earned,
- issuing partly paid shares that may be credited as fully paid upon the occurrence of certain events,
- contractually restricting rights attaching to shares – therefore,not allowing full voting or dividend rights until certain conditions are met.
These structures may themselves present their own complexities, and may not be acceptable to the counterparty. If the counterparty insists on being issued with full equity upfront, the same problem presents itself: can they pay it back if a future payment obligation is triggered?
Ordinary shares in Australian companies, once issued, can only be extinguished by a capital reduction or a buy-back. They cannot be transferred back to the issuing company and held without being cancelled (unlike in some other jurisdictions that permit companies to hold ‘treasury stock’ in themselves, for later use). However, it is possible for a counterparty to sell the consideration shares back to the issuing party (by way of a share buy-back), and have them cancelled upon the occurrence of a particular event. In the context of a scrip transaction, this effectively amounts to a full, or partial, unwinding of the transaction and means that the contracting party can effectively recoup some of the value paid to the counterparty.
A buy-back may therefore offer a form of security for payment for scrip transactions, but there remain some complex issues that need to be addressed:
- A company cannot take security over its own shares (section 259B of the Corporations Act 2001 (Cth)), so any arrangement needs to be carefully structured to ensure that the issuing company does not obtain an enforceable right to take a proprietary interest in shares in itself in the event of a default.
- The shares need to be available (and unencumbered) at the time of any buy-back – any interim sale or encumbrance of shares by the counterparty would frustrate the buy- back and negate the benefits of the arrangement.
- Once a buy-back agreement is entered into, the rights attaching to securities are suspended (section 257H(1)), which makes it more likely that any buy-back agreement should only be entered into after the relevant event has triggered a buy-back.
- A shareholder approval will be necessary to buy back shares, and (as a selective buy-back) will need a 75% approval. This adds delay, expense and, to some extent, uncertainty to the arrangement.
- Any buy-back will only occur if pursued by the contracting party. In circumstances where a potentially large payment of shares has been made to a contract counterparty, the counterparty may be able to exert some influence over the company and could, if it obtained board control, negate the benefits of any arrangement by causing the company not to pursue a buy-back.
Case study: novel structuring
In appropriate circumstances, and with careful structuring, there are ways to obtain security for payment in a scrip-based transaction.
Our team recently assisted ASX-listed mining services contractor Macmahon Holdings (Macmahon) to navigate these issues in the context of its transformational transaction with PT Amman Mineral Nusa Tenggara (AMNT). AMNT is an Indonesian company that owns the Batu Hijau copper-gold mine in Indonesia. Under the transaction, Macmahon agreed to purchase a large Indonesian-based mining fleet, which it would use to service the $3.9 billion Batu Hijau life-of-mine mining services contract to be awarded by AMNT. However, rather than pay A$194 million in cash for this mining fleet, Macmahon issued shares to AMNT representing 44.3% of Macmahon’s issued capital.
If, for any reason, the mining services agreement is terminated during an initial period, the agreement contains a requirement for Macmahon to transfer back the mining fleet in exchange for a ‘cessation payment’ from AMNT. Macmahon was keen to ensure that it had some form of security for this cessation payment (for the benefit of Macmahon and its existing shareholders), given that 44.3% of its securities would be issued as consideration for the purchase of the mining fleet.
After an analysis of all of the relevant legal issues (including those described above), we were able to put in place a novel structure whereby a third-party trustee company would hold the consideration shares for a defined escrow period. Macmahon and AMNT then entered into an escrow deed, which, among other things, contemplated that the escrow agent would be required to accept a buy-back offer made to it upon the occurrence of certain events. Restrictions on voting and other rights attaching to the consideration shares in certain circumstances also ensured that the integrity of the mechanism could be protected, despite AMNT’s large interest in Macmahon.
These risk-management mechanisms ultimately provided sufficient comfort to Macmahon, its board and its shareholders so as to permit Macmahon to proceed with its transformational transaction. The transaction was approved by shareholders in July 2017 and completed in August 2017.
This demonstrates that in appropriate circumstances, and with careful structuring, there are ways to obtain security for payment in a scrip-based transaction.