24 July, 2015
Summary
- The Federal Court’s recent judgment in the civil action brought by ASIC against Mariner Corporation Limited (Mariner) and its directors in relation to the cash bid announced for Austock Group Limited (Austock) has significant implications for Australian market participants.
- Importantly, the court has interpreted the test for ‘recklessness’ in s631(2)(b) (the takeover bid funding provision) not as the objective test propounded by the Takeovers Panel and ASIC, but rather as a subjective test. This interpretation bears little resemblance to bid funding expectations of the Takeovers Panel, ASIC and, most importantly, market participants.
- We suspect that the decision will lead to calls for legislative reform to harmonise the technical legal position, and the regulatory policy position of the Takeovers Panel and ASIC, in relation to bid funding.
Background
On 25 June 2012, Mariner announced a cash takeover bid for Austock. In a series of public interactions, Austock indicated several fundamental flaws with the announced bid, including querying how Mariner would fund its cash bid (noting that, on the most recent set of accounts, Mariner had negative net assets).
Mariner’s bid was stated to be conditional on Austock not disposing of any material subsidiary. On 9 July 2012, Austock announced that it had agreed to sell its property funds management business to Folkestone Limited (the transaction itself was subject to Austock shareholder approval) (Folkestone Transaction).
On 12 July 2012, Mariner applied to the Takeovers Panel submitting that the Folkestone Transaction frustrated Mariner’s bid and that the break fees in the Folkestone Transaction would have a coercive effect on the Austock shareholders when comparing the Mariner bid and the Folkestone Transaction.
However, during the course of the Panel proceedings, the Panel turned its attention to Mariner’s ability to fund its proposed bid for Austock and ultimately made a declaration of unacceptable circumstances against Mariner. The Panel applied its objective test (as set out in its Guidance Note 14 on bid funding) and found that Mariner did not have a reasonable basis to expect that it would have funding in place to pay for acceptances of its bid when it became unconditional.
On 3 April 2014, ASIC commenced civil action against Mariner and its directors in the Federal Court.
Federal Court proceedings
In the Federal Court proceedings, ASIC alleged that Mariner breached s631(2)(b) of the Act (the bid funding provision) when it announced its takeover bid for Austock as it was reckless as to whether it would be able to perform its payment obligations relating to the takeover bid.
Section 631(2)(b) of the Act states:
A person must not publicly propose […] to make a takeover bid if […] the person is reckless as to whether they will be able to perform their obligations relating to the takeover bid if a substantial proportion of the offers under the bid are accepted.
In construing s631(2)(b), Justice Beach made a number of observations, among the first being the temporal dimension of the section. Using an estimate of approximately 4 months between the date of the announcement of the Austock bid and the time when Mariner would have been expected to be required to make payments under the bid, his Honour stated:
Section 631(2)(b) is looking at an early point in time in the process, some 4 months before the consideration may have to be paid, and asking whether the person at that earlier point of time is reckless in the relevant respect. […] The closer one was to paying the consideration, the more firmed up one would expect or need to be in terms of having funding in place.
Relevantly, his Honour also stated:
s631(2) does not require certain or guaranteed funding being in place when the public proposal is made […] even when the bidder’s statement and offers were dispatched, no guaranteed funding even then needed to be in place.
His Honour found the test for ‘recklessness’ in s631(2)(b) was not the objective test propounded by the Takeovers Panel and ASIC, but was rather a subjective test and that, to prove a breach of s631(2)(b), ASIC was required to show that Mariner’s directors were aware of a substantial risk that Mariner would not be able to perform its obligations if a substantial proportion of offers were accepted and, having regard to the circumstances known to Mariner’s directors, the directors were not justified in taking that risk.
Application of s631(2)(b) to the facts
It was accepted that, at the time of the announcement of its bid, Mariner did not have the financial capacity to pay for any more than a small number of shares under the bid. In terms of potential financing, a subsidiary of Morgan Stanley (Arena) indicated to Mariner that it was quite interested (to put it at its highest) in acquiring the property funds management business of Austock from Mariner (after completion of the takeover bid) for an amount around $10–12 million.
However, Mariner did not have in place bridging finance from Arena or any third party to pay for acceptances at the time of announcement of the bid. His Honour identified a number of factors which would be relevant for Mariner’s ability to obtain bid funding, including its credit worthiness and balance sheet. Despite Mariner’s actual (lack of) capacity to pay, the Court indicated that what was relevant was the directors’ state of mind at the time of the announcement.
In the application of s631(2)(b), his Honour found that ASIC had failed to establish that Mariner had knowledge of, and had turned its attention to, a substantial risk that funding would not be available. Further, in his Honour’s view, even if this element had been established, he did not consider that ASIC had made it out that Mariner was unjustified in taking the risk.
In reaching this conclusion and the state of mind of the directors of Mariner on 25 June 2012, the Court determined that the directors were primarily influenced by the potential break-up value of the Austock compared to its (then) market value – an estimated break value of $20 million was accepted by the Court in comparison to a market value of around $14 million (based on a bid price of 10.5 cents per share). This fact was central to the Court’s decision.
His Honour acknowledged that the assets of the target could not be directly used to fund acceptances of the bid (noting that acceptances of the bid would have to be paid for before Mariner could sell off Austock’s assets) and Mariner had no firm commitments for third party financing. Despite this, his Honour held that:
there is little doubt that the directors had confidence, in my view bona fide, that such funding could be obtained by reason of the strength of the financial merits of the proposal.
Other factors relevant for his Honour’s findings included:
- in light of the circumstances, he did not consider it likely that the minimum acceptance condition would be satisfied – this was based on the low premium offered by the bid price and that a significant proportion of the shares were held by management who were unlikely to accept the bid;
- the temporal nature of s631(2)(b) – that funding would not need to be in place until a period of at least 4 months from the date of the 25 June 2012 announcement. His Honour considered that “The more remote in time [the obligation for payment], the more diffuse the risk”; and
- the potential significant benefits from the takeover bid if Mariner succeeded – that is, the difference between the market value of Austock (based on the price at which its shares were trading on the ASX) and the value of its underlying assets.
Funding representations
As part of the proceedings, ASIC also alleged that Mariner had engaged in misleading or deceptive by publicly representing to the market that it had reasonable grounds for believing it would be able to pay for acceptances when required to do so under its bid. ASIC argued that, when a person announces a takeover bid which announcement does not state that the bid is ‘subject to finance’, the market assumes (and trades on the basis that) that the person can and will proceed with the bid as announced and that the person has reasonable grounds to believe that it will be able to pay for all acceptances.
ASIC had pointed to, among other things, the existence of the Takeovers Panel’s Guidance Note 14 on bid funding (which requires a person to have a reasonable basis to expect that they will be able to fund their bid) as a basis for this representation.
The Federal Court found that no such representation was conveyed in relation to the 25 June 2012 announcement. The Federal Court also found that there was little basis, let alone evidence advanced by ASIC, to support the inference that the absence of a ‘subject to finance’ condition would convey to the market that Mariner had a particular view as to whether it would be able to pay for all shares in Austock.
Commentary
The Federal Court’s decision will inevitably lead to calls for legislative reform to harmonise the technical legal position, and the regulatory policy position of the Takeovers Panel and ASIC, in relation to bid funding.
Before the Federal Court’s decision, the generally accepted practice, based on the Takeovers Panel’s Guidance Note 14 on bid funding, was that persons who announce takeover bids should:
- at all times, have a reasonable basis for expecting that they will be able to pay for all the shares to which its takeover bid relates (an objective test); and
- have a sufficiently detailed legally binding funding commitment in place when the bid is announced or, by the latest, when offers are made to target shareholders.
The Federal Court decision has turned the assumed legal position on its head by interpreting s631(2)(b) as:
- looking only to the subjective belief of the bidder when a bid is announced; and
- not requiring guaranteed funding to be in place even at the stage when offers are made to target shareholders.
Section 631(2) is one of the fundamental tenets of market integrity. In this regard, it is difficult to argue with ASIC’s assertion to the Federal Court that:
it can be assumed that when a person announces that they intend to make a takeover bid, the market acts upon the basis that they can and will proceed with the bid as announced, and the shares in the target company are traded accordingly.
No one is (yet) advocating that Australia needs to go as far the UK City Code which requires a takeover announcement to contain a public statement (or a “cash confirmation statement” as they are colloquially known) from the bidder’s financial adviser to the effect that the bidder has sufficient resources available to satisfy full acceptance of the offer. (Although, perhaps a funding ‘train wreck’ on a takeover bid will change all this.)
However, surely market participants are entitled to assume, if a person announces a takeover bid, that that person has a reasonable basis for believing that they will be able to pay for acceptances in respect of all target shares. In addition, there needs to be a deadline by which bidders should be required to have legally binding bid funding arrangements in place (eg the time by which offers are made).
We would hope that, following the Federal Court decision, the Takeovers Panel takes appropriate steps to ensure that market participants are expected to continue to observe the higher standards in relation to the bid funding as articulated in the Panel’s Guidance Note 14 on bid funding.
ASIC has chosen not to appeal the Federal Court’s decision.
For further information, please contact:
Andrew Rich, Partner, Herbert Smith Freehills
andrew.rich@hsf.com
