Schemes v Takeover Bids

It has been identified in numerous papers that schemes of arrangements has become one of the main devices for achieving corporate control in Australia, and as a substitute for the formal takeover bid. Inherent in schemes of arrangement is its flexibility, certainty and low threshold. This paper outlines and reviews the validity of schemes of arrangements and compares it with the formal takeover bid, in particular Chapter 6 of the Corporations Act. This paper aims to do this by pinpointing the various attitudes and views of legal commentators and regulators. It also discusses how the Chapter 6 formal takeover bid can provide all the necessary benefits inherent in schemes with out the added court time and costs. This paper suggests that after decades of having schemes of arrangements facilitating corporate control transactions, it is time to give Chapter 6 formal takeover bids, in particular Section 611(17) a chance to prove that it is not only an alternative to schemes but could well and truly be a stand-alone mechanism for corporate transactions in Australia.

Introduction

The recent issue regarding the use of Schemes of arrangement and takeover bids under Chapter 6 of the Corporations Act [1] as a device to achieve change of corporate control has attracted much attention from regulators, shareholders and commentators both nationally and internationally. It involves a debate on whether schemes or a formal takeover bid is more effective in corporate control transactions. [2]

It has long been accepted that schemes are a legitimate and useful alternative deal structure to a takeover bid. This is due to schemes being seen as a more flexible approach. [3] Supporters of the ‘Schemes of Arrangement’ structure propose that schemes ‘facilitate a competitive market for listed companies, and are particularly well suited to negotiated or friendly’ deals. [4] Additionally, it would also allow companies to take part as well as lead to better value for shareholders. [5]

According to opponents of schemes, the usual reason for complaint against schemes of arrangement centres around perceived lower thresholds. [6] Other legal commentators propose that the schemes of arrangement should be abolished altogether due to the transaction costs and court hearing procedures which are time-consuming [7] , and that Chapter 6 should be a ‘self-contained’ structure to affect change control transactions. [8]

The discussion paper will start off with section 1 outlining the views of both schemes of arrangement and takeovers in Australia. The contention of this discussion paper will be focused on the drawbacks of schemes and how takeover bids can step up to the plate to avoid and facilitate these disadvantages. This will be further discussed in the last section (Section 3).

2. Views of two sides

The process of gaining control of a company in Australia, which is known as a takeover occurs under two processes: a formal process by means of a Scheme of Arrangement or a takeovers provisions under Chapter 6 of the Corporations Act [9] . Proponents of the latter group criticises the validity of schemes and claims that there is no need for a dual regime of to regulate takeovers in Australia. [10] On the contrary, advocates of schemes contend that there are valuable commercial benefits associated with schemes, thus, it is for this reason schemes have become so popular in facilitating takeovers in Australia. [11]

Schemes of Arrangement

A scheme of arrangement is a court approved compromise or arrangement; it is entered into between a company and its creditors or members or any class or classes of them in accordance with section 411, Part 5.1 of the Corporations Act. [12] Scheme of arrangements are commonly used by bidders wanting to increase their entitlement to shares beyond the 20% threshold and for obtaining control or absolute ownership of a target company. [13]

Accordingly, schemes are relatively limited in scope as it can only be used in ‘friendly’ or ‘agreed’ deal transactions. [14] The control process of schemes rests with the target company in which shareholders vote to approval a scheme of acquisition. It is usually initiated by the target company’s board of directors who represents the shareholder’s interest and negotiate on behalf of them with the bidder. [15]

One of the reasons schemes of arrangement has become such a popular method of achieving corporate control is due to the low threshold of achieving corporate control. The bidder company only has to achieve 75% of the target members votes (silence is regarded as a ‘yes’ vote’) in support of the merger proposal to acquire the shares of the dissentient shareholders and gain full ownership of the target company. [16]

Consistently, supporters of the schemes of arrangement contend that one of the main reasons for keeping schemes is that it allows shareholders a once off opportunity to decide and say yes or no, by shareholder vote, to a merger proposal. [17] As articulated by James Phillip in Lawyers Weekly, who acknowledges that this is one of the strongest popularity reasons for schemes:

“There is less shadowboxing and tactical manoeuvring under a scheme than a takeover bid. If shareholders say yes to the scheme, the bidder and its lenders know that it will have the benefits of full ownership. For less sophisticated shareholders – who may not understand all the nuances of takeover machinations – the simple vote for or against is particularly attractive.” [18]

Consistently with this notion, James McConvill also notes that “… the schemes provided a clean and, from a security holder’s point of view, simple process which gave the bidder and target security holders a complete solution.” [19]

Additionally, the authors of Schemes, Takeovers and Himalayan Peaks, Damian and Rich who are supporters of maintaining the use of schemes have expressed that schemes facilitate for a competitive market for listed companies, and according to the authors, they are also well suited for negotiated and ‘friendly’ deals. [20] By providing this alternative acquisition method also allows companies to take part, and the authors argue that they lead to better value for shareholders.

“We should be encouraging control transactions that deliver value to shareholders and that keep the pressure on management teams to perform.” [21] He said, “Securing the future of schemes is one way of doing that”. [22]

Furthermore, schemes are also seen by most supporters as a flexible arrangement and practical procedure that can be adapted to the needs of particular companies to achieve various forms of corporate reorganisation, in some circumstances a change of corporate control. [23]

The next section will outline the diverging views of Takeover bids under Chapter 6 of the Corporations Act [24] .

Chapter 6 Takeover bids

The takeover bid procedure involves the formation of contracts between the bidder and individual holders of the securities in the target company and that the bidder is offering to obtain. The procedure is similar to that of contracts law, offer and acceptance. [25]

Takeover bids are regulated under Chapter 6 of the Corporations Act which facilitates for corporate control or restructuring transactions that involves acquisition of voting shares by a bidder in a target company which has more than 50 members. [26] It is outlined in the Corporations Act [27] that an acquisition which influences more than 20% of voting shares in the target company should be subject to regulatory supervision. Further, acquisitions are supervised until 90% of the target company has been acquired.

The takeovers provision ensures that the acquisitions of corporate control are carried out in an efficient, competitive and informed market. [28] That is, it seeks to ensure that shareholders including market participants have access to all necessary information about the takeover and that they are able to assess the merits of particular proposals in a timely manner.

An avid supporter of a ‘self-contained’ Chapter 6 for takeovers regulation in Australia is Dr James McConvill who asserts that: “…while using schemes has certain benefits, these can be obtained through a self-contained Chapter 6…” [29] Further to this he also notes that the involvement of a scheme of arrangements is unnecessary in takeovers law in Australia.

Further, in the report by Jennifer Payne Schemes of Arrangement, Takeovers and Minority Shareholder Protection, she contends that with regards to minority shareholder protection, there is more protection put in place for minority shareholders in the target company by takeovers than exists in the context of a scheme. [30] As she asserts:

“By contrast the protection put in place for minority shareholders in a scheme is relatively meagre, even though the effect of a successful scheme is that all shareholders, even those that dissent, are bound to sell their shares to the bidder, which raises the possibility, at least of abuse of minority.” [31]

In takeover bids the Takeover Panel has a vital role in dealing with most issues concerning takeover bids and protects the rights of target companies and its shareholders during a takeover bid. [32] The Takeovers Panel is a body made up of members with expert commercial experiences that not only looks at the literal meaning of the Chapter 6 of the Corporations Act but also the spirit of the Eggleston principles. [33] The Eggleston principles under Section 602 are based on recommendations in a 1969 report adopted of the Company Law Advisory Committee. The principles essentially ensures that the identity of the bidder known, the time period given to shareholders for approval, that shareholders have equal opportunity to participate, and that all such information are given to shareholders to make an informed decision. [34]

The Takeover Panel’s primary role is to ensure that these policy principles are followed during the processes of a takeover bid to ensure that takeover bids are conducted in an efficient, competitive and informed market and that the conditions of the Eggleston principles are satisfied. [35] Accordingly, like takeover bids, ASIC needs to ensure that schemes adhere to these policy principles for the same reasons. If a takeover bid fails to meet the conditions of section 602 and the Eggleston Principles, the Takeovers Panel shares ASIC’s power to declare whether ‘unacceptable circumstances’ has occurred. [36]

As stated by the Explanatory Memorandum to the CLERP 4 Bill in regards to the Takeovers Panel, “…is a specialist body largely comprised of takeover experts, who will resolve takeover disputes as quickly and effectively as possible, on the basis of their commercial merits, and thereby minimise tactical litigation.” [37]

Accordingly, critics of the current dual regime for takeovers regulation in Australia believe that it is time for Chapter 6 provision to act alone without the schemes of arrangement under Part 5.1 of the Corporations Act. [38] It would be more effective and cost-efficient for shareholders and potential controllers to opt for a self-contained Chapter 6 which has all the necessary commercial benefits that schemes possess without the unnecessary costs and time-consuming court procedures. [39]

Overall, as discussed above, there are pros and cons to both sides of the debate. The last section of this discussion paper will focus mainly on the disadvantages of schemes of arrangement and how takeover bids under Chapter 6 can facilitate achieving corporate change more effectively with the use of section 611 of the Corporations Act.

4. Chapter 6 Takeover bids – A better choice

Introduction

With the recent debate on whether schemes of arrangement or a takeover bid is more effective in achieving corporate change transactions has attracted much attention from various legal scholars and economists. As discussed above, there are opposing views to the debate on whether to abolish the current dual system of corporate regulation and impose Chapter 6 as a self-contained structure to regulate takeovers.

Other views in regards to schemes claims that there are commercial benefits when pursuing schemes, however, these imbedded benefits can also be obtained by the use of Chapter 6 and by avoiding all the costs and time associated with schemes. Accordingly, as one particular scholar has noted, Chapter 6 can be used to uphold all these benefits by using section 611(17) of the Corporations Act. [40] Therefore, under this notion, it is irrelevant to pursue the use of schemes of arrangement if Chapter 6 is able to do all this without the costs and court procedures.

Drawbacks of Schemes of arrangements

In the past decade, schemes of arrangement have been used as an alternative to takeovers due to its commercial benefits, in particular its flexibility to adapt to the needs of companies. It is imbedded in the nature of the scheme that it provides more flexibility of how to structure a bid. [41] However, this advantage can be taken over by a more flexible procedure in takeover, especially when it comes to intervening events. That is, in a takeover, it is common for the bidding company to relinquish conditions initially set by it, if that is the commercial dynamic of the takeover. [42] Moreover, in a takeover bid it is easier to increase bid consideration and there is a prescribed rule for allowing this under the Corporations Act [43] . However, in a scheme it may be harder to manage intervening events once the information are disclosed to shareholders and the meeting dates set, shareholders must be given adequate time to consider the information relevant to their decision.

Consistently, one of the main advantages of using schemes is the low approval threshold needed to allow a bidder to acquire absolute control of the target company. The 75% threshold in schemes for approval to achieve compulsory acquisition is well short of the 90% requirement in a takeover bid. [44] Therefore, the period for which a bidder acquires the target company is shorter compared to a takeover bid in which the 90% holder. However, the lack of interest in a scheme by minority shareholders can make it easier for another bidder to emerge and create a competitive auction for the company. [45] Accordingly, Part 5.1 of the Corporations Act does not impose any criterion, such as fairness or reasonableness, which must be satisfied if the scheme is to bind minorities. Moreover, Chapter 6 provides substantive protections compared to Part 5.1 regulating schemes. [46] In particular, as the Eggleston principles is protected under section 602 of the Corporations Act, the Takeovers Panel ensures that these principles are used to impose substantive obligations so that acquisitions are to take place in an efficient, competitive and informed market in takeovers. [47]

Schemes can be used to reach many different objectives and not just takeovers alone. [48] However, in relation to takeovers, schemes are only limited to ‘friendly’ takeovers. Although it has been argued by certain critics that the possibilities of having a ‘hostile scheme’ have been suggested, where a bidder could effectively compel the target to seek Court orders and to put the matter to shareholders, this has not been a generally accepted view. [49] Schemes would not be a practical alternative to a hostile bid and the idea of having a scheme adapted to facilitate this would be inconsistent with the true character. It is the target company who initiates the scheme of arrangement booklet which is then sent out to the shareholders for consideration. [50] Therefore, it is the target shareholders that must approve of the scheme, a scheme process therefore cannot commence without an agreement from the target company. [51] Accordingly, the concept of a ‘hostile scheme’ would be detrimental to members as lower premiums can result. [52] The reason for this is that in a scheme, where a potential controller is proposing a scheme there is a need to encourage the board of directors by making the proposal attractive so that the board can put it to its members. This would no longer occur if the potential bidders were able to avoid the board. [53]

As already noted, schemes of arrangements are heavily supervised by a court. [54] It is impossible for a company to arrange a meeting about the scheme or send out information to shareholders or implement the scheme without first getting approval of the court. [55] In the process of schemes, the court is involved in two stages. The first court hearing is where the explanatory statement is made by the target company, which seeks court approval for an order to organise the shareholders’ meeting either generally or of the relevant class. The second hearing is where the court reviews the votes conducted at the shareholders meeting and decide on whether to approve or not. [56] Therefore, it is evident that the court plays a significant role in the process of schemes, in which it establishes both legal principles and procedural matters that must be followed.

In a takeover bid, there is no involvement or supervisory requirements by the Court in relation to the content within the bidder and target statements before they are sent out to the target or bidder company. [57] Further, in a takeover bid, there is no approval needed from the Court to seek full ownership once a bidder obtains compulsory acquisition threshold.

In addition, the Court in overseeing scheme transactions provides many advantages, in particular protective features which a takeover bid may not possess. It has been stated that the court provides a supervisory role over schemes, which closely examines fairness in relation to the sufficiency of disclosure. [58] The court is able to order specific course of actions to be taken such as a scheme to be restarted [59] or for members to vote again for the scheme. [60] However, even if the court will ensure that all matters to schemes will be overseen and considered by the court, the court will generally only look to compliance with the law. The Court will only intervene if shareholders are not properly provided or informed with details of the proposal or where the classes of members who gave a separate approval were not properly constructed to reflect various interests. [61]

Furthermore, as there are set timetables for scheme meetings which require Court order to proceed, therefore any adjournment due to various reasons such as new information emerging or a requirement to redraft the scheme proposal would likely to cause a second application to the Court for a new hearing. [62] Therefore, due to court involvement, schemes are slow, costly and inflexible. [63]

Thus, without the use of court procedures, takeover bids may be the best alternative to regulate takeovers.

The Takeovers Panel has many advantages over the need to use a court in takeover procedures. [64] The Takeovers Panel is made up with members possessing commercial skills and expertise, which maintains a close association with all areas of takeovers market in Australia. [65] Compared to the Court proceedings in schemes, which generally look more at compliance to the law, the Takeovers Panel aims to resolve takeover disputes in a fast commercial and efficient manner. [66] Additionally, the Takeovers Panel not only addresses points of law and legal principles, it provides value judgements, in which the law is also taken into consideration but it is included with factors such as policy consideration, economical impacts and commercial and market factors and not to mention the public’s interest. [67] On this note, the Panel also seeks to obtain outcomes in conjunction with making declarations of ‘unacceptable circumstances’. [68] Additionally, in declaring an ‘unacceptable circumstance’, the Takeovers Panel aims to give remedial orders, instead of punitive orders like the Courts. Additionally, decisions made by the Takeovers Panel may be reviewed by the Court in relation to takeover bids; however, the Court’s involvement in Takeovers is still lower when compared to schemes. [69]

Additionally, Part 5.1 of the Corporations Act which allows schemes to be used outside of Chapter 6 is somewhat contradictory between the dual regime of Part 5.1 and Chapter 6. This is due to the controversial section 411(17) of the Corporations Act, which schemes are subject to the provisions under section 602. [70] Some critics suggest that section 411(17) should be repealed when pursuing a scheme of arrangement in control transactions. [71] Others also suggest that Australia should completely remove its dual system of takeover regulation and that all formal takeovers can be facilitated through Chapter 6 alone due to the provision of section 611(7). [72]

An avid supporter of this concept is Dr James McConvill who proposes that by employing section 611(7) of the Corporations Act can be utilized to promote a flexible and efficient system of takeover regulation compared to the Australia’s current dual regime of takeover regulations. As he asserts: “A provision which is quite unremarkable in appearance but can have remarkable implications.” He further notes that section 611(7) arrangement can provide for all the commercial benefits of a scheme of arrangement but without the costs associated with schemes.

Accordingly, it has also been stipulated that section 611(7) provides flexibility and efficiency by allowing shareholders to “opt out” of the formalities of a Chapter 6 bid. [73] Under this section, the Takeovers Panel would also continue to have authority over corporate control transactions. [74] For this reason and reasons stated above, it is irrelevant to carry out the dual regime of schemes and takeovers if takeovers under Chapter 6 can do it in the same manner but with relatively the same benefits and protections.

Conclusion

It is evident that there are commercial benefits and regulatory benefits for pursuing scheme of arrangements. One of the reasons for the popularity of schemes is due to the lower thresholds and regulatory benefits such as the protection afforded by the courts in schemes. However, as stated above, there are disadvantages in relation to schemes of arrangements. The main drawbacks for schemes which are better facilitated in Takeovers are mainly due to the time consumed in court hearings and the costs associated. Additionally, schemes are also heavily supervised by courts. As a result, courts will only generally look to compliance with the law. Furthermore, unlike the proceedings of a Court, the Takeovers Panel aims to resolve disputes in a fast expeditious commercial and efficient manner and provides value judgements, which aims to make remedial orders not punitive orders. Moreover, Chapter 6 provision can become a ‘self-contained’ product for regulating takeovers with the elevating use of Section 611(7), which can provide for all the commercial benefits of schemes without the costs. With the above statements in mind, it is irrelevant to have both regimes under takeovers regulation in Australia, therefore, after decades