We expect that boards which are faced with such activism will feel considerable pressure to engage with the activists in an attempt to avoid the activists invoking the formal procedures available to them under the Corporations Act.
We saw in our last article how, as a result of the NRMA case, shareholder activists cannot use a general meeting to issue instructions to directors. They could, in theory, achieve the same objective by using a general meeting to incorporate their objectives into the company's constitution. However, as detailed in our discussion of the NRMA principle, that is not practical, both because of the high voting threshold for changing a constitution and because a constitution is too unwieldy to function as a business plan.
The only viable option, therefore, is to threaten the board itself through a spill motion. Oftentimes, the mere prospect of a credible spill motion will be enough to prompt a board to open discussions with an activist. This could result in the board's adopting the activist's agenda, co-opting the activist's nominees to the existing board or, in extreme cases, standing down and being replaced by the activist's nominees.
There are three methods of putting a spill motion before a meeting:
- using the Two Strikes rule;
- requisitioning or calling a general meeting to consider the spill motion;
- moving a spill motion at a meeting that the board has called for another purpose.
From a shareholder activist's point of view, these options have advantages and disadvantages.
The biggest advantage of the Two Strikes Rule arises from the fact that it is automatically triggered by a 25% No vote on the remuneration report at the company's AGM. This means that:
- the activist only has to organise the numbers, and does not have to follow any of the procedural steps required for requisitioning or calling a meeting;
- the incumbent board has to spend the next 12 months planning on ways to avoid a second strike – effectively forcing it to negotiate with shareholders.
The disadvantage of the Two Strikes Rule is that it is only available during the relatively short window of the AGM season.
Requisitioning or calling a general meeting has the advantage of flexibility, since it can be sprung on the board at any time. On the other hand, it is legally finicky: the persons requisitioning or calling the meeting have to comply with the strict procedural requirements of Corporations Act sections 249D and 249F.
In both cases, the requisitionists must control at least 5% of the voting shares in the company. By itself, this is not a major obstacle, because an activist who couldn't muster 5% of the votes in the company would not be a credible threat to the board anyway, and the association/substantial holder provisions of the Corporations Act are not tripped by collective action by institutional investors.
However, the 5% requirement does often provide the first line of defence for the incumbent board. A board's first reaction to a meeting requisition is to go through the requisition documentation with a fine-tooth comb, to see if all the legal requirements have been met. For example, where there are multiple requisitionists, the board will check that the requisitionists hold sufficient shares to get over the 5% threshold and that they have all signed their names to the same requisition.
The 5% threshold will in practice, prove to be a low one as it is likely that any serious activist will have a shareholding in excess of that percentage.
If the requisition is valid, the directors must hold the meeting within two months of receiving the requisition.
If the company fails to convene the requisitioned meeting within 21 days of receiving the requisition, the requisitionists may proceed to convene the meeting themselves, at the company's expense and using the company's register of members (which the company must supply to the requisitionists free of charge): section 249E. This may look like a better option for the company and the board, since it throws the administrative burden onto the requisitionists. However, section 249E also provides that, where the company pays the requisitionists' expenses, it can recover those expenses from its directors.
Activists can also bypass the requisition route completely, by calling a general meeting themselves. In order to do this, the activists must control at least 5% of the voting shares and must pay all the expenses of calling and holding the meeting (which is why this option is rarely taken).
Finally, activists who hold at least 5% of the voting shares can move motions at a general meeting, provided that they have given at least two months' notice. Given the long timeframe and the rarity of general meetings outside the AGM season, this is not a particularly attractive option for activists.
Can a board go too far? The Advance Bank case
The mid 1980s were the best of times and the worst of times for incumbent boards in Australia.
On the plus side, the NRMA case restricted the ability of pressure groups to challenge board decisions. On the other hand, the Advance Bank case truncated the ability of boards to defend their company against spill motions – even ones which had the potential to damage the interests of the company.
The issue arose when FAI Insurances put forward four nominees for election to the board of Advance Bank at its 1986 AGM. FAI held just under 10% of the Bank. The rest of the shareholding was widely dispersed, reflecting the Bank's recent conversion from a mutual.
The board of the Bank (some of whom were themselves up for election) resolved that the company should oppose the election of the FAI nominees. The directors who were running for re-election did not participate in the actual planning or implementation of the anti-FAI campaign (which would involve the expenditure of Advance Bank funds on, among other things, canvassing shareholders by letter and phone calls).
Given what is now known about the financial state of FAI, the Advance Bank board probably had legitimate cause for concern. However, the revelation of FAI's problems was still some time in the future, and so the anti-FAI campaign could only highlight the fact that the election of the FAI nominees could see a 10% shareholder gain control of the board and hence the company. The campaign also claimed that the re-election of the existing board would continue the Bank's strong performance.
FAI took the Bank and its board to Court, complaining that the use of Bank funds to oppose the FAI nominees was ultra vires.
The NSW Court of Appeal held that a company does have the power to spend money on a board election. However, that power has to be exercised for a proper purpose. The Court split on what was "proper".
The majority held that company funds can only be spent on "neutral" materials:
"such expenditure should normally be kept to a minimum, confined to the supply of essential information, avoid self-praise and irrelevant issues of personality and, so far as issues of policy are concerned present information in a way which promotes an informed decision and thereby contributes to the proper corporate objective, viz. a due election."
On this view, the Bank board may have been acting from the best of motives, but had overstepped the mark, by attacking the FAI nominees and promoting the re-election of the existing board.
The other judge, Justice Mahoney, agreed that the Bank's directors had gone too far in this case. Nevertheless, he was prepared to concede that there could be other instances in which a board would be entitled to campaign against a board nominee:
"[A] company is not required to stand neutral in a contested election. As I have suggested, a company may have a legitimate interest in the suitability and efficiency of those who comprise its board of directors. That interest does not, in my opinion, stop at the point of a contested election. If a nominee for election would, if elected, harm the business or reputation of the company the company may, in particular circumstances, be entitled to take steps to inform the shareholders of that fact. If a criminal were seeking to control the company for organised crime, the existing board would be entitled to investigate the facts, present them to the shareholders, and do that with an appropriate degree of advocacy. If the election of a particular director would, because it would involve the contravention of a statutory provision, cause the company to lose a valuable asset such as a banking or television licence, the company would be entitled to, and may have a duty to, inform the shareholders of this and to do what properly should be done to suggest that he be not elected."
At first glance, Justice Mahoney's position might appear to be more favourable to incumbent boards. On the other hand, the reality is that Australia's defamation laws would make it almost impossible for a board to disseminate election materials suggesting that a candidate for the board would harm the company's business or reputation, or was a criminal.
The result of the Advance Bank case is that Australian boards are generally regarded as unable to spend company money by taking sides in a board election, whether at the AGM or on a spill motion.
In the succeeding quarter of a century, there have been arguments that the Court of Appeal's decision wrongly inhibits the ability of boards to defend their companies' best interests. Despite this, the chances of any board being willing to take the issue back to Court are fairly slim: as well as holding that the Bank's directors had misused their powers, the Court of Appeal ordered them to personally reimburse the Bank for the money that it had spent on the election campaign.
We believe that the principles in the Advance Bank case remain a work in progress. It will almost certainly be construed narrowly in any board spill in the present era. In particular, the board will be keen to ensure that the company's resources can be applied in demonstrating to the shareholders why the strategies and objectives being adopted by the present board are in the best interests of the company and its shareholders.
The Australian legal framework which governs the way shareholder activists can exert pressure on a company, and how the company's board can respond to such activism, is generally much more restrictive on boards than that which exists in the US.
As a result, we expect that boards which are faced with such activism will feel considerable pressure to engage with the activists in an attempt to avoid the activists invoking the formal procedures available to them under the Corporations Act. Like it or not, it appears that shareholder activism is a movement which is here to stay and likely to develop further in the future.
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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.