In the deal by jpo51691


									In the deal
M&A update Issue 11, December 2004

                      Jon Webster                                            Ewen Crouch
                      Co-head of M&A                                         Co-head of M&A

In recent weeks, a surge in M&A activity on the back    The Coalition’s return to power with an increased
of strong corporate earnings and a buoyant broader      majority in the House of Representatives and
economy has led the ASX All Ordinaries Index to         a majority in the Senate (from July 2005) also
all-time highs. A broad range of sectors have been      raises the prospect of potential changes in media
involved, including property trusts, health care,       ownership laws. Such changes may take longer
consumer staples and resources. Although News           than expected, but that hasn’t stopped the market
Corporation has completed its reincorporation in the    speculating about potential consolidation in the
United States, the level of M&A activity in Australia   Australian media sector.
reflects confidence in the Australian economy as an
attractive place for global investment.                 A CEO of one of our major banks has suggested
                                                        that the Federal Government should reconsider the
The prospects for a continuation of this activity       ‘four pillars policy’ that prohibits mergers between
look good. At some point, the wave of consolidation     Australia’s big four banks: the NAB, ANZ, the
that has swept across the listed property trust         Commonwealth and Westpac. There is no doubt
sector will surely slow. However, there still appears   that the competitive landscape in the Australian
to be a number of deals that have yet to be done.       banking industry has changed significantly in
And increasingly, the mega-trusts of the likes of       the years since that policy was put in place. The
Multiplex and Westfield are turning their attention      emergence of strong regional banking competitors
to opportunities in the United Kingdom and other        has occurred at the same time as the ‘four pillars
foreign jurisdictions, using the capital of local       policy’ has prompted the big four to look for growth
investors.                                              opportunities overseas. Recent developments
                                                        in the US banking industry suggest that further
                                                        consolidation in the Australian financial services
                                                        sector is inevitable.

                                                        This issue of In the deal examines a number of legal
CONTENTS                                                developments relevant to M&A activity in Australia.
                                                        Senior Associate Emma Marsh and Lawyer Yvonne
NEW GUIDELINE FOR INFORMAL                              Schmaedeke report on the ACCC’s new Guideline for
MERGER REVIEW PROCESS                    2              Informal Merger Review. Partner Craig Henderson
                                                        and Senior Associate Lisa Ashcroft discuss the
TRUMPING A TAKEOVER BID                                 distinguishing features of Newbridge Capital’s
BY SCHEME OF ARRANGEMENT:                               proposal to acquire Australian Leisure & Hospitality
                                                        Limited by way of scheme of arrangement. Finally,
                                                        Partner Andrew Finch and Law Graduate Jonathan
IN THE PAN?                              3              Stambolis review other recent trends in merger
                                                        schemes of arrangement.
SCHEMES OF ARRANGEMENT                   5

                                                                 to issues raised, or where the ACCC has not been
New guideline for                                                able to make market enquiries because of the
                                                                 confidential status of a merger proposal.
informal merger                                               • Where applicable, the public register will include a
                                                                Statement of Issues and Competition Assessment.
review process                                                  A Statement of Issues will only be published
                                                                in those matters where competition issues
In brief: The ACCC’s new Guideline for                          have been identified and those issues require
Informal Merger Review is intended to make                      further information and consideration. Since
                                                                their introduction earlier this year, Competition
the informal merger clearance process more
                                                                Assessments have outlined the ACCC’s reasons
open and informed. Understanding and                            where a merger was rejected, the merger was
giving effect to the Guideline’s requirements                   subject to enforceable undertakings, or the merger
will be critical to gaining the ACCC’s                          parties requested it. In future, these assessments
informal clearance for a merger in a timely                     will also be provided where a merger is approved
manner. Senior Associate Emma Marsh and                         and the ACCC considers that there are important
Lawyer Yvonne Schmaedeke report.                                competition issues that should be made public.
                                                              • An outline of the issues to be considered by the
The Australian Competition and Consumer Commission              ACCC has been included in the Guideline to provide
(the ACCC) implemented its new Guideline for                    greater certainty about the information required by
Informal Merger Review (the Guideline) on 18 October.           the ACCC to make a proper assessment. The issues
The Guideline applies to all new and complex non-               reflect the merger check-list identified in section
confidential merger proposals received by the ACCC               50(3) of the Trade Practices Act 1974. The parties
after this date and is aimed at providing greater               are advised to provide written submissions to the
transparency and accountability for the informal                ACCC outlining background information about the
merger clearance process, in light of the International         parties, the structure of the market (including any
Competition Network’s Guiding Principles and                    information about major market participants) and
Recommended Practices (ICN).                                    the commercial rationale for the merger. Guidance
                                                                on the format of submissions is also provided.
The ICN named eight guiding principles: sovereignty;            Under the new Guideline, the ACCC will expect
transparency; non-discrimination; procedural fairness;          initial submissions to deal with all relevant matters,
efficient, timely and effective review; coordination;            both positive and negative to the desired outcome.
convergence; and protection of confidential                    • Additional guidance is provided regarding
information. These were the foundation of the new               communications between the parties to the
Guideline, and extensive consultation with the public,          merger, their advisers and the ACCC staff and
key industry players and other interested parties also          commissioners. Those involved, and other
played a significant role in shaping it.                         interested parties, will be informed when
The Guideline will have a significant impact on the              commissioners and staff are able to meet and of the
timeframes for gaining informal clearance, on the               appropriate contact person(s) at the ACCC.
level and timing of information to be provided to             The ACCC has said that, given the nature of the
the ACCC and on the availability of ACCC staff and            informal merger clearance process, it is likely that
commissioners.                                                the Guideline will be subject to further review
                                                              and amendment. It is intended to be a ‘dynamic
The major changes that the Guideline introduces               document’. The Guideline will ultimately be
include:                                                      incorporated into the ACCC’s existing Merger Guideline.
• A new public register on the ACCC’s website that
  will publish information on merger proposals.
  Confidential merger proposals will not be included
  in the public register and are not covered by the
• In addition to the general timeframes set out in
  the ACCC’s existing Merger Guideline (published
  in 1999), the ACCC will provide an indicative                                     Emma Marsh
  timeline for parties involved in complex matters.                                 Senior Associate
  This will note the key assessment milestones,
  triggers for meetings with the merger parties, an
  outline of the timing for market enquiries, and
  the expected decision date. The timeline, which
  will be published on the public register, may be
  affected by subsequent events such that the clock
  may be stopped. For example, clock stoppers
  include requests by the ACCC for more information,
  requests by the parties for more time to respond                                  Yvonne Schmaedeke
                                                            because the bidder’s stake blocks the rival bidder
Trumping a                                                  from accumulating, under a takeover bid, 90 per cent
                                                            or more of the target, being the percentage interest
takeover bid                                                needed to trigger compulsory acquisition of the
                                                            remaining minority shareholders’ shares. In contrast, a
by scheme of                                                scheme of arrangement can, depending on the size of
                                                            the blocking stake, potentially still succeed. This was

arrangement: a new                                          Newbridge Capital’s position.

trend or a flash in                                          To succeed, a scheme of arrangement needs (among
                                                            other approvals) the approval of more than 50 per
                                                            cent of those of a target’s shareholders that vote at the
the pan?                                                    scheme meeting and those shareholders must hold at
                                                            least 75 per cent of the shares of shareholders voting
In brief: It is unusual for a hostile Chapter               at the meeting. As Bruandwo held only 16 per cent
6 takeover bid, conditional on 50 per cent                  of ALH, these scheme thresholds were achievable,
                                                            provided sufficient shareholders participated at the
acceptances, to be trumped by a scheme
                                                            proposed shareholder meeting.
of arrangement. However, that is exactly
what happened in the battle for control of                  The ALH/Newbridge deal
Australian Leisure & Hospitality Limited
when Newbridge Capital proposed to acquire                  Of course, for a scheme of arrangement to succeed, it
ALH by scheme of arrangement in response                    needs the cooperation of the target, which Newbridge
to Bruandwo Pty Ltd’s two-month-old                         Capital obtained through a merger implementation
                                                            agreement (MIA) with ALH.
takeover bid. Senior Associate Lisa Ashcroft
and Partner Craig Henderson highlight                       Newbridge Capital’s offer involved a price of $3.05
the distinguishing features of Newbridge                    cash for the transfer of each ALH share held by ALH
Capital’s proposal.                                         shareholders to Newbridge. Conditions precedent
                                                            were minimal, to ensure the higher price offered
                                                            by Newbridge was not undermined by substantial
The Bruandwo bid                                            conditionality. Again, Newbridge Capital’s scheme
At the time Newbridge Capital launched its competing        proposal is unique in this regard, showing that a
offer for Australian Leisure & Hospitality Limited          scheme of arrangement can be competitive, not
(ALH), ALH had been the subject of a hostile takeover       only on price, but also on conditionality.1 Aside from
bid under Chapter 6 of the Australian Corporations          standard conditions precedent such as material
Act 2001 (Cth) (takeover bid) from Bruandwo Pty Ltd         adverse change, prescribed occurrences and regulatory
(Bruandwo) for more than two months. In addition,           approvals (including approvals under the Australian
Bruandwo – a joint venture between Woolworths               Foreign Acquisitions and Takeovers Act 1975 (Cth),
Limited and a Bruce Mathieson-controlled company –          and various liquor and gaming authority approvals),
held a pre-bid stake of 16 per cent of ALH. Bruandwo        there were only two conditions of significance: first,
was offering $2.75 ($2.685 ex-dividend) for each ALH        that the conditions precedent to Newbridge Capital’s
share, conditional on various factors including 50.1        funding arrangements be satisfied as at particular
per cent minimum acceptance of Bruandwo’s bid.              times; and, second, that costs incurred by ALH
                                                            relating to Bruandwo’s bid or other third party bids not
                                                            exceed $21 million.
Scheme versus takeover bid
Although not always the case, typically an existing         Leveraged schemes of arrangement
takeover bid is countered with another takeover
bid. Alternative merger options, such as schemes            Debt funding in schemes of arrangement raises
of arrangement under Part 5.1 of the Corporations           the potential for a mis-match between conditions
Act, are not often considered. The flexibility, and          to the availability of funding and conditions to
potentially shorter time-frames for completion,             implementation of the scheme of arrangement. If this
offered by takeover bids, as opposed to schemes of          mis-match inadvertently occurs, a bidder could find
arrangement, often drive this outcome. However, one         itself bound to pay the scheme consideration without
situation where a scheme of arrangement is not only         having firm funding in place.
a viable, but perhaps the most practical, alternative
                                                            1. The subsequent offer for ALH shares made by CMM Hotel & Retail
is where a bidder accumulates a target stake in
                                                            Investments Pty Ltd via a scheme of arrangement (discussed further
excess of 10 per cent and a rival bidder is seeking         below) went even further than the Newbridge Capital proposal, as it
100 per cent control of the target company. This is         was ‘unconditional’ (that is, the scheme was subject only to court and
                                                            shareholder approvals).


This potential mis-match arises as a result of the             Break fee serving its purpose
unique requirement that schemes of arrangement
be approved by the court before being implemented.             As is now common in agreed mergers, ALH agreed
To give this approval, the court typically prefers the         to pay Newbridge Capital a break fee if certain
scheme of arrangement to be unconditional at the               events occurred, being events preventing successful
time of the court hearing, even though the scheme will         implementation of the scheme of arrangement. In this
not be implemented for some days after that hearing.           case, the break fee was $11 million. Break fees are
In contrast, funding arrangements typically remain             often justified as being necessary to induce a potential
conditional until a transaction is implemented.                bidder to bid, and being covered by the increased
                                                               share price obtained for shareholders from a higher
Although courts prefer schemes of arrangement to be            third-party bid (should a higher bid trigger payment of
unconditional, they will, generally, approve a scheme          the break fee).
of arrangement that is subject to the satisfaction of
conditions precedent or subsequent after the second            Newbridge Capital’s scheme of arrangement offer is
court hearing, provided the scheme is self-executing           a shining example of a break fee succeeding on both
in the sense that certain results (eg termination of           of these fronts. Less than 48 hours after announcing
the scheme) follow in certain defined events, and the           Newbridge Capital’s MIA with ALH, Bruandwo
relevant terms are clear, certain and fair.                    increased its cash offer to $3.15 per share, and
                                                               less than two weeks after that announcement, Coles
A scheme of arrangement, providing that                        Myer Limited and Macquarie Bank joined forces and
implementation of the scheme is conditional on the             announced a joint cash offer of $3.35 per ALH share.
satisfaction of all funding conditions, may not satisfy        This triggered a bidding war between Bruandwo and
this criteria, even though the scheme may appear on            the Coles Myer / Macquarie Bank bidding vehicle,
its face to be self-executing, with clear, certain and         CMM Hotel & Retail Investments Pty Limited (CMM),
fair terms. This is likely to be because (among other          that has resulted in shareholders receiving a 40 per
reasons):                                                      cent premium to the price offered under Bruandwo’s
• it is common for some funding conditions to be               original takeover bid. In addition, the Newbridge
   within the control of the scheme company, which is          Capital scheme of arrangement structure formed
   likely to offend the ‘self-executing’ principle; and        the basis of the subsequent CMM offer. Although
                                                               competing schemes of arrangement may continue to
• it is common for the satisfaction of certain funding
                                                               be scarce in the takeover bid context, they certainly
   conditions to depend on a determination by the
                                                               proved their worth to target shareholders in the ALH
   scheme company or the financiers that certain
                                                               bidding war.
   events have not occurred (for example, determining
   whether an event has had a ‘material adverse
   effect’ on the scheme company), which is likely to
   offend the ‘clear, certain and fair’ principle.
Newbridge Capital addressed these issues by making
the scheme of arrangement conditional on satisfaction
of the funding conditions as at the court hearing
date, other than those conditions that were of such a
nature that they could only be satisfied at or about the                             Craig Henderson
scheme implementation date. Only those conditions                                   Partner
that did not infringe the principles mentioned above
fell into the category running until implementation.

Courts have in the past approved schemes of
arrangement where implementation of the scheme
was subject to this type of condition precedent (see,
for example, United Energy Limited’s recent scheme
of arrangement). However, for the reasons outlined
above, a court would have strong grounds to withhold                                Lisa Ashcroft
its approval of a scheme of arrangement where it was                                Senior Associate
conditional on the satisfaction of all of the conditions
to funding being satisfied, rather than a limited
number of specifically carved out conditions.

                                                                             necessary to assess the similarity of the legal
Recent trends in                                                             character of the rights and obligations of those
                                                                             members or creditors, and then to assess whether

merger Schemes of                                                            a proposed scheme will affect those rights and
                                                                             obligations in a similar way.

Arrangement                                                              • Second, it is not necessary for the interests of
                                                                           members or creditors of a particular class to be
                                                                           identical. It is sufficient if there is similarity in
In brief: As the use of schemes of                                         interests to the extent that those within the class
arrangement in merger contexts increases,                                  would reasonably be able to consult together with
several interesting trends in judicial                                     a view to their common interests as members or
practice have recently emerged. The stand-                                 creditors.
off between competing bidders, using                                     • Finally, the fact that certain persons within a class
alternatively schemes of arrangement and                                   have commercial interests that may influence
takeover bids, in the battle for control of                                whether they approve or reject a proposed scheme
ALH (see story on pages 3 & 4) makes this                                  is no impediment to those persons meeting in the
                                                                           one class with other persons who do not share their
an opportune moment to reflect on some of
                                                                           commercial interests. Such extraneous interests
those trends. Partner Andrew Finch and law
                                                                           or motives are merely a secondary consideration
graduate Jonathan Stambolis report.                                        that may lead the court to place less weight on the
                                                                           commercial judgments expressed by persons within
Defining scheme classes                                                     the class.

A scheme of arrangement is basically a court-                            Two common ‘class’ issues have recently been
endorsed agreement between a company and one                             examined by the courts, and provide some helpful
or more ‘classes’ of its members and/or creditors.                       guidance in this testing area.
That equation begs the question of how a ‘class’
of members or creditors is defined. The definition                         Foreign shareholders
is critical because the result of a vote by a class of
members or creditors on a scheme can be challenged                       Schemes of arrangements that involve a scrip-only
on the ground that the class(es) were not properly                       consideration will typically include a ‘cash out’
constituted.                                                             mechanism for foreign shareholders because the
                                                                         ‘bidder’ is unwilling or practically unable to issue
The courts’ definition of ‘class’ has been shaped by                      its securities into foreign jurisdictions in a way that
two competing considerations: on the one hand, if a                      complies with foreign securities laws. However,
class is identified too broadly, there is a danger that                   recent cases have demonstrated that it does not
members or creditors with dissimilar interests will be                   automatically follow that a court will regard the
compelled to vote together in a way that is unjust for                   interests of such foreign shareholders as being
a dissenting minority; on the other hand, if classes                     sufficiently similar to the interests of resident
are identified too narrowly, there is a danger that a                     shareholders to allow them to ‘consult together with
scheme will be defeated by a minority of members                         a view to their common interest’. Indeed, where
or creditors in a way that is unjust for an approving                    the foreign securityholders constitute a significant
majority. The leading decision about constituting a                      proportion of securityholders, a proposal that they be
class reflected the attempt to strike a balance between                   cashed-out might lead a court to declare them to be
these two considerations:1                                               a separate class. On the other hand, as is typically
                                                                         the case, if foreign securityholders constitute only a
  It seems plain that we must give such meaning to the term
                                                                         small proportion of the total number of members, to
   ‘class’ as will prevent the section being worked as to result
   in confiscation and injustice, and that it must be confined
                                                                         categorise them as a separate class would run the risk
   to persons whose rights are not so dissimilar as to make it           of giving that minority a veto power over a majority
   impossible for them to consult together with a view to their          decision.2
   common interest [emphasis added].
                                                                         Pragmatically, the courts have recently demonstrated
In our experience, three principal themes have                           a willingness to ‘recognise an intermediate position
emerged in applying these guidelines:                                    where the members are not so differentiated as to
• First, in determining which members or creditors                       make it impossible for them to consult together as a
  should be included in a particular class, it is                        single class with a view to their common interest, yet

1. Bowen J in Sovereign Life Assurance Co v Dodd [1892] 2QB 573 at       2. In Re CSR Ltd (2003) 45 ACSR 34 at 36, for example, the court
583.                                                                     held that the ‘small segment’ of foreign shareholders had a sufficient
                                                                         ‘community of interest’ with resident shareholders, even though the
                                                                         scheme of arrangement treated them differently by cashing-out the
                                                                         foreign shareholders.


having sufficiently divergent commercial interests as                be discernible and wide degrees of difference even
would have the court look with special care at the size             within the class… the capital gains tax position of
and composition of the approving majority over and                  members vary and are as numerous as there are
above the requisite 75 per cent’.3 In Re James Hardie               members.’5
Industries Ltd, the court declared that the company’s
foreign shareholders were in a special position within              However, even these recent cases qualify this general
a class or a sub-category ‘whose voting result would                rule by reiterating that the court may, in instances
be separately identified.’ The purpose of that ‘tagging’             where a large number or proportion of securityholders
(as it has come to be known) is to leave the question               is affected adversely by the proposed categorisation
of whether the foreign shareholders should have to                  ‘exercise its discretion whether or not to approve the
approve the scheme as a separate class until they                   scheme having regard to all the circumstances of the
have voted, and to compare the outcome of their vote                case.’6 For example, in Re Direct Acceptance Corp
to that of resident shareholders to determine whether               Ltd,7 the court refused to approve the scheme of
they should be in a separate class. Importantly, this               arrangement because the evidence established that
‘tagging’ of foreign securityholders allows the court to            247 out of the 720 shareholders not only failed to
assess the impact of the vote, and make a decision                  receive any substantive benefit under the scheme, but
on classes, at the second court hearing, without                    would instead lose their capital gains tax free status.
the need to restart the entire process if the court
                                                                    This overriding qualification suggests to us that the
determines that a separate class vote should have
                                                                    courts may take the same pragmatic approach to
been undertaken.
                                                                    differing tax effects as that taken in James Hardie
In summary, therefore, consideration will always need               for foreign shareholders. That is, the courts may be
to be given in scrip-based schemes of arrangement                   inclined, in appropriate circumstances, to ‘tag’ the
as to whether or not the cashing-out of foreign                     votes of a particular group or groups of members (or
securityholders deems them to be a separate class, of               creditors) according to the tax impact of the scheme,
which separate special majority approval is required in             and to assess at the second court hearing whether
order to approve the scheme. In instances where there               separate classes ought to have been created ahead
is a large proportion of foreign securityholders, in                of the vote. In practice, of course, the courts are only
particular, the scheme company would be well advised                likely to reach a conclusion of that kind if the ‘tagged’
to consider the ability to issue the relevant scrip into            members voted in a significantly different way to
as many as possible foreign jurisdictions, in order to              other members. In those circumstances, if the court
reduce the proportion of foreign securityholders being              determines that a separate class in fact existed, there
cashed-out.                                                         will be a material risk that the court will refuse to
                                                                    approve the scheme.
Differing tax effects of a scheme
                                                                    Deeds poll: binding ‘outsiders’
The question of the proper constitution of classes
also arises where the scheme results in differing tax               A court-approved scheme of arrangement is, by
consequences for different groups of shareholders. The              definition, an arrangement or compromise between
traditional view is that the personal tax consequences              a company and its members or creditors. The courts
of a scheme for a particular group of shareholders                  do not have jurisdiction under the scheme provisions
does not constitute sufficient grounds for that group to             of the Corporations Act to bind ‘outsiders’, including
be placed in a separate class (with the attendant ‘veto’            the ‘bidder’ in a merger context. That limitation
power).                                                             poses a challenge in the implementation of schemes,
                                                                    which often depends on the active performance of
For example, in recent Australian and UK schemes                    obligations by an ‘outsider’.
of arrangement, the courts have refused requests
by certain securityholders that the specific tax                     In a practice developed over the past 40 years,
consequences of a scheme for them made it                           courts have come to accept the practical inclusion of
impossible for them to be grouped with other                        ‘outsiders’ by the execution of deeds poll enforceable
securityholders. The principal reason given by the                  by members and creditors directly. The courts have
courts for those refusals is that any grouping of                   accepted that directly enforceable rights against the
shareholders according to the particular taxation                   ‘outsider’ are sufficient comfort in approving schemes
impact of a scheme would be likely to produce an                    of arrangement for which the actions of the ‘outsider’
‘endless’4 list of classes and, moreover, ‘there would              are critical.

3. Re James Hardie Industries Ltd [2001] NSWSC 741 at 741.          5. Bryson J in Re Matine Ltd & Ors (1998) 28 ACSR 268.
4. Chadwick LJ in Re BTR plc (unreported, UK Court of Appeal,       6. Re BTR plc (unreported, UK Court of Appeal, 19 February 1999) per
19/2/1999).                                                         Clarke LJ.
                                                                    7. (1987) 5 ACLC 1037.

The courts’ confidence in the use of deeds poll to bind           the scheme even though there were three (mostly
‘outsiders’ was for the first time recently endorsed              procedural) conditions subsequent because none of
when a deed poll executed for such a purpose was                 those three conditions introduced a ‘new decision
enforced by an order for specific performance in favour           making process… after Court approval’. So long as the
of particular company shareholders. In Toal v Aquarius           ‘scheme is, according to its own terms, self-executing
Platinum Limited,8 the court held that an order for              in the sense that certain results follow in certain
specific performance of the deed poll was justified as             defined events… including any terms which dictate
it would ‘recognise and uphold the importance of the             future steps and provide for termination in clearly
ancilliary contractual obligations which were relied             defined events’ the courts will be willing to give their
upon in securing the judicial approval for the Scheme            approval.
of Arrangement’. Such an order was appropriate, even
though the scheme company was able to demonstrate                These considerations were taken into account more
that damages were a sufficient remedy (which                      recently in GE Mortgage Insurance Pty Ltd,11 where
normally avoids the need for a court to order specific            the court was willing to give its approval to a scheme
performance) because the courts place enormous                   that was subject to a condition subsequent, because
faith in deeds poll of the kind sought to be enforced.           failure of the condition subsequent to be satisfied
The court therefore ordered the ‘bidder’ to deliver the          terminated the scheme and restored the pre-scheme
number of its shares it should have delivered under              status quo.
its deed poll, if it had not (incorrectly as it turns out)
                                                                 Accordingly, the courts appear to be willing to
determined that the applicants (the Toals) were foreign
                                                                 approve schemes that take effect immediately after
shareholders and compelled them to be ‘cashed out’.
                                                                 court approval, even if their continued operation and
The Toal decision underlines the importance that the             implementation of their terms depends upon the
courts have placed on the use of deeds poll to bind              fulfilment of some obligation later in time, subject to
outsiders. Indeed, more recently, the courts have                the factors explored in NRMA and GE Mortgage.
reiterated that importance by referring to deeds poll as
a ‘highly desirable safeguard’ for members who have              Optionholders: Contingent
approved a scheme involving the performance of some
obligation by an outsider.9
                                                                 members or contingent creditors?
                                                                 As noted in Allens Arthur Robinson’s In the deal,
Conditionality                                                   December 2003, the decision in Re Niagara Mining
                                                                 Ltd12 held that optionholders were more properly
Traditionally, the courts have been reluctant to approve         regarded as contingent members, rather than as
schemes that have elements that remain contingent                contingent creditors, which, until that judgment, had
or conditional upon some event taking place after                been the traditional view.13 If the Niagara decision
the court approves the scheme. The principal reason              became authoritative on the question of how to treat
for this reluctance is that the court’s jurisdiction             optionholders, it may have simplified the method of
ceases once it gives approval: courts cannot oversee             calculating the number of votes each optionholder
the implementation of schemes after approval, and                would have for a scheme, by granting one vote per
therefore require all conditions to be satisfied before           option held. However, that formulation had the
that approval is given.                                          propensity to skew votes in schemes involving options
                                                                 against holders whose options were ‘in the money’.
However, the courts have more recently demonstrated
                                                                 It would also have thrown into doubt the accepted
some flexibility in this hitherto strict principle. In
                                                                 methods of dealing with and valuing options under
Re NRMA Insurance Ltd,10 for example, the court
                                                                 schemes of arrangement.
outlined the considerations that it must weigh in
exercising its discretion to confirm a scheme subject             Since Niagara, the courts have, on a number of
to a condition subsequent (ie a condition dependent              occasions, respectfully, resiled from the view that
upon a future event that may lead to the termination             optionholders are best viewed as contingent members.
of the agreement/scheme). The court identified                    In the matter of Kaz Group Limited,14 for example, the
those considerations as: clarity; certainty; fairness;           court noted the decision in Niagara, but concluded
and whether the status quo would be substantially                that it should ‘follow what might be called the main
restored if the condition subsequent was not fulfilled.           stream of authority… and which has been followed
In the NRMA case, the court was willing to approve               (apart from Niagara) fairly universally’. Similarly, in

8. [2004] FCA 550.                                               11. [2004] FCA 154.
9. Westfield Holdings Limited & Ors [2004] NSWSC 458.             12. [2002] FCA 1651.
10. [2000] 33 ACSR 595.                                          13. At the very least since Cohen J’s seminal judgment in Re Asia Oil
                                                                 and Minerals Ltd (1986) 5 NSWLR 42.
                                                                 14. [2002] FCA 738.


MIA Group Ltd,15 the court concluded that ‘it would             methodology by the courts has, at least in part,
be inappropriate… to do otherwise than to follow the            reflected ASIC’s propensity to favour the methodology.
clearly predominant trend’. Subsequent decisions                Indeed, in the recent News Corporation reincorporation
have not had cause to reopen the issue, continuing              proposal, ASIC requested that the Black-Scholes
without comment to treat optionholders as contingent            methodology for valuing the votes of optionholders be
creditors.                                                      adopted.

                                                                The Black-Scholes methodology was applied recently
The value of an optionholder’s vote                             also in the matter of Kaz Group Limited17 and in RG
The view that optionholders are contingent creditors            Capital.18
has always posed the dilemma of how to calculate
                                                                Accordingly, the trend in the most recent schemes
the voting rights of optionholders for the purposes of
                                                                of arrangement has been to adopt the Black-Scholes
schemes of arrangement. The scheme of arrangement
                                                                option valuation methodology as the benchmark proxy
provisions require, in addition to the scheme being
                                                                to measure the value of votes in options schemes
approved by a simple majority of actual optionholders
                                                                of arrangement. However, we would expect that the
voting (in person or by proxy), that the majority’s debts
                                                                proportional Sonic Healthcare methodology will make
and claims against the scheme company amount in
                                                                a reappearance in an appropriate case in which there
aggregate to at least 75 per cent of the total amount
                                                                is a large proportion of ‘out of the money’ options that,
of debts and claims of all the optionholders present
                                                                under Black-Scholes, would be rendered valueless
and voting at the scheme meeting. There is no clear
                                                                and, therefore, voteless. Watch this space.
judicial authority on how the 75 per cent threshold
should be calculated, just as there is no authoritative
or uniformly accepted economic model for valuing                Conclusion
                                                                The increasing use of schemes of arrangement in
Intuitively, however, the value of an optionholder’s vote       merger contexts, including, for example, in the recent
in a scheme ought to reflect in some way the extent              raft of property trust-manager ‘staplings’, makes this
to which its options are ‘in the money’. This intuitive         an opportune moment to reflect on recent judicial
response has led the courts to accept or propose a              trends.
range of methods for measuring optionholders’ votes.            • The delineation of scheme ‘classes’ is a perennial
For example, in Sonic Healthcare Ltd16 voting rights              challenge. The courts’ recent opinions about
were distributed to optionholders according to the                foreign shareholders and the tax impact of schemes
value of the (contingent) debt attributable to each               suggest that the courts can be pragmatic in
option. Options that were the most ‘in the money’ (ie             assessing when groups of members or creditors
those with the lowest exercise price and hence the                ought or ought not to vote together. However,
largest potential claim against the company) were                 the advent of ‘tagging’ the votes of certain
given one vote; votes for the other options (with higher          members or creditors who have traditionally been
exercise prices and thus the potential for smaller                classified as part of the general body of members
claims against the company) were scaled according                 or creditors raises the prospect that a court may
to the difference between their exercise price and the            refuse approval of a scheme if the ‘tagged’ votes
lowest possible exercise price. In other words, even              of the relevant members or creditors substantially
those options that were ‘out of the money’ (ie with an            objected to the scheme. That prospect increases
exercise price above the market value of the share)               the practical imperative to reduce the proportional
attracted some voting value.                                      size of any groups of members or creditors who
More recently, however, the courts have leaned in                 may be treated or impacted on differently under a
favour of the Black-Scholes methodology of option                 scheme.
valuation (which takes into account factors such as             • The recent Toal decision, in which the court
the price and volatility of the underlying share, the             granted an order of specific performance of a deed
exercise price of the option and the expiry date of               poll given by a ‘bidder’ in favour of the scheme
the option to calculate the ‘value’ of the option under           company’s shareholders, is a practical example of
that model) as the appropriate proxy for the value                the courts’ requirement for an effective method of
of an optionholder’s contingent claim against the                 binding ‘outsiders’ to a scheme of arrangement.
scheme company. The embrace of the Black-Scholes

15. [2004] NSWSC 712.                                           17. N 868 of 2004.
16. [2002] FCA 1235.                                            18. No N 1093 of 2004, Federal Court of Australia, Hely J.


• The NRMA and GE Mortgage cases have clarified
  the willingness of courts to accept particular
  kinds of conditions in schemes of arrangement
  that operate after court approval, and conversely
  reiterated the requirement that schemes be ‘self-
  executing’ from the moment of court approval.
                                                                                                             Andrew Finch
• Finally, a string of recent cases regarding options
  has made it clear that courts will continue to
  regard optionholders as (contingent) creditors and
  made it (at least comparatively) clear, that the
  votes attaching to options ought to be measured
  by reference to the Black-Scholes valuation
In the deal will aim to keep you posted on
developments in these trends, and the emergence of
any new trends in the law or practice of schemes of
                                                                                                             Jonathan Stambolis
                                                                                                             Law graduate

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