Member Article

Schemes of arrangement continue to be a popular method of structuring friendly takeovers. Schemes are also a conventional mechanism for accomplishing internal reconstructions such as demergers, demutualisations and changing the principal listing or jurisdiction of incorporation of a company (so-called 're-domicile' schemes). Given the prevalence of schemes in the Australian market, it is timely to consider the impact of recent reforms proposed for schemes.

On 28 January 2010, the Commonwealth Government released a report by the Corporations and Markets Advisory Committee (CAMAC) on schemes of arrangement. CAMAC's report sets out a number of recommendations for reform to the scheme rules. This article considers those reforms proposed by CAMAC which are likely to be of practical relevance to listed entities and their advisers contemplating a friendly takeover scheme.

Before considering those reforms, it is worth noting that CAMAC ignored calls from some critics who have lobbied over recent years against the use of schemes to effect friendly takeovers. CAMAC's position is that schemes have a legitimate place as an alternative to a Chapter 6 takeover bid for change of control transactions. This is consistent with ASIC's policy. Minter Ellison shares CAMAC's view that the statutory framework for schemes, including the ASIC review process and judicial oversight, is sound and provides appropriate protections to ensure that changes of control through schemes take place in an efficient, competitive and informed way.

Which leads to the key reforms proposed in CAMAC's report that are likely to be of most interest to market participants. In our view, there are three such proposed reforms.

Repealing the 'headcount test' for shareholder approval of schemes

At present, a scheme requires the approval by a company's shareholders under the following two tests: 

• first, a simple majority in number (i.e. at least 50% plus one) of each class of shareholders who vote at the scheme meeting (either in person, by proxy or otherwise) must vote in favour of the scheme – this is the so-called 'headcount test', and
  
• secondly, the resolution in favour of the scheme must be passed by at least 75% of the total number of votes cast by the shareholders in each class – this is the so-called 'voted shares test'.

The effect of the headcount test is that each participating shareholder has one vote on the scheme, regardless of the number of shares they hold. The rationale for the headcount test is that it provides a check on the ability of large shareholders to determine the outcome of the scheme vote, and otherwise reduces the possibility of schemes being used to oppress minority shareholders or ignore their interests. However, the headcount test is susceptible to manipulation in that it allows parties who oppose a scheme to engage in share splitting. This occurs where one or more shareholders transfer off-market small parcels of shares to a large number of other persons willing to vote in accordance with the wishes of the transferor. By splitting shares to increase the number of members voting against the scheme, an individual or small group opposed to the scheme may cause the scheme to be defeated. This may occur even though a special majority is achieved under the voted shares test (being the second limb of the current shareholder approval requirements for a scheme).

CAMAC has recommended the removal of the headcount test for the approval of schemes, on the basis that it gives small shareholders disproportionate power and potentially enables them to defeat a scheme. CAMAC considers that decisions on a fundamental corporate matter such as a scheme proposal should be determined by the number of shares voted, rather than the number of shareholders who vote, and that the interests of small shareholders in schemes are already adequately protected.

We support this reform recommendation and note that a stand-alone scheme approval test of 75% of shares voted would be consistent with the voting threshold for other important corporate proposals that may fundamentally affect shareholders. These include changes to a company's constitution and other proposals that call for approval by special resolution.

Abolishing the takeover anti-avoidance requirement

If a scheme is approved by the requisite majority of shareholders, the next step is to seek court approval for the scheme. One aspect of court approval of schemes that has attracted considerable attention over many years is the operation of s411(17) of the Corporations Act. This section provides that the court must not approve a scheme unless:

(a) it is satisfied that the scheme has not been proposed for the purpose of avoiding the takeover provisions in Chapter 6, or

(b) ASIC provides a statement that it has no objection to the scheme.

Both matters do not have to be satisfied: an ASIC no objection statement under paragraph (b) precludes the court from exercising its power under paragraph (a). But if ASIC does not provide its no objection statement under paragraph (b), the proponents of the scheme must satisfy the court that no substantive takeover avoidance purpose exists. Even if ASIC does provide a 'no objection' statement under paragraph (b), the Court can still take into account any avoidance purpose in exercising its discretion whether to approve the scheme.

Section 411(17) has been interpreted by the courts, and applied by ASIC, in a manner that does not preclude the use of schemes to achieve a change of control. Therefore, a party seeking to acquire control of a publicly listed company may choose a scheme over a conventional takeover bid, provided there is some commercial justification for that choice and the target company's board supports the change of control proposal.

However, the precise operation of s411(17), in particular paragraph (a) of that subsection, has not been definitively tested. Consequently, it remains a source of uncertainty. Although schemes have to date survived various challenges over the years in relation to alleged takeover avoidance, this may not always be the case. The possibility remains that a properly funded party will successfully challenge a takeover scheme on the basis that the scheme structure has been chosen to avoid the operation of the takeover provisions of Chapter 6. This is particularly the case given ASIC's unofficial policy of withholding its s411(17)(b) 'no objection' statement at the second court hearing in relation to a takeover type scheme where an objector wishes to argue 'avoidance' of the takeover provisions in Chapter 6 at the approval hearing. For these and other reasons, the existence of s411(17) has for a long time presented a completion risk to a friendly takeover scheme.

CAMAC has recommended the repeal of the takeover avoidance provision in section 411(17)(a). CAMAC notes that this section dates back to the 1970s and early 1980s when the takeover laws in Chapter 6 as we know them today were being formulated. Back then, there was a question mark as to whether schemes were an appropriate alternative structure to takeover bids for achieving a change of control. The concern at that time was that the scheme provisions were never drafted with takeovers in mind. Accordingly, s411(17) was introduced as a statutory safeguard. However, over the past 25 years, the courts have consistently stated that a scheme of arrangement is an appropriate alternative mechanism for effecting a change of control transaction. Accordingly, CAMAC considers that section 411(17)(a) no longer fulfils any real purpose.

CAMAC recommends that section 411(17) be recast so that:

• section 411(17)(a) is repealed
  
• ASIC retains the right to provide the court with a statement of objection or no objection in relation to the proposed scheme, and
  
• the court retains the ultimate power to approve or reject a scheme, irrespective of whether or not ASIC provides a 'no objection' statement.

We support this reform recommendation, as we believe that the repeal of section 411(17)(a) removes the current uncertainty and completion risk associated with a potential challenge to the scheme on takeover avoidance grounds.

Extending the scheme provisions to listed managed investment schemes

Listed managed investment schemes form a significant portion of the market for ASX listed securities. For example, listed property trusts represent approximately 10% of the ASX index. The growth in the number and market capitalisation of listed managed investment schemes is partly attributable to the growth of superannuation funds, as well as to the emergence of 'stapled' entity structures involving a combination of shares in a listed company stapled to units in a listed managed investment scheme. At present, the scheme provisions cannot be utilised by listed managed investment schemes. Consequently, the restructuring of listed managed investment schemes is usually more complicated and involves compliance with a combination of trust and corporate laws. In contrast, the takeover bid provisions were amended in March 2000 to allow for takeovers of listed managed investment schemes, as well as companies.

CAMAC recommends the extension of the scheme provisions to both listed and unlisted managed investment schemes. This would allow changes of control or other reorganisations of managed investment schemes to be undertaken in a simpler, more transparent and streamlined way, rather than the current approach whereby unitholders are required to pass a special resolution amending the constitution of their managed investment scheme to authorise a cancellation or transfer of units, as well as a separate resolution to permit the intending controller to acquire more than 20% of the units. It would also provide greater certainty of outcome, particularly in the case of stapled structures, as the scheme meetings of the company and the managed investment scheme would potentially run simultaneously. Extending the scheme of arrangement provisions to listed managed investment schemes will also better protect the interests of unitholders, including through ASIC involvement and court review of a proposed scheme.

Conclusion

Other reforms proposed by CAMAC include streamlining and simplifying the disclosure requirements for scheme explanatory statements so that information is presented to shareholders in a clearer and more concise manner. The aim is to discourage companies from including extraneous or only marginally relevant information that results in voluminous and less comprehensible scheme documents, in the belief that potential liability is minimised by including more rather than less material.

CAMAC has also acknowledged the anomaly in directors having due diligence defences in takeover and fundraising documents but not for scheme documents. CAMAC supports a principle of harmonising the liability and due diligence defences across all disclosure documents and explanatory materials produced by listed entities, whether for fundraising, takeovers or schemes.

Overall, the reforms proposed by CAMAC are sound and are generally well supported. The reforms will assist in strengthening the important role that schemes play in the Australian market for control of listed entities.