Schemes of Arrangement David Robb and Malcolm Stephens Allens Arthur Robinson INTRODUCTION This afternoon we will discuss a form of corporate reconstruction of remarkable flexibility known as a scheme of arrangement. We will track some recent developments in the law and highlight two trends that have and are still occurring – the separation of takeovers principles and scheme principles and the redefining the role of the Court and the Australian Securities & Investments Commission. Our firm acted in two independent schemes proposed by CMPS&F Pty Ltd – a privately owned engineering company which had the good fortune of taking an initial equity stake in a highly profitable State Wide Roads – owner of the M5. Our experience in both cases introduced us to the active approach of the court, principally in the form of Mr Justice Santow, who brought his commercial solicitor skills into the court room and was keen to correct defects to scheme documentation and he also sought to refine and even suggest improvements to the proposals brought to him. The result of the Santow era were a range of practices and also law which are now undergoing some revision by the current court. Today we will be talking only about schemes with the members of a company. We will not explore the rarer class of scheme, being schemes with creditors. The fact of the matter is, that although the regime was originally designed to facilitate schemes with creditors, these are relatively rare these days as deeds of accompany arrangement and voluntary administrations are a more common form of dealing with creditor interests. Accordingly, to those insolvency practitioners in the audience, we trust that the talk is of some interest in any event. Before we talk through some of these trends and developments, first we shall briefly explain what a scheme of arrangement is. WHAT IS A SCHEME OF ARRANGEMENT? As hinted above, 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 2001. A further category of compromise or arrangement is a reconstruction or amalgamation, as contemplated in section 413, by which companies can effect transfers of assets or liabilities (including legal proceedings), through the stroke of the court’s pen in the form of its court order, along with the disillusion, without winding up, of the transferring corporation. dars S0111035743v3 150220 8.1.2003 Page 1 Interestingly, the terms compromise, amalgamation and reconstruction are all undefined under the Corporations Act and have been given wide meaning by the Courts. A “compromise” connotes the existence of some antecedent controversy or dispute over rights where the members or creditors give up certain rights. In this sense, the term “compromise” is given a somewhat limited meaning, as it does not permit the giving up of rights unless there is some form of pre-existing dispute (Mercantile Investment – General Trust Co v International Co of Mexico [1893]1 Ch 484-Lindley LJ). However, the term “arrangement” is defined in section 9 and in an inclusive way as “includes a reorganisation of the share capital of a body corporate by the consolidation of shares of different classes, by the division of shares into different classes, or by both these methods.” As was said by Mr Justice Santow in Re NRMA Ltd (2000) 33 ACSR 595 at 603: The word has been given a liberal meaning. Generally speaking, unless the arrangement is ultra vires the company or seeks to deal with the matter for which a special procedure is layed down by the Corporations [Act] or to evade a restriction imposed by the Corporations [Act], almost any arrangement otherwise legal which touches or concerns the rights and obligations of the company or its members or creditors, and which is properly proposed, may come under section 411. Schemes of arrangement can be effected only by Part 5.1 bodies – these are defined as being a company (that is a company registered under the Corporations Act), or a registerable body that is registered under Division 1 or 2 of Part 5B.2 – such bodies are most forms of body corporate, including incorporated associations and foreign bodies corporate. Australian entities that are not Part 5.1 bodies include statutory corporations and, until recently for example, Westpac Banking Corporation. The power of a scheme of arrangement comes as a result of the wide definition of the term “arrangement”; that it can incorporate compromises as well as offers; that it is effected merely by the stroke of the Court issuing its order (thereby reducing what would otherwise be an impossible amount of paperwork with separate agreements being entered into between the company and the relevant scheme participants); and that it is binding on dissentients and non-voters, provided that the requisite majorities approved the scheme and the Court exercises its discretion in favour of the scheme. Furthermore, in the context of merger or minority buy-out schemes the Gambotto expropriation principles do not apply. WHAT IS A SCHEME USED FOR? Members schemes of arrangement are most regularly adopted for the following corporate re-organisations – top hatting, merger, spin off, demerger and demutualisation. A “top hatting” scheme involves the parent company of a group being replaced with a new holding company. Such schemes have been adopted in order to create a holding company that is separate from its trading subsidiaries where the former holding company had itself dars S0111035743v3 150220 8.1.2003 Page 2 undertaken such trading activities or to transfer the place of incorporation of the holding company in order to obtain more favourable listing, capital raising or taxation regulation. As mentioned in the Santow quote above, a scheme of arrangement can only permit what is not otherwise prohibited or prescribed by another provision of the Corporations Act (Australian Securities Commission v Malborough Gold Mines Ltd (1993) 177 CLR 485). Accordingly, a reduction of capital cannot be effected under a scheme of arrangement and a separate company convened meeting must be held. This is because the reduction of capital provisions state that the power of a company to reduce its capital is conferred by Section 256B and that a company may not reduce its capital unless it does so in accordance with that section. Similarly, the only way a public company can give financial benefits to a related party on other than commercial terms is by following the procedures layed out in Part 2E of the Corporations Act – a scheme cannot be used to override those disclosure or approval requirements (Re NRMA Ltd (2000) 33 ACSR 595). Redeemable preference shares can be redeemed only on the terms on which they are on issue (section 254J(1)) and, accordingly, cannot be redeemed under a scheme. Similarly, a conversion of a class of preference shares into redeemable preference shares is not permitted because a conversion of that kind can only take place if the steps appropriate to a reduction of capital and a simultaneous increase of capital have been taken (Re St. James’ Court Estate Ltd [1944] Ch 6). Finally, the Corporations Act prescribes what sort of conversions of status a company can undertake – for example a proprietary company limited by shares can convert into an unlimited proprietary company, an unlimited company or a public company limited by shares and a company limited by guarantee can convert into a company limited by shares. However, for example, a company limited by shares cannot convert into a company limited by guarantee. A scheme of arrangement cannot be used to effect a direct change of company type (Australian Securities Commission v Malborough Gold Mines Ltd (1993) 177 CLR 485), although there is often another way around this problem, for example by effecting a top hatting scheme and, rather than converting a scheme company, placing a new parent company above it. TAKEOVER Vs SCHEME In the early days of considering a merger, we often have to advise on the relative merits of the takeover vs a scheme. There are certain transactions that are naturally suited to a scheme or takeover, such that the relative merits do not arise. For example, a top hatting scheme, which is essentially an internal re-organisation, is most appropriately effected by a scheme, while a cash bid for all the shares of the company more naturally effected by a takeover. Furthermore, a hostile or surprise bid can never be effected by a scheme of arrangement because the scheme dars S0111035743v3 150220 8.1.2003 Page 3 memorandum sent to shareholders is sent by the target company, not the bidder and the target cannot be compelled to do so while it can be compelled to issue a target statement. In a friendly merger, it does become relevant to consider the relative merits. It is inherent in the nature of the scheme that it provides more flexibility of how to structure a bid – for example, it does allow for compromises to be effected as part of the scheme and some of the more limiting rules under the takeovers code, for example, of no collateral benefits or unacceptable circumstances normally will not apply. This advantage of structuring flexibility may be weighed against a more flexible procedure in a takeover, especially with respect to intervening events. For example, it is quite common in a takeover for the bidding company to waive conditions initially set by it, if that is the commercial dynamic of the takeover. It is easier to increase bid consideration in a takeover and there is a prescribed regime for permitting this under the Act.