Schemes of arrangement are so much a part of the M&A landscape that we often forget that they are quite different from takeovers. Australian takeover laws include “equality of opportunity” rules designed to provide every shareholder with the same rights in a takeover. But the Woolworths bid for David Jones reminds us that there’s less equality when the deal is done by scheme of arrangement.
The proposed shareholder vote on June 30 brings to a head Woolworths’ $2.5 billion bid for David Jones. Recent reports suggest Solomon Lew is working on a side deal with an as yet undisclosed purpose but one which many have speculated has a connection to a buyout by the South African retail giant of Lew’s 11.8 per cent stake in Country Road at a premium to the market value, in return for the votes he controls in David Jones (which might include votes held through equity swaps).
In mergers and acquisition parlance, it’s known as a collateral benefit, as the “premium” received on Lew’s Country Road parcel is not available to all shareholders. And the Takeovers Panel takes a dim view of it.
Commentators are questioning how Lew may have acquired the votes and whether we need to re-examine interests arising under swaps etc, but that’s just a distraction. The real issue is whether a shareholder in a scheme can get a benefit that would not be allowed in a takeover.
Even if you put that question aside, potential problems remain in the current proposed scheme, for two reasons. Firstly, if he transacts with Woolworths, Lew’s interests will vary from other shareholders because he will receive a collateral benefit. If the collateral benefit is a net benefit (by reference to the commercial balance of advantages flowing to and from Lew, as per the Takeovers Panel guidance note), that’s likely to mean one of two things; either Lew should be in a separate class or his votes should be disregarded.
The former would be fatal to the scheme as presently conceived if the transaction were to occur prior to the 30 June meeting because the meeting is not set up for different classes. In May, David Jones asked the court to convene the meeting with a single class of shareholders, which the court did. If the classes have been improperly constituted at the meeting, the court simply can’t approve the scheme even if the scheme would still have been approved by members had the classes been correctly constituted. In cases where ASIC perceives there to be a collateral benefit, ASIC has been known to press hard for separate classes. In some cases, companies have settled on a compromise position with ASIC where the shareholder who receives the collateral benefit abstains from voting.
However, if any side deal were to occur, it is unlikely to affect Lew’s rights under the scheme, which means that it’s unlikely to be a class issue, but rather an “interest” issue which should be dealt with by either disregarding or discounting Lew’s votes. But that doesn’t entirely solve the problem because the court has a general fairness discretion in deciding whether to approve the scheme.
Before the court can approve the scheme, judges have emphasised that where there is no opposition to the approval of the scheme, and there are no public policy grounds for withholding approval, considerable weight should be given to the commercial judgment of those who have voted to approve the scheme. Depending on the nature and extent of the collateral benefit, there might be a few shareholders wanting to oppose the approval of the scheme, not to mention ASIC.
Secondly, if any side deal were to occur, it would require supplementary disclosure to shareholders, which may require an updated report from the independent expert. The most prudent approach would be to ask ASIC and the court to approve the supplementary disclosure. But that takes time and is unlikely to occur before the current meeting date of 30 June as ASIC generally requires that shareholders receive at least ten days’ notice in relation to any supplementary disclosure. What this means is that if a deal is struck, the scheme meeting will need to be adjourned to a later date to give shareholders time to consider the disclosure and decide whether they want to change or lodge a proxy or attend the scheme meeting to vote in person.
These issues would be material and would threaten the current scheme timetable and potentially the viability of the scheme. It is quite rare for courts not to approve schemes, but in this case several questions need to be considered.
What would happen, for example, if the court decided that circumstances had changed materially between the initial hearing and the scheme meeting, and the shareholders and the court had not been appropriately updated about those circumstances prior to the scheme meeting. There is enough authority to suggest that the court would not be happy. Or, what would happen if one or more shareholders raised concerns in the meeting or at the approval hearing that they weren’t given any notice (or sufficient notice) of the collateral benefit and challenged the validity of the vote?
Courts generally adopt a commercial approach to schemes and in this case a court would be reluctant to derail a deal of this size with an estimated transaction cost of $38 million without good reason. But can the same be said for ASIC? The regulator has shown a willingness in the past to challenge what it perceives to be collateral benefits and it would be open to it to oppose the scheme at the approval hearing. Is this a case where ASIC would or should?