My scheme of arrangement is “not fair”, what now?
Schemes of arrangement continue to be a popular method for buyers looking to acquire public companies in Australia. An alternative to a takeover, a scheme of arrangement is a statutory process under Part 5.1 of the Corporations Act 2001 (Cth) (Corporations Act) which allows a company to be acquired or reorganise its share capital, assets or liabilities with shareholder and Court approval.
The increasing number of schemes is providing a greater array of examples and potentially raising some hurdles for boards considering their options for a sale. Does the market understand the mechanics, particularly companies (and their boards) encountering a scheme for the first time?
Schemes of arrangement can potentially offer more flexibility than a takeover, particularly with companies with more than one class of share. Another advantage is the binary nature of a scheme which, if approved, binds all shareholders, providing the buyer with greater certainty of outcome.
In order to obtain shareholder approval, companies looking to undergo a scheme of arrangement must provide its shareholders with an explanatory statement (often referred to as the “scheme booklet”) setting out the details of the scheme. Before the booklet can be issued to shareholders, it is closely scrutinised by the Australian Securities and Investments Commission (ASIC) and the Court to determine whether shareholders are being adequately informed of the information surrounding the proposed scheme.
Key features that ASIC and the Court are looking for in a scheme booklet are whether it clearly sets out the advantages and disadvantages if the scheme were to proceed, identifying any benefits to directors or key persons, and for many schemes the opinion of an independent expert (contained in an independent expert’s report).
When is an independent expert report required?
Under the Corporations Regulations 2001, the scheme booklet must contain an independent expert’s report if:
- the other party to the proposed scheme holds at least 30% of the shares in the target company; or
- there are common directors in both the other party and the target.
That being said, recent market practice has been that an independent expert’s report is obtained as a matter of course and ASIC often expects one to be included, even if not legally required. In our experience, the Court will also find the inclusion of an independent expert’s report of comfort when considering whether the matter should proceed to a shareholders’ meeting for approval.
What does an independent expert report say?
An independent expert for a scheme of arrangement provides a report opining on whether the proposed scheme is in the best interests of the target company’s shareholders and sets out the reasons for that opinion.
ASIC’s Regulatory Guide 111 (RG111) sets out ASIC’s expectations on the contents of an independent expert’s report. As schemes of arrangement are considered as an alternative deal structure to a takeover, ASIC anticipates that the analysis undertaken by an independent expert is largely the same and invites experts to apply the same methodology for both a takeover and a scheme of arrangement.
As the test to be established by an independent expert in a takeover is whether it is “fair and reasonable”, this has led to a practice in recent years for independent experts to assess whether the scheme is “fair and reasonable” in the first instance. ASIC addresses the slight difference in tests in RG111 as it notes that if the independent expert concludes that a scheme is “fair and reasonable”, it can then be concluded that the scheme is “in the best interests of shareholders”.
There are three potential outcomes to an independent expert’s report as noted in RG111:
|✔||✔||The expert will conclude that the scheme is in the best interests of shareholders.|
|✖||✔||The expert may still conclude the scheme is in the best interests of shareholders, based on other factors.|
|✖||✖||The expert cannot find that the scheme is in the best interests of shareholders.|
The vast majority of schemes of arrangement ultimately approved by shareholders and the Court in the last 24 months were determined by the expert to be “fair and reasonable”.
Fair and reasonable
A scheme is generally considered to be “fair” if the price offered for the shares is greater than the determined market value of the shares. If the expert considers the scheme to be “fair”, it can be deemed to be “reasonable” in the circumstances.
Earlier this year, Coca-Cola delayed its $9 billion scheme of arrangement to purchase Amatil when better-than-expected sales figures impacted its valuation and cast doubt on whether the independent expert would find Coca-Cola’s offer price to be “fair”.
Not fair, but reasonable
As the test for fairness is rather binary and based on valuation, you may find yourself in a situation where the expert has concluded that your proposed scheme is “not fair”. As the expert’s independence remains paramount, it is not possible to manage or negotiate any valuation reached by the expert, although they will take into consideration any additional factual information which may affect the valuation and potentially whether they consider the scheme to be “fair”. In many cases, the conclusion may be a simple function of (a) not being able to apply comparable methodologies to both the bidder and the target (especially unlisted or illiquid shares); (b) an insufficiency of data; or (c) a target asset may involve elements of risk or speculation such that there is an inability to confidently ascribe a valuation.
RG111 also sets out the criteria for an expert to assess whether the proposed scheme is “reasonable”, even if it is “not fair”, which includes:
- the other party’s existing holding in the target;
- the liquidity of the market for the target’s securities;
- the likely market price if the scheme was unsuccessful; and
- the value to an alternative purchaser and likelihood of another offer being made.
The guidance therefore clearly allows for situations where the scheme may be considered to be “not fair but reasonable”. ASIC notes that it is still open for an expert to conclude that such schemes are still in the best interests of shareholders, but the expert must clearly state in the report that the consideration is not equal to or greater than the value of the shares. The report must also set out the reasons which led the expert to conclude that, notwithstanding this valuation, it is in shareholders’ best interests to vote in favour of the scheme.
Not fair and not reasonable
Where the expert finds that the proposed scheme is neither fair nor reasonable, they cannot conclude that the scheme is in the best interests of shareholders. One example of this is the failed acquisition of ASX-listed cannabis company Creso in 2019, where the scheme was terminated by mutual agreement following a supplementary report by the independent expert, which concluded that the deal was “neither fair nor reasonable”.
Does it matter to the Court if my scheme is “not fair”?
The Court will be involved at two key points of the scheme of arrangement process:
- to determine whether to convene a meeting of shareholders to approve the scheme (First Hearing); and
- if shareholders approve the scheme, to determine whether the scheme should be implemented (Second Hearing).
At the First Hearing, the Court will not carry out an extensive analysis of whether the scheme should be approved by the Court unless the scheme appears on the face of it to be “blatantly unfair” or otherwise inappropriate to proceed to the next stage. Generally the Court considers that it is ultimately for shareholders to decide, provided they are properly appraised of the reasons why the scheme is not fair and why, despite this, the expert considers the scheme to be in their best interests.
Before the Court grants orders under section 411(4) of the Corporations Act to approve the scheme at the Second Hearing, it must have regard to a number of factors, including whether the scheme is fair and reasonable. In the 2006 case Zenyth Therapeutics, Dodds-Streeton J warned that “Courts should adopt a cautious approach to the approval of any scheme which the independent expert considers “not fair”, particularly when it may involve expropriation at an undervalue”, however there has been a slew of case law since to support that Courts will approve schemes that are “not fair, but reasonable” where shareholders are fully informed and there are compelling reasons for the scheme continuing to be in the best interests of shareholders.
Relevantly, the Court has regard to ASIC’s assessment of the scheme. ASIC may make submissions and enter an appearance in matters where they have a concern.
How do you mitigate unfairness?
ASIC are looking for a balanced approach in assessing the advantages and disadvantages of a scheme in the scheme booklet so will likely take a pejorative view of documents which fail to adequately disclose unfavourable factors such as a finding of unfairness by an expert.
In short, the way to mitigate the risk is not to suppress that information, but address it in context with the other factors to be considered.
If the independent expert concludes that a scheme of arrangement is “not fair”, this is not necessarily fatal to the success of the proposed scheme. Provided that the scheme booklet clearly sets out:
- the reasons why the scheme is considered not fair;
- the basis for that assessment (including the analysis adopted by the expert); and
- the reasons why, in the opinion of the expert, the scheme is still in the best interests of the shareholders to approve it,
then the Court is generally satisfied that shareholders will be able to determine whether the “unfairness” is a sufficient reason to vote against the scheme.
Pitfalls for cross-jurisdictional structures
Additional complications may arise where the proposed transaction has international elements, as the concept of “fairness” can have different implications and meanings in different jurisdictions. For example, if a target has US shareholders and the proposed scheme has an element of scrip consideration, this may trigger the requirement to produce a disclosure document (such as a prospectus) under US legislation, unless an exemption applies. Section 3(10) of the US Securities Act of 1933 exempts offers such as schemes where the Court has determined the terms and conditions of the scheme to be fair. A finding by an independent expert that the scheme is “not fair, but reasonable” may therefore cause confusion to US advisers. It is, however, the Court in the Second Hearing who determines, having regard to the independent expert’s report, the procedural steps taken, the level and quality of disclosure to shareholders, and the substance of any objections made by shareholders, whether the scheme as a whole should be implemented, which is relevant to the US Securities Act of 1933 exemption.
Always ensure full and frank disclosure
Should you find yourself in a situation where the expert has determined that your scheme of arrangement is “not fair”, the best way to optimise success of the scheme is disclosure in the scheme booklet. Full, balanced and appropriate disclosure of any disadvantages (not just those arising from the expert’s report) is more likely to lead to a favourable outcome as the Court will be satisfied that shareholders have made an informed decision on whether to approve a scheme.
 Both the Federal and State Supreme Courts have jurisdiction to determine scheme matters.
 Made under the Corporations Act
 Blackgold International Holdings Ltd, Re Blackgold International Holdings Ltd  FCA 601
 Re CIC Australia Limited  NSWSC 557 at 
 Zenyth Therapeutics Ltd v Smith  VSC 436
This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.