A recent Takeovers Panel decision has highlighted the importance for unlisted public companies with more than 50 shareholders to act as if they are, essentially, listed companies when it comes to compliance with Chapter 6 of the Corporations Act.
Whilst technically speaking the decision does not change what has been indisputably the law in Australia since the adoption of the modern takeovers provisions, it does highlight that there is a significant risk that where unlisted companies consider themselves unlikely to be scrutinised by the Takeovers Panel (or ASIC) in control transactions, this may not be the case.
In the Smoke Alarms Holdings Limited (SAH) decision (Smoke Alarms Holdings Limited – TP20/02), an aggrieved shareholder made an application to the Takeovers Panel for a declaration of unacceptable circumstances in circumstances where a major shareholder of SAH (Fast Future Pty Ltd (Fast Future)) sought to subscribe for convertible notes which would, if all tranches of notes and interest had been converted into ordinary shares, provide the shareholder with voting power of 80.04% of SAH.
Whilst SAH did seek shareholder approval under Item 7 of section 611 of the Corporations Act, critically, the notice of meeting did not include an independent expert’s report.
In a listed public company context, it is market standard for companies to issue a notice of meeting seeking approval under Item 7 of section 611 of the Corporations Act, accompanied by an independent expert’s report prepared in accordance with ASIC Regulatory Guide 111/112. Whilst technically speaking, even ASIC acknowledges that Item 7 of section 611 of the Corporations Act does not itself mandate the inclusion of an independent expert’s report, ASIC states that:
“we consider that the directors of the target entity should provide members with an independent expert’s report or detailed directors report on the proposed transaction to satisfy the obligation to disclose all material information on how to vote on the Item 7 resolution”. RG 74.29 (our emphasis)
And again:
“the analysis of the proposed transaction should usually be in the form of an independent expert’s report, which is standard market practice”. RG74.31
Further, where directors seek to issue a notice of meeting without an independent expert’s report and seek to provide only a “detailed directors report on the proposed transaction”, ASIC is of the view that directors should only do so if they have “sufficient expertise, experience and resources to prepare a report “and that members should not receive “lesser quality information from directors than they would from an independent expert” (RG74.32).
Clearly, ASIC is of the view that the bar is extremely high for directors should they wish to issue their own form of detailed analysis, rather than an independent expert’s report.
In the case of SAH, clearly the Panel has taken the view that information provided by SAH was insufficient to meet this bar.
In coming to its decision, (that the disclosure SAH had made in its notice of general meeting, was deficient and constituted unacceptable circumstances), the Panel noted the following:
- The failure to provide the independent expert’s report was exacerbated by the fact that Fast Future was an entity related to a director of SAH.
- Further, the director of SAH who principally was involved in negotiating the agreement with Fast Future was also involved in certain investments with Fast Future’s controller. SAH did not protect against this conflict of interest by utilising appropriate protocols and processes. These conflicts made the requirement for an independent expert’s report even more critical.
- Even ignoring the absence of an independent expert’s report, the explanatory statement provided by SAH to shareholders contained “insufficient or misleading information” in a variety of respects including failing to disclose certain fundamental matters as the use of funds to be raised under the agreement, how many notes had been issued and financial information of SAH.
- As can be seen from the above, the circumstances surrounding SAH’s entry into the relevant convertible note agreement and issuing of the notice of general meeting to shareholders constitute, at least according to the Panel, a fairly clear cut case of failure to comply with Item 7 of section 611 of the Corporations Act. So much so, that ordinarily a decision of this nature would not constitute “newsworthy” commentary.
However, what it indicates, and the lesson that ought to be taken out of this case, is that the scrutiny of the Panel (and for that matter, ASIC) is not simply limited to large listed companies, or indeed any listed company. A public company with more than 50 shareholders is bound by the same criteria and must be measured up against the same bar as applied to the largest of Australia’s listed public companies. It is clear from the SAH decision that partial compliance is not nearly enough and that directors of smaller unlisted and potentially less financially stable companies cannot ignore the requirements of the Corporations Act, whether willfully or otherwise.
The upshot in the SAH decision was, somewhat surprisingly, that although the Panel made a declaration of unacceptable circumstances, it allowed Fast Future to subscribe for the remaining convertible notes and convert those notes into shares (thereby increasing Fast Future’s holding to a control position). The downside for Fast Future was the loss of the optionality associated with convertible notes by forcing conversion and also removing the interest component which would cease to apply following conversion of those notes. They were also prevented from exercising options associated with the grant of the notes unless new shareholder approval was sought (which approval must be accompanied by an independent expert’s report).
The Panel noted in its decision that it took the somewhat unusual step of allowing conversion of the notes despite non-compliance with Item 7 of section 611 of the Corporations Act, given the precarious financial position of SAH and concerns of its near-term solvency. Accordingly, one must presume that no party exited the SAH matter particularly happy; the complaining shareholder was unable to prevent the passing of control via the issue of convertible notes, SAH were not able to avoid immediate dilution by virtue of the issue, and Fast Future lost its optionality and interest payments under the notes as well as certain rights attached to the option securities.
Not to mention that any perceived cost saving in not seeking an independent expert’s report was no doubt more than lost through the Takeover Panel proceedings.