The Federal Court recently declined to approve a scheme of arrangement after the independent expert changed its opinion more than a week after the target shareholders had voted in favour of the scheme. We examine the circumstances leading up to the Court’s decision.
- The Court recently declined to approve a proposed scheme of arrangement after the target announced that the independent expert had advised that a “fundamental error had been identified in the valuation methodology” resulting in the target’s expert changing its opinion from “fair and reasonable” to “not fair, but reasonable”.
- This change in opinion was publicly announced after shareholders had approved the scheme with a 92% majority but before Court approval had been obtained.
- The Court stated that even if an improved deal could have been negotiated with the bidder, the Court would have required the whole scheme process to start again.
Background and summary
In a recent example of successful shareholder activism, a small group of minority shareholders scuttled the proposed merger between Kasbah Resources Limited (Kasbah) and Asian Mineral Resources Limited (AMR) after two court applications and one independently commissioned expert’s report.
By way of background, Kasbah, is an ASX-listed mineral exploration and development company with a focus on tin and counts the World Bank amongst its major shareholders. Kasbah’s proposed merger with AMR was structured as an all-scrip scheme of arrangement and would have resulted in the merged entity being held 47.8% by existing AMR shareholders and 52.2% by existing Kasbah shareholders, on a fully diluted basis.
The first Court application was brought by a minority shareholder who sought, unsuccessfully, for the scheme meeting to be adjourned.
The second Court application was filed by a group of objecting minority shareholders who held approximately 4% of the Kasbah shares – they opposed Court approval of the scheme and produced, as part of the supporting materials for their application, an opposing independent expert’s report.
After reviewing the materials filed by the objecting shareholders, the independent expert appointed by Kasbah acknowledged a “fundamental error” in its valuation methodology and changed its opinion of the scheme from “fair and reasonable” to “not fair but reasonable”.
Unsurprisingly, the Court declined to approve the scheme at the final Court hearing.
This article outlines the issues canvassed by the Court and sets out the chronology of events leading up to the Court’s decision to stop the scheme from proceeding.
Shareholder seeks adjournment of scheme meeting
On the day before the scheduled scheme meeting, a Kasbah shareholder brought an urgent Court application seeking an adjournment of the scheme meeting. The facts giving rise to the application had only recently been unearthed so the Court was not critical of the timing.
After considering the shareholder’s points (discussed below), the Court dismissed the application, noting that the issues raised by the shareholder could be re-ventilated at the final Court hearing, if necessary. The Court considered that the balance of convenience could not justify the cost involved in postponing the meeting (which was to be held within a few business hours) compared with the matters being considered at the final Court hearing.
The shareholder raised three issues in support of its application:
- first, that changes in world tin prices since the scheme booklet was published materially affected the accuracy of the key base valuation of the target;
- second, that the interests of the major shareholder in Kasbah were not disclosed in the scheme booklet and that shareholder should vote in a separate class; and
- third, that the scheme booklet did not disclose the identity of the individual who controlled the 72% shareholder in AMR (that shareholder was Pala Investments Ltd (Pala)), nor any information about his intentions for the merged group. The shareholder noted that Pala would have a beneficial interest of approximately 38% in the merged group and would also be a major creditor of the merged group – the effect being that Pala would, the shareholder submitted, have effective control of the merged group.
The Court indicated that the first of these issues was “arguably the most important issue” but concluded that it was not appropriate to adjourn the meeting as a result because:
- the expert’s sensitivity analysis accommodated significant fluctuation in tin prices; and
- all of the information put before the Court in relation to tin prices had, in substance, been put to the expert and the expert had concluded that there was no reason to adjust its opinion.
In relation to the second issue, the Court noted that the votes of the major shareholder would be “tagged” so that the effect of those particular votes on the outcome of the scheme could be evaluated at the final Court hearing.
Finally, in relation to the third issue, the Court’s view was that Pala’s role had been clearly conveyed in the scheme booklet and no more needed to be said.
The scheme meeting proceeded as scheduled and the scheme was voted in by shareholders with an overwhelming 92% majority.
Expert changes opinion
Prior to the final Court hearing, a small group of objecting shareholders who, in aggregate, held approximately 4% of the Kasbah shares filed objections with the Court opposing the approval of the scheme at the final Court hearing. As a result of the objections, the Court adjourned the final Court hearing by approximately a week.
The supporting material that the objecting shareholders filed included an opposing independent expert’s report. Following a review of the opposing report, Kasbah’s independent expert acknowledged a “fundamental error” in its valuation methodology and changed its opinion to “not fair, but reasonable”.
While Kasbah did not provide details of what this “fundamental error” was, one newspaper reported that, according to the opposing expert’s affidavit on this matter, it was due to a miscalculation of the number of shares that would have been on issue in the merged entity.
Final Court hearing
After the independent expert changed its opinion, Kasbah announced that it considered the condition precedent requiring approval of the scheme by the Court as “currently incapable of being satisfied”. Accordingly, Kasbah sought to further adjourn the final Court hearing in order to renegotiate with AMR. The opposing shareholders objected to this further adjournment.
This time, the Court agreed with the objecting shareholders, concluding that it was pointless to simply adjourn the scheme because, even if an improved deal could be reached with AMR, the whole scheme process would need to start again.
The result of the Court’s decision was that the scheme of arrangement was abandoned.
Placement of 19.9% to Pala – Takeovers Panel application
Following the failure of the scheme, Kasbah completed a placement to Pala (the 72% shareholder in AMR, the proposed bidder) resulting in Pala holding 19.9% of Kasbah.
A Takeovers Panel application was lodged by objecting shareholders on the basis that Pala and an existing Kasbah shareholder (15.7%) were associates and therefore the combined holdings of Kasbah and its associates would exceed 35.6% if the placement proceeded.
The Panel declined to conduct proceedings and the placement proceeded to completion.
The key takeaways are as follows:
- Shareholder activism – be aware: activist shareholders have many tools available to block or, at the very least, delay the completion of public M&A deals. Recent examples in the Australian market include the proposed ROC Oil and Horizon Oil merger where a major shareholder of ROC Oil (the bidder) sought to have ROC Oil’s constitution amended to prevent ROC Oil from being able to issue more than 30% of its issued share capital without shareholder approval. The shareholder’s proposal ultimately failed but it demonstrates that shareholders can do more than refuse to sell their shares or vote in favour of a deal. While shareholder activism campaigns in Australia are primarily spearheaded by major shareholders, the proposed Kasbah scheme demonstrates that even small shareholders are capable of disrupting a deal.
- Court approval is not a rubber stamp: Courts have consistently demonstrated that Court approval of a scheme is not a rubber stamp process.1 Courts have also stressed the importance of ensuring that target shareholders are aware of their objection rights in relation to a scheme of arrangement – requiring, for example, prominent disclosure of those rights in a target’s scheme booklet. This deal should serve as a reminder, if one was needed, that Court approval is not a rubber stamp process.
- Obligation to update material information: targets and bidders must ensure that they have appropriate processes in place to continue to monitor all relevant information throughout the course of a scheme or takeover. This obligation does not end after the initial scheme or takeover documentation is released. Targets and bidders must continue to assess new circumstances to consider whether shareholders should be provided with updates by way of supplementary statements.
- For another recent example of a scheme that was not approved by a Court, please see the following article.
The contents of this publication, current at the date of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2020