A big year for schemes

• This year has seen a large number of schemes, including the country’s biggest, Coles Group.
• The takeover avoidance debate has been rekindled but appears to be manageable.
• Other issues demonstrate that schemes continue to develop in the way they are executed and approved by courts.

There is little doubt that 2007 has been a big year for schemes. Within the context of that year, Friday 9 November 2007 was itself a significant day. In the historic surrounds of the Old High Court building in Melbourne, Justice Robson of the Victorian Supreme Court approved the country’s biggest ever scheme, that of Coles Group. In a busy day for his Honour, Justice Robson then promptly set about examining and approving Commonwealth Bank’s acquisition of IWL by way of scheme.

Elsewhere that Friday, in the Federal Court in Sydney, Justice Emmett approved the despatch of the scheme document for the National Hire/Carlyle acquisition of Coates, a transaction that demonstrates the strength of the Australian market in light of credit and other issues affecting other markets.
This article examines some of the developments we have seen in schemes in 2007.

Takeover avoidance rears its head

Unfortunately, the debate as to whether or not change of control transactions should be effected by way of scheme has been reignited in 2007 with the decision of the Queensland Supreme Court in the Mincom scheme. In that decision, Justice Fryberg undertook a comprehensive analysis of the purposes of the parties in using a scheme for that transaction. In evidence before the court, a number of reasons were provided including:

• a comparatively certain and slightly shorter timetable
• the all or nothing nature of a scheme, which ensures 100 per cent ownership if it succeeds, and
• the fact that a meeting was required to amend Mincom’s constitution anyway and so it was convenient to do it all at the one meeting on the one day.

Justice Fryberg conducted a journey through the authorities in the area, many of which had generally been considered to support the view that reasons such as those offered above were proper ones to advance a scheme as opposed to a takeover. His Honour concluded that the preference for a set timetable sufficed to give rise to an improper takeover avoidance purpose, namely the avoidance of the right to extend a takeover under section 650C.

There was a further issue for his Honour to deal with. ASIC had provided a certificate of no objection on takeover avoidance grounds.

There are authorities which support the view that once ASIC provides its certificate, then that is the end of the takeover avoidance debate. Other cases suggest there is a residual ability of the court to consider these issues as part of its general discretion.

Justice Fryberg held that the court’s general discretion allowed the court to consider takeover avoidance issues even if ASIC had provided its certificate. Having found that this discretion existed, his Honour then held that he did not need it: despite finding the impugned takeover avoidance purpose, Justice Fryberg was prepared to approve the scheme.

While the reasons are yet to be provided, the approach of Justice Robson in both Coles Group and IWL appears to be more consistent with past authorities. At the second hearing for Coles Group, his Honour asked the question of ASIC as to what was the role of the court where ASIC provided its certificate of no objection. ASIC submitted that the court’s general discretion could still take into account issues associated with takeover avoidance.

In both Coles Group and IWL, evidence was provided as to the requisite purposes. These included traditional purposes for which schemes have been advanced, consistent with past authorities. Given that consistency, the approach of Justice Robson is likely to be preferred to that of Justice Fryberg in Mincom. That means that despite another moment in the spotlight, takeover avoidance should remain a manageable issue.

Lock-ups face increased scrutiny

The emergence of private equity in large public to private transactions in recent times has seen courts view certain issues from a slightly different perspective. One instance of this was the position of Justice Lindgren when the APN News and Media scheme proposal was before the court. His Honour noted that it would be ‘desirable’ if target companies provided evidence at the first hearing to show that:

• the no-shop and no-talk provisions were the result of normal commercial negotiation
• the independent directors believe the no-shop and no-talk provisions do not operate against shareholders interests, and that it was in the shareholders’ interests to enter into the provisions, and 
• the break fee represents 1 per cent of the equity value of the company.

The precise extent and application of this thinking remains to be tested. It may be that in future schemes, factual differences will see courts get more comfortable with standard lock ups without requiring evidence of this kind.

It will be different, as Justice Emmett in the Gloucester scheme proposal noted, where ‘you have got completely independent [directors]’.

Issues relating to the independence of directors will be the key consideration in this area.

Justice Lindgren has also suggested in another recent scheme that he will shortly be expressing his views on break fees, with a particular focus on fees payable upon shareholders voting down schemes.

Justice Lindgren was not the only judge scrutinising lock-ups: as discussed in our July edition, Justice Fryberg extensively examined this area in the Mincom scheme.

Voting agreements

Voting agreements in schemes remain an important and to some extent unresolved area. In 2007, they have begun to emerge in Australia. While certain styles of voting agreement have had some acceptance in other jurisdictions, including their blessing by the High Court of Ghana, they are not yet a settled feature of our M&A landscape.

Agreements to vote in favour of a scheme, or the giving of proxies to the bidder, can be a powerful deal protection measure.

Commercial issues aside, the relevant potential legal constraint is whether an agreement between a shareholder and the bidder for the shareholder to vote in favour of a scheme places that shareholder in a separate class distinct from other members. The issues associated with the class voting system are complex. The class test is based on the rights of shareholders under the scheme. Arguably, an agreement to vote does nothing to alter the treatment of the relevant shareholder under the scheme. However, given the novelty of the proposition, and given that courts also have an overriding discretion to ignore votes as part of their review of the fairness of the scheme, it is clear that risks remain with this approach.

The use of a voting agreement in the Peptech / Evogenix scheme, while helpful, is on one view not definitive. It is not clear that the relevant issues were considered in a fashion that would put the matter beyond doubt.

Two volume scheme booklets

The Coles Group scheme had a pioneering two volume scheme booklet. The scheme booklet contained a summary of the experts’ report and the implementation agreement. It was 160 pages long. The ‘scheme booklet supplement’, available on request, contained the full version of each (and ran to an additional 244 pages).

The Alinta Scheme, in which Freehills was also involved, also had a two volume scheme booklet although both parts were sent to shareholders. If only the first summary volume is to be sent out, the company and its advisers need to be able to get comfortable that it contains all material information on a stand-alone basis, because of the absence of incorporation by reference provisions in relation to schemes.

Proxy handling fees

Proxy handling fees, the scheme equivalent of the broker handling fee in a takeover, have emerged. While contemplated in a number of deals, the recently proposed Symbion transactions, which included a scheme, include broker handling fees to encourage brokers to procure the retail vote.

A setback for share splitters

Schemes need to be approved not just by 75 per cent of the shares present and voting but also by a majority in number of shareholders present and voting. This is known as the head count test. An amendment to the Corporations Act, effective at the end of this year, is a helpful start to the reform of that provision. It provides the court with a discretion to overrule the head count test.

The head count test is arguably an anomaly reflecting the genesis of our scheme provisions in legislation that dealt with insolvency scenarios. The requirement can be traced back to the English Companies Act 1862 which at the time only envisaged creditors’ schemes. It was there to ensure that large creditors did not carry the day.

The relevance of them to mergers in 2007 is highly questionable. Deals such as MIM and the redomiciling of News Corporation have thrown into focus the problems of the area. The very unsuccessful attempt of a shareholder to split a holding of 100,000 Commonwealth Bank shares into 100,000 separate holdings of one share each, to take advantage of rounding provisions in the Colonial scheme, is also a sobering reminder of the lengths people will go to so as to interfere with legitimate commercial transactions.

While the amendments do not remove the head count test, which would be clearly preferable, the fact that there is now a discretion and that this has received legislative attention, is a good start.

Conclusion

This year will be viewed as an important one for schemes of arrangement in Australia. The long list of developments in the area demonstrates the dynamic and evolving nature of schemes to deal with the issues of the day.

Freehills acted for Coles Group, Commonwealth Bank and National Hire on the deals referred to above.

For more information please contact

Name : Tony Damian
Title : Partner
Office : Sydney
Phone : +61 2 9225 5784
Fax : +61 2 9322 4000
Email : tony.damian@freehills.com