- Call option agreements and voting agreements (or public statements of support) have become increasingly prevalent deal protection devices in schemes of arrangement.
- The courts have considered such agreements in three recent schemes.
- If properly drafted, such agreements should not be class creating or require the court to discount or disregard votes.
Pre-scheme option agreements and pre-scheme voting agreements between target shareholders and bidders have become increasingly prevalent deal protection devices in schemes of arrangement.
A series of recent court decisions have made it clear that, if properly drafted, such agreements should not require the relevant target shareholder to be placed in a separate class for the purposes of voting on the scheme or require the court to discount or disregard the votes of the relevant shareholder.
Two relatively recent deal protection innovations in Australian schemes of arrangement are pre-scheme option agreements and pre-scheme voting agreements.
Although the terms of such agreements can vary widely, in summary:
- under a pre-scheme option agreement, a target shareholder grants the bidder a call option to acquire some or all of their shares, and
- under a pre-scheme voting agreement, a target shareholder agrees in favour of the bidder to vote in favour of the scheme in respect of some or all of their shares. (A similar result can be obtained by the shareholder simply making a public statement to the same effect—in such a case that shareholder would be held to that statement under ASIC’s ‘truth in takeovers’ policy.)
In light of Australia’s 20% takeover threshold, such agreements can never relate to more than 20% of the target’s shares in aggregate.
The issue that scheme proponents have grappled with over the years is whether such agreements require the relevant target shareholder to either:
- be placed in a separate class for the purposes of voting on the scheme, or
- have their votes discounted (or even disregarded) by the court on the grounds of an extraneous (or special) interest.
These issues have been considered by courts in three recent schemes of arrangement. Although the specific terms of each such agreement will always need to be carefully considered, it is now clear that, if properly drafted, such agreements should not be class creating or require the court to discount or disregard votes.
Mitchell Communications Group – option agreement
In this scheme, the bidder, Aegis Group, entered into a call option agreement with a target shareholder in respect of 19.9% of the target shares (the shareholder had a 30% stake). The bidder had the right to acquire the shares at any time during the nine-month period after the date of the agreement, if a competing proposal was announced. The exercise price was to be equivalent to the consideration under the scheme. If, following the exercise of the option, the bidder subsequently sold the shares into another takeover or scheme, the shareholder was entitled to one-third of the notional profit realised by the bidder on the on-sale.
ASIC had asked the scheme proponents to explain why, in their view, the agreement was not class creating. ASIC was presumably satisfied with the response as it did not attend either court hearing. Nevertheless, the scheme proponents drew the court’s attention to the option agreement. The court concluded that it was satisfied that the agreement did not give rise to a separate class.
Although the relevant shareholder did not enter into a voting agreement with the bidder, it was stated, in the announcement of the transaction, that the shareholder intended to vote in favour of the scheme, in the absence of a superior proposal.
The MAC Services Group Limited – option agreement
In this deal, the bidder, Oil States International, entered into a call option agreement with a target shareholder in respect of 19.9% of the target shares (the shareholder had a 52% stake). Under the agreement, the bidder was only entitled to exercise the call option if:
- a competing proposal was made in respect of the target, and
- the bidder subsequently made a matching (or superior) proposal which the target board determined was more favourable than the competing proposal.
In such a scenario, the call option was exercisable at a price equal to the consideration proposed to be paid under the matching proposal.
The court noted that it was conceivable that the relevant target shareholder had an interest in the emergence of a matching proposal that differed from other shareholders. This was because the other shareholders would only receive the increased price under a matching proposal if that proposal was carried through to completion; whereas the mere announcement of a matching proposal would potentially secure the increased price for the relevant target shareholder (if the bidder elected to exercise the option). However, the court went on to note that this did not result in that shareholder forming a separate class.
Although the shareholder did not enter into a voting agreement with the bidder, it was announced that the shareholder’s ‘current intention’ was to vote in favour of the scheme, in the absence of a superior proposal.
Straits Resources Limited – voting agreement
On this occasion, a person held notes in the scheme company that were capable of being converted into a 19.4% shareholding. The note holder agreed in favour of the bidder, PTT Mining, that it would:
- convert the notes into shares before the scheme meeting
- vote in favour of the scheme
- not dispose of any of the new shares, and
- not support a competing proposal,
unless the scheme implementation agreement was terminated or the board of the scheme company ceased to recommend the scheme.
The court concluded that the agreement did not result in the note holder being placed in a separate class as the note holder would receive (in its capacity as a shareholder) the same consideration for its shares as the other shareholders, albeit that it would receive its consideration as a result of the conversion of the convertible notes.
Despite this conclusion, at the first court hearing, the court required that the votes of the note holder be separately tagged and counted so the court could consider whether it was appropriate to discount or disregard the votes at the final court hearing. At the final court hearing, the court noted that, even if the votes cast by the former note holder had been disregarded, the scheme would still have been agreed to by an overwhelming majority. However, importantly, the court did not suggest that it would have declined to approve the scheme if, when those votes were disregarded, the scheme would not have been agreed to by the requisite statutory majority.
As bidders are limited by Australia’s takeover rules to acquiring a pre-scheme interest in only 20% of the target’s shares (which is low by international standards—for example in the EU a 30% threshold is common), it is likely that bidders, buoyed with confidence by these recent court decisions, will increasingly look to push the envelope in relation to the terms of pre-scheme option and voting agreements.
We should expect to see such agreements start to edge towards their most purest (bidder friendly) forms, namely:
- for pre-scheme option agreements – a simple call option to acquire target shares at a fixed price, irrespective of what happens in the scheme (eg whether or not an auction develops), and
- for pre-scheme voting agreements – a simple agreement to vote in favour of a scheme, whether or not a superior proposal emerges.
Prospective bidders will hope that such variations to these agreements withstand judicial scrutiny in the same way as their ancestral archetypes have done so to date.