Recent schemes of arrangement, including the Telstra-KAZ and MYOB-Solution 6 transactions, have involved pre-bid deals between the acquirer and a major shareholder in the scheme company. The ability of bidders in takeovers to utilise pre-bid stakes to further their prospects of achieving control is well known. In a merger by way of scheme of arrangement, the issues are more complicated. In this article, the use of pre-bid deals in schemes is examined, along with a look at how these recent deals have dealt with these matters.
Pre-bid stakes: Takeovers and schemes
In a takeover, a significant pre-bid stake can be a powerful starting position for a bidder. Not only will it assist the bidder reach its desired threshold of ownership, it may also act to dissuade counter-bidders. A successful pre-bid raid may also give the bid momentum from the outset.
There are a number of legal issues associated with pre-bid stakes in takeovers. In particular, the minimum bid price rule will mean that the price paid by the bidder for that stake will set the floor price for a bid in the next four months. Insider trading issues and relevant regulatory matters, such as the Foreign Acquisitions and Takeovers Act, or any industry specific ownership restrictions, also need to be considered. The timing of the disclosure of the acquisition, in light of the substantial holding provisions, also requires thought.
From a commercial perspective, vendors of shares may be reluctant to sell if they are aware a potential bidder is aggregating a stake. Often, the compromise that is reached is that the vendor of target shares will either agree to sell some but not all of their shares, or agree not to sell their shares but to accept the bid if it is made, but only in the absence of a superior offer.
Schemes: Classes and voting
The situation in a scheme of arrangement is quite different. While a significant starting stake may dissuade counter-bidders from joining the auction for the target company, it will not be able to be voted by the bidder at the scheme meeting of shareholders. This is because the voting electorate in a scheme is not necessarily the entire body of shareholders. Rather, it is correctly constituted classes of members.
A class of members will be those persons whose rights under the scheme are not so dissimilar as to make it impossible for them to consult with regard to a common interest.
In some transactions, there may only be one class of member. However, shares held by the bidder will constitute a separate class. Thus a significant pre-bid stake in a scheme actually decreases the number of shares in the voting pool of ordinary members which will vote to approve the scheme. The consequence of this reduction is that it makes the stake needed by a spoiler to block the scheme vote smaller.
It should also be noted that in the event a bidder in a scheme nevertheless decided to acquire a pre-bid stake, the other legal issues will be similar to pre-bid acquisitions in takeovers. In particular, ASIC will seek to apply the minimum bid price rule in takeovers through the takeover avoidance provisions of section 411(17) of the Corporations Act (although attempts to do so will not always be successful, noting the Ranger Minerals case in the Supreme Court of Western Australia in 2002).
Voting agreements and proxies
Confronted with the class voting system in a scheme of arrangement, scheme proponents may look to a number of possibilities short of outright ownership of a stake, including voting agreements and proxies.
These mechanisms may be able to replicate, to a limited extent, the effect of a pre-bid stake in a scheme. Agreements to vote in favour of a scheme, or the giving of proxies to the bidder, would assist a bidder in a scheme to move closer to what it needs to obtain control: a successful scheme vote.
There are however three important constraints on the usefulness of agreements of this kind.
The first of these is a legal constraint. It is as yet untested as to whether or not an agreement between shareholder and 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 other constraints are likely to be commercial. A target shareholder in a scheme (particularly an institutional investor charged with fiduciary responsibilities) may be reluctant to enter into an agreement along these lines without some significant carve outs. Shareholders will be keen to see that their agreement to vote in favour of the scheme is subject to no superior offer emerging. Thus the agreement to vote in effect becomes a statement that the vendor is a willing seller to whoever ends up with the best offer for the target company. Additionally, a voting agreement alone will not necessarily dissuade counter-bidders. The scheme proponent will not have any ownership rights in relation to the shares.
Depending on its terms, an option agreement may be able to provide scheme proponents with some comfort in relation to ownership rights and the ability to dissuade third partes.
In a number of recent deals, including Telstra's scheme of arrangement with KAZ Group, MYOB's scheme with Solution 6 and AMP Henderson's acquisition of Sabre Group, the acquiring entities have entered into option agreements with major shareholders. Under those agreements, the bidder has had a right to acquire the shares held by the shareholder in relatively limited circumstances.
Those options have had the following key features:
the option terms provided that exercise is conditional on there first being a third party proposal
- the exercise price per share was identical to the consideration offered under each scheme (as increased to match competing proposals)
- the exercise period for the option has been for a set period of time, often tied to the date of the scheme meetings (or the date by which those meetings should have been held)
- the shareholder has agreed not to dispose of their shares until the end of the option exercise period, and
- the shareholder is expressly stated to be free to vote its shares at the scheme meeting in whatever manner it sees fit.
The standstill agreement described above confers on the bidder a relevant interest in the shares the subject of the option. Accordingly, this needs to be taken into account in calculating the bidder's voting power. If the bidder's voting power, including that conferred by the option agreement, is greater than five per cent then the terms of the agreement will need to be disclosed to the ASX in a substantial holder notice.
Beyond options: Greater control in the future?
In some ways, option agreements in schemes resemble pre-bid agreements in takeovers where the seller agrees to accept the bid, in the absence of a superior offer. While both those agreements and option agreements in schemes have their limitations, they nonetheless may be considered commercially useful in assisting the success of the relevant transaction.
The question remains as to whether greater control can be had over voting outcomes in schemes. The various legal issues mean that such a course of action would not be free of risk. While the use of the scheme procedure to effect acquisitions has from its inception had to confront a number of difficult legal issues, it remains to be seen whether voting agreements will become part of the landscape of Australian schemes of arrangement.
Freehills acted for Telstra Corporation in its acquisition of KAZ Group and for MYOB in its merger with Solution 6.
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