Australia: Reverse Scheming May Not Be Noble

Introduction

The deal structuring phase of any transaction involves an assessment of the road blocks to implementation.

In the past, reverse takeovers or schemes have been seen as a mechanism to overcome a road block, such as dissentient shareholders, who could block a potential transaction if it proceeded by way of a more traditional transaction structure (such as a takeover bid or scheme proposal by the larger company to acquire the smaller company).

A reverse takeover or scheme generally refers to a transaction where a bidder seeks to acquire a larger target using its own securities as consideration. If implemented this would result in the former shareholders of the target acquiring more than 50% of the combined company.

A reverse takeover or reverse scheme that leads to one or more target shareholders acquiring more than 20% voting power in the acquiring company is likely to be closely scrutinised by ASIC, and may also be reviewed by the Takeovers Panel or the Courts.

Deal structuring and regulatory oversight

Section 611, item 4 of the Corporations Act provides an exception to the general 20% takeovers prohibition for acquisitions. It is this gateway that is often relied on to facilitate a reverse takeover. However, the ability to rely on section 611, item 4 is subject to the effect of the reverse takeover. If the effect of thereverse takeover breaches the Eggleston Principles, which underpin Australia's takeover laws and are enshrined in section 602 of the Act, section 611 can not be relied on.

In the reverse scheme context, the Court has the task of considering whether to approve the proposed transaction. Relevantly, section 411(17) of the Corporations Act expressly prohibits the Court from approving the proposed scheme unless:

  • the Court is satisfied that it has not been proposed for the purpose of enabling the avoidance of the takeover provisions of the Corporations Act; or
  • ASIC has provided a certificate to the Court stating that it has no objection to the scheme.

ASIC notes in Regulatory Guides 60 and 142, that schemes of arrangement that have a reverse takeover effect are often likely to raise issues of concern, especially where the shareholders of the acquiring company are not given the opportunity to ratify the proposal.

In ASIC's view, a scheme is likely to be characterised as a reverse takeover (in effect) if the consideration comprises the acquirer's scrip and:

  • the market capitalisation of the target is larger than that of the acquirer;
  • a shareholder of the target is likely to be the largest shareholder of the combined company;
  • the relative shareholdings of members of the acquirer are likely to be materially affected by the scheme.

ASIC may therefore seek to oppose reverse schemes (and reverse takeovers for that matter) which do not provide the shareholders of the acquiring company with the opportunity to vote on the proposed transaction.

In those circumstances, the onus falls on the scheme proponent to satisfy the Court that the transaction has not been structured for the purpose of avoiding the takeover provisions of the Corporations Act. This can be a potential problem for the scheme proponent as the reverse scheme may well have been structured so as to avoid veto rights which may otherwise have arisen if the transaction proceeded by way of a takeover.

For listed companies, there is also the potential for the ASX to apply Listing Rule 11 to force a bidder to obtain shareholder approval where the transaction is likely to result in a significant change to the nature or scale of its activities.

The Takeovers Panel decision in Gloucester Coal Ltd

The concern surrounding the ability of merger partners to structure around the interests of dissentient shareholders came to the fore in the recent Takeovers Panel decision in Gloucester Coal Ltd.

On 19 February 2009, Gloucester Coal Ltd (Gloucester) and Whitehaven Coal Ltd (Whitehaven) announced plans to merge through an off-market scrip takeover offer by Gloucester for all the shares in Whitehaven (Merger).

In what was essentially a reverse takeover, Gloucester offered 1 of its shares for every 2.45 Whitehaven shares held. If successful, Whitehaven shareholders would own two-thirds of the combined company, and Whitehaven representatives would comprise a majority of the combined company's board (with Whitehaven's existing Chairman and Managing Director to assume the roles of Chairman and the initial Managing Director of the combined company).

The structure of the Gloucester takeover bid meant that it was likely to become unconditional shortly after dispatch of its bidder's statement as:

  • the only significant conditions to Gloucester's offer proceeding was an 80% minimum acceptance condition (which acceptance by the Whitehaven directors and their associates would go a long way towards satisfying) and FIRB approval (which has now been obtained);
  • at the time of announcement of the takeover bid, Whitehaven directors and their associates, who in aggregate control approximately 74% of Whitehaven, publicly indicated they would accept the Merger in the absence of a superior proposal for Whitehaven; and
  • the merger implementation agreement entered into by Gloucester and Whitehaven required Gloucester to waive all of its bid conditions once the minimum acceptance and FIRB conditions have been satisfied.

Relevantly, the Merger was not subject to Gloucester shareholder approval and Gloucester did not retain a 'fiduciary out' in its takeover announcement to enable its directors to consider superior proposals made for Gloucester.

Enter Noble Group Limited (Noble).

Noble was a 21.7% shareholder in Gloucester who had in the past been successful at scuttling a previous change of control proposal for Gloucester.

Noble announced its own cash takeover bid for Gloucester, conditional on (among other things) the Merger not proceeding. Noble also made an application to the Takeovers Panel alleging that the Merger had been structured to lock out rival proposals for Gloucester and prevented Gloucester shareholders having any say in whether the Merger should proceed, and sought orders that the Merger be conditional on Gloucester shareholder approval.

Is bidder shareholder approval required to implement a reverse takeover?

The proposed Merger between Gloucester and Whitehaven was clearly a reverse takeover.

Both Gloucester and Whitehaven acknowledged during the Panel proceedings that the transaction was intentionally structured so as to specifically disenfranchise Noble, as Noble's shareholding in Gloucester was sufficiently large to block Whitehaven from acquiring 100% of Gloucester through a more traditional transaction structure. Gloucester submitted during the Panel submissions that:

"If the transaction could not have been structured in this way, or if the deal was subject to the approval of Gloucester's shareholders, there would simply have been no deal."

The Initial Panel found that the structure of the proposed Merger deprived Gloucester shareholders of the ability to consider very significant changes (or potential changes) in control of their company or the acquisition (or potential acquisition) of a substantial interest in their company, and imposed a requirement that the Merger be conditional upon Gloucester shareholder approval. In their view, the Eggleston Principles which require that:

  • target shareholders have sufficient information to assess the merits of a proposal that will affect the control of their company; and
  • target shareholders have adequate time to consider such a proposal,

would be meaningless if Gloucester shareholders were not given the opportunity to assess and decide upon the proposal itself. In reaching this view, the Initial Panel considered that Parliament had set 20% as the takeovers threshold for when a transaction will affect the control of a company.

In ordering that the Merger be subject to Gloucester shareholder approval, the Initial Panel excluded the common Whitehaven/Gloucester shareholders that had provided commitments to accept the Merger proposal from voting at the meeting. However, the Initial Panel permitted Noble to vote at that meeting, so as to effectively provide Noble with the potential veto rights that the transaction structure deliberately sought to avoid.

On review, the Review Panel found that not every acquisition of more than 20% of the bidder through acceptance of a scrip takeover bid triggers a requirement for bidder shareholder approval, and that to require otherwise brings the need for the gateway provided in section 611 item 4 into question. The Review Panel found that it is only where the effect of the proposed transaction on the control of the bidder is of sufficient nature and scale that approval of the bidder's shareholders should be sought.

On the facts of the case, the Review Panel found that no one Whitehaven shareholder would acquire voting power in the combined company which was of sufficient nature and scale so as to warrant requiring Gloucester shareholder approval to the proposed transaction, and overturned the Initial Panel's decision on this point.

Locking out rival bidders in reverse takeovers and schemes

As mentioned above, the Merger announcement did not provide the Gloucester directors with a 'fiduciary out' to the exclusivity undertakings provided to Whitehaven.

Accordingly, as Gloucester was compelled at law to proceed with its bid for Whitehaven on terms not substantially less favourable terms than those announced, the Gloucester directors were unable to consider competing proposals which may be made for Gloucester (such as Noble's bid).

Both the Initial Panel and the Review Panel found that the structure of the proposed Merger prevented an auction for control of Gloucester.

In essence, the inability of the Gloucester directors to consider competing proposals to the Merger, when coupled with the commitments of Whitehaven's directors and associates to accept the Merger, was found to give rise to unacceptable circumstances because:

  • it prevented the acquisition of control over Gloucester shares taking place in an efficient, competitive and informed market by preventing bids for Gloucester stand-alone (such as the Noble bid), as opposed to the combined Gloucester/Whitehaven; and
  • it prevented the Gloucester board from considering a superior proposal for Gloucester, such that Gloucester shareholders do not have a reasonable and equal opportunity to participate in the benefits which may accrue to Gloucester shareholders through an alternative proposal (such as the potential to receive a control premium for their shares etc).

Accordingly, the Review Panel ordered that the Merger be subject to a condition to the effect that no superior proposal for Gloucester be made or announced. Such an order was thought to be appropriate as it enabled the Gloucester directors to consider competing proposals and, if such proposals were thought to be superior, for Gloucester shareholders to participate in any benefits accruing from that proposal.

However, the Review Panel did not go so far as to require every bid to include a condition that there is no superior proposal made or announced for the bidder itself, although noted that such a condition was more likely to be appropriate for a reverse takeover than an ordinary takeover.

Postscript

Interestingly, since the Review Panel's decision, Noble has increased its bid for Gloucester by a further 24%. As at the time of writing Gloucester is yet to respond as to whether the revised Noble bid represents a 'superior proposal' to the Merger, although Noble has raised concerns about the length of time taken by Gloucester to decide the matter.

Noble has now applied to the High Court of Australia for judicial review of the Review Panel's decision.

Comments

The Takeovers Panel decisions in Gloucester Coal Ltd provides a pertinent reminder of the care that must be taken in seeking to structure transactions so as to circumvent potential veto rights of key stakeholders.

At this stage, and subject to the outcome of Noble's application to the High Court to review the Review Panel's decision, there are no hard and fast rules that requirebidder shareholder approval to be sought for all reverse takeovers and schemes. Whether such approval is required is likely to depend on the particular facts of the proposed transaction and the rationale for the proposed deal structure.

In appropriate cases, there may be merit in conceding that the transaction be made conditional on bidder shareholder approval so that at least the parties can try to shape the ground rules for that meeting (in particular, the voting exclusions that may apply at that meeting), rather than to have such requirements dictated to them.

Until the High Court finally decides the matter, parties plotting reverse takeovers or schemes should proceed with extreme caution.

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.

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