A scheme of arrangement to acquire shares in a company must be approved by the requisite majorities set out in the Corporations Act 2001 (Cth), at a meeting or meetings of the shareholders or "class" of shareholders of the target.
It is not unusual for a shareholder of a target company to also hold options or convertible securities in the target. In such cases, in order to achieve the benefits of full ownership of the target, the bidder will often propose a separate arrangement with that shareholder to acquire or otherwise deal with their other securities. The issue for consideration by the target company in such a scenario is whether that shareholder, because it will be receiving a benefit that is not provided to the other shareholders, constitutes a separate class for the purposes of voting on the scheme.
The decisions in two recent schemes provide some insight into the court's and ASIC's approaches in relation to this issue.
The proposed scheme was one between Cellestis Limited (Cellestis) and its shareholders, which would result in the acquisition of all the ordinary shares in Cellestis by QIAGEN Australia Holding Pty Limited (QIAGEN Australia).
In addition to the ordinary shares in Cellestis, there were also unlisted employee options on issue. These options (of which there were three tranches, each with a different exercise price) were to be cancelled pursuant to a deed entered into between Cellestis, QIAGEN Australia and each option holder. The consideration payable by Cellestis for the cancellation of these options was derived using the Black-Scholes methodology.
Although it was not proposed that there be separate scheme meetings for the shareholders who were also option holders, Davies J stated that the court should nevertheless consider whether the option holders should be regarded as a separate class for the purposes of voting on the scheme.
The following submissions were accepted by the court in support of the finding that the proposed treatment of the options did not give rise to any class issue:
- the scheme related to shares in Cellestis and any shares held by the option holders would participate on the same basis and receive the scheme consideration as shares held by all other Cellestis shareholders who were not option holders;
- the cancellation of options was not part of the scheme;
- the consideration to be paid for the cancellation of the options was derived using the Black-Scholes valuation methodology which was a commonly used methodology, and the extent of any difference in the consideration to be paid to the option holders and the scheme consideration was a product of the valuation methodology; and
- not all of the option holders were shareholders.
Two directors of Cellestis who collectively held 23.8% of the shares in Cellestis granted QIAGEN Australia, in consideration for $10, a call option over 19.9% of their shares. The call option could only be exercised where:
- a competing transaction was announced or received by Cellestis and QIAGEN Australia provided to Cellestis a matching or superior proposal to that competing transaction;
- a competing transaction that was superior to the scheme was announced or received by Cellestis and QIAGEN Australia did not provide to Cellestis a matching or superior proposal to that competing transaction and QIAGEN Australia reasonably formed the view that the competing transaction was likely to be successful if the shares the subject of the call option participated; or
- during the option period, the directors dealt with any of the call option shares except as contemplated by the call option deeds.
Here, the issue was whether these two directors might constitute a separate class. The court concluded that there was no separate class because of the following:
- the event triggering the right to exercise the call options was the emergence of a competing proposal;
- the directors would receive the same scheme consideration for their parcel which was the subject of the call options as the other scheme shareholders would receive;
- both directors had recommended the scheme to the shareholders and stated their intention to vote their shareholding in favour of the scheme in the absence of a superior proposal;
- the call option deeds expressly provided that nothing in the deed restricted the ability of the directors to exercise the votes attaching to the call option shares; and
- the directors had another parcel of shares not covered by the call options which would be participating in the scheme.
iSOFT Group Limited
Here, there were two schemes proposed - a share scheme between iSOFT Group Limited (iSOFT) and its shareholders and an option scheme between iSOFT and its optionholders - which if implemented, would result in iSOFT becoming a wholly-owned subsidiary of CSC Computer Sciences Australia Holdings Pty Limited (a wholly-owned subsidiary of the American company, Computer Sciences).
iSOFT initially proposed only one meeting of all of its shareholders to consider the share scheme. Following concerns raised by ASIC, a separate meeting was held for one of iSOFT's substantial shareholders, which was also a convertible noteholder and warrant holder.
Warrants and convertible notes
Oceania Capital Partners Limited, through its subsidiary Oceania Healthcare Technology Investments Pty Limited (OHTI), held approximately 24.57% of the iSOFT shares. OHTI also held all of the warrants and convertible notes issued by iSOFT.
It was proposed that:
- all of the warrants held by OHTI be extinguished in consideration for an amount payable to OHTI equivalent to the consideration paid to shareholders under the share scheme less the exercise price for the warrant; and
- all of the convertible notes be paid out their full face value of approximately $39.7 million.
As a result of concerns expressed by ASIC and some shareholders, a separate valuation was made of the convertible notes by the independent expert, Lonergan Edwards. Lonergan Edwards' conclusion was that because of the risk of iSOFT not being able to repay the principal amount of the convertible notes, an investor (in a non-change of control scenario) would apply a discount of between 20% to 25% to the face value of the convertible notes when assessing their value. On this basis, Lonergan Edwards concluded that the value of the convertible notes ranged between $18.3 million and $26.7 million (in contrast to the $39.7 million that OHTI would be paid out for them under the proposal). There was therefore a concern that OHTI would be receiving a benefit as holder of the convertible notes that was not being provided to the other shareholders of iSOFT.
In this case, the court did not need to decide whether OHTI constituted a separate class from the other iSOFT shareholders as the directors concluded that it was appropriate that there be separate meetings of OHTI and of the other shareholders. It is worth noting that the court's reasons for judgment stated that this decision of the directors was a result of discussions between iSOFT, ASIC and other shareholders.
The court's reasons also indicated that, in its letter to iSOFT, ASIC noted that the full and early repayment of the convertible notes held by OHTI may amount to a collateral benefit. On the basis that iSOFT proposed to have OHTI vote on the share scheme in a separate class from the other iSOFT shareholders and that the proposed explanatory memorandum adequately disclosed the benefit conferred by the repayment of the convertible notes and the implications for shareholders, ASIC did not propose to oppose the schemes.
The mere fact that a shareholder receives some benefit from the overall proposal that the other shareholders do not receive does not automatically mean that the shareholder constitutes a separate class. However, a close examination of the relevant circumstances will often be required, particularly in light of ASIC's approach in relation to iSOFT. Target boards will also need to consider whether an independent expert should be commissioned to give an opinion as to whether the relevant benefit constitutes a special or net benefit to the shareholder.
Target boards should also bear in mind that even if the court at the first court hearing does not find that a separate meeting is required for the shareholder receiving the collateral benefit, if the scheme is approved only as a result of the votes of this shareholder, the court may take the benefit received by the shareholder into account when it exercises its discretion whether or not to approve the scheme at the second court meeting.
In the case of Cellestis, one of the reasons for the court finding that the two directors did not constitute a separate class was that the call options deeds did not restrict the directors' ability to exercise the votes attaching to their shares the subject of the call option. This raises the question of where the bidder (or its related body corporate) is a target shareholder and therefore can exercise votes at the scheme meeting, whether the bidder (or its related body corporate) constitutes a separate class. In such a situation, provided the bidder (or its related body corporate) will be receiving the same scheme consideration for its shares as the other shareholders, then the bidder (or its related body corporate) is unlikely to constitute a separate class for the purposes of the scheme meeting.
 Re Cellestis Limited  VSC 284
 iSOFT Group Limited, in the matter of iSOFT Group Limited  FCA 680
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.