CSR wins appeal – clarity provided for demergers

On Friday 23 April 2010 the Full Court of the Federal Court allowed CSR’s appeal in relation to the scheme to demerge its sugar business. Previously, a single judge of the Federal Court had refused to convene a scheme meeting to allow shareholders to vote on the sugar demerger.

The way is now clear for CSR to continue with the scheme.

The Full Court’s decision also provides important clarifi cation on the principles to apply in a demerger.

Background

CSR had proposed to demerge its sugar business from its building products and aluminium divisions. Similar to numerous demergers previously undertaken (including CSR’s demerger of Rinker in 2003), the CSR demerger was proposed to be undertaken by a scheme of arrangement and associated capital reduction involving distribution of shares in a new company (Sucrogen) to CSR shareholders. The scheme was necessary to enable shareholders to take shares in the new company. The capital reduction, which was a condition precedent to but not part of the court approved scheme, was required to be separately approved by shareholders under section 256B of the Corporations Act 2001 (Cth) (Corporations Act).

When CSR fi rst sought the Federal Court’s approval to convene a scheme meeting, Justice Stone refused to convene the meeting. Her Honour’s judgment focused on the uncertainty surrounding actuarial estimates and other expert opinions relating to CSR’s asbestos liabilities. Her Honour concluded that she could not ‘be satisfi ed that the provisions made are consistent with commercial morality or that the Scheme, if given effect, would not involve an unfair or oppressive result’. The same concerns led Her Honour to conclude that ‘the material in the explanatory statement cannot provide adequate disclosure to CSR shareholders of New CSR’s ability to meet these future liabilities’. These comments placed a cloud over not only the CSR demerger but also demergers generally,especially those involving long dated liabilities or liabilities that may be diffi cult to quantify.

The Full Court’s decision

In a unanimous decision (with two separate judgments delivered) the Full Court of the Federal Court (Keane CJ, Jacobson and Finkelstein JJ) allowed CSR’s appeal and ordered that a scheme meeting be convened. The Full Court concluded that there is not an ‘at large’ commercial morality or public policy discretion vested in the court when determining whether to convene scheme meetings. The policy to be applied by the court needs to be discerned from the provisions of the Corporations Act.

In this case, whilst the capital reduction was not formally part of the scheme, it was permissible for the court to have regard to the impact of the capital reduction on CSR’s creditors in determining whether to convene the scheme meeting. In so doing, the court needs to have regard to the same test that applies on stand alone capital reductions, namely whether the reduction materially prejudices the company’s ability to pay its creditors.

The court did not provide defi nitive guidance on what would constitute ‘material prejudice’ to creditors, but did make clear it has to go beyond theoretical or abstract risks. The court rejected arguments that a company’s ability to pay its creditors is materially prejudiced if it chooses to resort to asset sales rather than cash flow and confi rmed that a company’s ability to pay its debts is an objective measure of capacity to be determined by reference to all of the company’s resources, whether income or assets.

In CSR’s case, the Full Court concluded that the evidence presented at the fi rst court hearing ‘does not contain any suggestion that one may reasonably predict that CSR will not be able to pay all its creditors, in the event of the demerger proceeding, even in scenarios of extraordinary stress’. Or put another way ‘it is not appropriate to refuse the scheme on a merely theoretical fear of adverse consequences … on the material before the court, it appears that the company would be able to pay all creditors should the worst eventuate’.

By ordering that the scheme meetings be convened, the Full Court disagreed with Stone J’s conclusion that the level of uncertainty attendant on CSR’s asbestos liabilities was such that adequate disclosure could not be made to its shareholders.

Whilst a signifi cant step, the Full Court’s decision is not a green light to CSR’s sugar demerger completing. Whilst the decision of the Full Court was that the evidence presented at the fi rst hearing did not warrant the conclusion that the scheme could never be approved at the second hearing (and therefore the scheme meeting should be convened), the court did suggest that it would be open to the opponents to the scheme to mount ‘a better informed and more focused challenge to the reduction of capital by the means open to them….by way of opposition on the application for fi nal approval’ of the scheme.

Implications of the decision for demergers

The Full Court’s decision provides welcome clarity to the law on demergers to be effected by schemes of arrangement with an associated reduction of capital. The concern that courts would be able to apply broad, subjective notions of commercial morality or public policy would appear to have been put to rest. A company proposing to undertake a demerger will still need to do extensive due diligence to ensure that the proposal does not materially prejudice the company’s ability to pay its creditors. Where there is uncertainty in a position, the company will also need to be careful to ensure that adequate disclosure regarding the uncertainty is made to its shareholders.

Freehills acted for CSR on the appeal.

This article was written by Philippa Stone, Partner, Andrew Pike, Partner and Daniel Krutik, Senior Associate, Sydney.

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