8 November, 2019
A hot topic in scheme of arrangement decisions this year has been the question whether a target director who will receive a personal benefit on implementation of the scheme may recommend the scheme to shareholders. Despite some apparent disagreement among judicial authorities, with some suggesting that interested directors should decline to make a recommendation and others that directors are usually obliged to make a recommendation, the latest judicial commentary is that this divergence may be more apparent than real and that the question ultimately depends on the facts.
Background
Members' schemes of arrangement often involve the target company agreeing to pay incentive or retention bonuses to, or entering into revised employment arrangements with, key executive directors if the scheme is successful. The "traditional" view is that such a contingent benefit, which is not available to shareholders generally, would not prevent a director from recommending that shareholders vote in favour of the scheme, provided the benefit is appropriately disclosed to shareholders.1
However, the Gazal decision2 earlier this year suggested that a director who will receive a substantial benefit which depends on the success of the scheme should decline to make a recommendation and explain the reasons for this to shareholders. This view was approved in a number of subsequent decisions.3
The Kidman decision4 then expressly disagreed with that view, stating instead that the regulatory requirements for scheme booklets, particularly Regulation 8301,5 ordinarily oblige each target director to make a voting recommendation, even if they will receive a personal benefit on implementation of the scheme. A number of subsequent decisions have preferred the Kidman approach over Gazal.6
ASIC also addressed the question in its corporate finance report published in late September 2019.7 While citing decisions from both sides of the debate, ASIC not surprisingly expressed the more conservative view that an interested director should carefully consider whether it may be appropriate to refrain from making a recommendation. Following the Gazal approach, ASIC also emphasised the need to prominently and repeatedly disclose any benefits received by directors, and suggested giving consideration to addressing this issue in the Scheme Implementation Agreement to ensure appropriate terms are incorporated (see below).
Wellcom
The more recent Wellcom decision8 helpfully looks for some common ground between these two lines of authority. Although it was not necessary in the circumstances to resolve the issue, Wellcom suggests that the divergence in views may be more apparent than real and that the question is "fact sensitive". The Court agreed that Regulation 8301 requires the scheme booklet to include a voting recommendation from each director except, for example, where a director does not feel justified in doing so. However, the Court observed that its supervisory jurisdiction over schemes extends to both the content of the voting recommendation and the circumstances in which the recommendation is made, and that the more traditional view (which permits recommendations where personal interests are appropriately disclosed) does not preclude the Court from exercising its supervisory jurisdiction in that manner. The Court observed that there may be circumstances where a director should not make a recommendation due to the nature and extent of additional benefits that the director will receive if the scheme is implemented (for example, in circumstances where it would be unrealistic to expect that a director could bring an unbiased mind to the recommendation), and where disclosure of those benefits may not be sufficient.
Practical implications
Whether real or apparent, there certainly seems to be a wide gap between the Gazal view that it is "better practice" for an interested director to decline to make a recommendation and the Kidman view that all directors are "ordinarily obliged" to make a recommendation. However, while it may be difficult to reconcile these positions in principle, in practice there seems to be little divergence in approach or outcome. It remains standard practice for scheme booklets to state the recommendation of each director, including those receiving a benefit which depends on the success of the scheme. ASIC appears to have raised concerns about the issue in only a few of these cases, and those concerns were generally resolved through additional disclosure and ASIC did not appear to object further on this point. Nor have the Courts declined in any of these cases to convene the scheme meeting or to approve the scheme, despite any reservations expressed regarding director benefits and recommendations.
As emphasised in Wellcom, the issue is fact specific. There may be a narrow range of circumstances where the benefit to be received by a director is so significant that the Court may refuse to approve a scheme booklet containing that director's recommendation, however prominently the benefit is disclosed. In the broad majority of circumstances, however, we would expect that interested directors' recommendations will continue to be permitted and shareholder protection will continue to be achieved through a focus on disclosure of directors' interests.
Some consideration of director benefits and recommendations by the Court can be expected in relevant situations, but this is unlikely to have significant practical consequences for the transaction provided disclosure of the director benefit is adequate. As emphasised in many of the recent decisions and ASIC's commentary,9 this will generally mean disclosing the benefits to be received by directors prominently, including repeating the disclosure every time the directors' recommendation is referred to, not only in the scheme booklet but in other shareholder communications such as a script for telephone canvassing.
In addition, where a director will receive a significant benefit which depends on the success of the scheme, it may be prudent for the target to seek provisions in the Scheme Implementation Agreement allowing the director to withdraw or qualify their recommendation if required by the Court without this constituting a breach of the agreement or triggering a break fee payable to the bidder.
To navigate these issues, public companies that are the target of a scheme of arrangement should ensure they are well advised from an early stage. Target directors should also carefully consider, and take advice, on how any benefits they will receive from the scheme may interact with their personal obligations and duties.
For further information, please contact:
Richard Lustig, Partner, Baker & McKenzie
richard.lustig@bakermckenzie.com
1 Re SMS Management & Technology Ltd [2017] VSC 257.
2 Re Gazal Corporation Limited [2019] FCA 701; also see Re Ruralco Holdings Limited [2019] FCA 878.
3 Re Nzuri Copper Ltd [2019] WASC 189; Re Navitas Ltd (No 2) [2019] WASC 218; Re Spicers Ltd (No 2) [2019] FCA 1110.
4 Re Kidman Resources Limited [2019] FCA 1226.
5 Regulation 8301 of Schedule 8 of the Corporations Regulations 2001 (Cth).
6 Re Villa World Limited [2019] NSWSC 1207; Re GBST Holdings Limited [2019] NSWSC 1280; Re Aveo Group Limited [2019] NSWSC 1348.
7 ASIC Report 630: ASIC regulation of corporate finance: January to June 2019, page 14.
8 Re Wellcom Group Limited [2019] FCA 1655.
9 See note 7.
