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Australia – Financial Difficulties Test Limits Of Panel’s Policy On Lock-Up Devices.

29 October, 2012

 

In brief

 
  • In Mission NewEnergy Limited [2012] ATP 19 the Panel considered exclusivity provisions in a refinancing transaction where the company urgently needed the funds to continue as a going concern.
  • The Panel found that despite the exclusivity provisions being contrary to Guidance Note 7, the urgent need for funds prevailed over its policy on lock-up devices. A review Panel dismissed an appeal relying on slightly different reasons.

  

Background
 
Mission NewEnergy Limited is a small renewable energy provider. Although, Mission’s operating revenues are growing, in 2012 Mission incurred an operating loss of $5.3 million and at the time of the initial application had a cash balance of $1.4 million. In short, Mission urgently needed further funding to survive.
 
In August 2012, Mission announced that it had entered into a term sheet with SLW International, LLC to secure a two year US$5 million facility. SLW also held the majority of Mission’s $32 million convertible notes. A condition to the financing package was that Mission restructure the convertible notes so that the 4% coupon was no longer payable and the conversion ratio changed from 1:4 to 1:433. The increase in the conversion ratio meant that, if converted, the convertible note holders would hold 96% of Mission’s shares. This would deliver control of Mission to SLW. Mission intended to seek shareholder approval (under ASX Listing Rule 7.1 and section 611 Item 7) for the eventual conversion of the convertible notes into shares and had engaged an independent expert to opine on whether the transaction was fair and reasonable to shareholders.
 
Exclusivity provisions
 
Mission’s largest shareholder, McDermott Industries Limited, made an application to the Panel regarding the exclusivity provisions in the financing term sheet claiming that they were inconsistent with the Panel’s guidance on lock-up devices in Guidance Note 7. The following table gives an overview of the different exclusivity provisions, the Panel’s guidance and the exclusivity provisions in the term sheet between Mission and SLW.
 
Exclusivity Provision Guidance Note 7 Mission Term Sheet
No-talk
 
Prohibits the company from negotiating a competing proposal.
 
 
In the absence of an effective “fiduciary out”, a no-talk restriction is likely to give rise to unacceptable circumstances.
 
 
The no-talk restriction was not subject to a “fiduciary out”.
 
No-shop
 
Prohibits the company from
soliciting a competing proposal.
 
 
A limited and reasonable no-shop restriction generally does not require a “fiduciary out”.
 
 
Mission was not allowed to solicit or encourage a competing proposal.
 
No-due diligence
 
Prohibits the company from
granting due diligence access to a third party.
 
 
Safeguards such as a “fiduciary
out” applicable to no-talk clauses
apply to no-due-diligence
restrictions.
 
 
The no-due diligence restriction
was not subject to a “fiduciary
out”.
 
Notification obligation
 
A provision that requires the
company to disclose details of any potential competing proposal to
the original “bidder”.
 
 
A notification obligation must be limited and reasonable in the circumstances.
 
This will depend on the level of detail required to be disclosed and whether it is subject to a “fiduciary out”.
 
 
Mission agreed to notify SLW of any contact between it and a third  party regarding a competing proposal.
 
The notification obligation was not
subject to a “fiduciary out”.
 
Matching right
 
A provision that allows the bidder
to match  the third party deal
proposed to the target.
 
 
The Panel will consider whether the competing “bidder” has a reasonable opportunity to make a further competing bid if its initial bid is matched.
 
 
If the transaction does not proceed, SLW has a first right of refusal on any third party financing for three months following the shareholder vote. 
 
 
McDermott claimed that the exclusivity provisions gave rise to unacceptable circumstances as they were anti-competitive and coercive – specifically, that the restructure of the convertible notes could deliver control of Mission to SLW and that the shareholder approval was illusory given Mission’s urgent need for
funds.
 
Mission submitted that it was in financial difficulty and needed the funds in order to continue as a going concern, its board and advisers had considered and exhausted all other funding options (both debt and equity) before proceeding with the SLW proposal and that it was a “last resort” necessary for the continuation of Mission as a going concern. Mission explained that it had tried to negotiate the terms of the exclusivity provisions, however, given its financial predicament, it was unable to resist SLW’s demands.
 
Does Guidance Note 7 apply to a refinancing transaction?
 
The Panel’s guidance on lock-up devices primarily concerns more traditional control transactions such as schemes and takeovers. On some occasions the Panel has been unwilling to interfere with financing arrangements (see our 8 May 2012 Takeovers Legal Update discussing the RCL Group Limited decision). However, due to the potential for the transaction to effect a change in control of Mission, the Panel considered that Guidance Note 7 applied.
 
Initial Panel’s concerns
 
The Panel reiterated that no-talk and no-due diligence restrictions should be subject to an effective “fiduciary out” clause – allowing the directors to be relieved of an exclusivity provision where their duties require them to undertake the proscribed action. The Panel also found that the coupling of the no-shop, no-talk and no-due-diligence clauses with the notification obligation and matching right increased the anticompetitive effect of the provisions as a whole – which was all the more reason to require a “fiduciary out”.
 
The Panel was concerned that the exclusivity provisions, when considered as a whole, acted as a fetter on the discretion of the Mission board to pursue unsolicited, alternative proposals in order to obtain the best value for shareholders.
 
While the exclusivity provisions were clearly inconsistent with the Panel’s guidance on lock-up devices, the Panel emphasised the need to consider the provisions in context, that of a company in a precarious financial position. The Panel considered the situation analogous to the circumstances in Perilya Limited 02 where the Panel declined to make a declaration of unacceptable circumstances where a target company in financial distress granted a call option over one of its assets during a hostile takeover bid to a white knight in order to secure a loan in order to continue as a going concern. The Panel noted that where the relevant company is in a precarious financial position, careful consideration must be given to the impact of the Panel’s decision on the company and its shareholders. The question therefore became whether the need for funds was so compelling that it should prevail over the policy in Guidance Note 7.
 
The decision
 
The Panel accepted the available evidence to it that Mission had a genuine urgent need for funds, it had made efforts to seek alternative funding and the board believed that there was a limited likelihood of a competing financing proposal emerging during the exclusivity period.
 
The Panel also considered that the proposed shareholder approval would mitigate the effect of the exclusivity provisions because if a competing proposal emerged, its existence would likely be material information requiring disclosure to shareholders. Mission gave an undertaking to the Panel that if a competing proposal emerged that, but for the exclusivity provisions, it would be prepared to consider further, it would notify shareholders and the independent expert of the details of the proposal.
 
The Panel also took comfort from the fact that the exclusivity provisions expressly anticipated that Mission could seek SLW’s consent to be released from the lock-ups. Therefore, if Mission sought such consent and SLW refused, it would be open to Mission to make an application to the Panel claiming that failing to release it from the relevant lock-up was unacceptable.
 
The Panel ultimately decided that in the context the exclusivity provisions did not amount to unacceptable circumstances. The Panel however warned against the decision setting a precedent cautioning that the decision was based on “the very unusual circumstances of this case, where the company is in a financially precarious position and in urgent need of funds to remain solvent and there is to be a shareholder vote and an undertaking has been provided.”
 
But wait, there’s more…
 
After Mission gave the undertaking to the Panel, McDermott submitted a competing proposal offering to underwrite 50% of a renounceable rights issue to raise US$8 million (conditional on McDermott completing financial due diligence). Reluctant to second guess the judgement of the Mission directors, the Panel noted that at first instance it is up to the Mission directors to consider whether the McDermott proposal triggers the obligations in the undertaking.
 
McDermott also sought a review of the Panel’s decision. Mission then announced that the terms of the agreement with SLW had been amended so that the US$5 million facility was no longer conditional on the restructure of the convertible notes.
 
Review Panel affirms decision, but for slightly different reasons
In the review proceedings, McDermott again claimed that the exclusivity provisions constituted unacceptable lock-up devices that prevented Mission from dealing with the McDermott proposal (Mission NewEnergy Limited 01R [2012] ATP 20). The review Panel considered that the decoupling of the US$5 million facility and the restructure of the convertible notes meant that the exclusivity provisions were no longer linked to a control transaction and declined to conduct proceedings.
 
The review Panel went on to consider the position had the facility and the restructure of the convertible notes not been separated. The review Panel agreed with the initial Panel that the exclusivity provisions did not give rise to unacceptable circumstances, although for slightly different reasons.
 
While the initial Panel focused on the need for shareholder approval, the undertaking given by Mission and the provision in the term sheet seeking consent to be released from the lock-ups, the review Panel focused on what it saw as the “commercial reality” of Mission’s predicament. That is, the commercial reality was that Mission was unlikely to be able to service the convertible notes, let alone repay them. Therefore, the existence of the exclusivity provisions was irrelevant in a commercial sense because Mission would have had to deal with SLW as
the holder of the majority of the convertible notes in any event.

 

 

For further information, please contact:

 
David Ryan, Partner, Ashurst
david.ryan@ashurst.com
 

Stuart Dullard, Ashurst

stuart.dullard@ashurst.com

 

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