WHAT YOU NEED TO KNOW

• Re Cape Alumina Limited warns directors to carefully consider whether exclusivity constraints on the exercise of their fiduciary duties are consistent with those duties.
• The Court accepted that a reciprocal break fee of almost 2% was not an obstacle to convening the scheme, given the target’s circumstances.

Background

Farrell J made some interesting comments regarding exclusivity provisions in the course of convening a meeting to consider a scheme of arrangement for a proposed merger between Cape Alumina Limited (CBX) and MetroCoal Limited (MTE). Under the scheme MTE would acquire all CBX shares and former CBX shareholders would end up holding 55% of MTE.

Exclusivity Provisions

The Scheme Implementation Agreement contained reciprocal “no shop”, “no talk” and “notification” provisions. Farrell J expressed concern that exclusivity provisions have become a standard feature of transactions, suggesting that it was sometimes difficult to see appropriate justification for the complexity and cost they add. Farrell J commented on:

• A prohibition on CBX directors changing or withdrawing their favourable recommendation of the scheme unless required to do so by their fiduciary duties as directors (having first obtained the opinion of a Queen’s Counsel/Senior Counsel acceptable to MTE and provided a copy to MTE). Farrell J expressed concern that the provisions sought to prescribe the manner in which the directors established and acted on their fiduciary duties (especially the requirement that MTE had to approve the particular barrister providing the opinion).
• “Highly formulaic evidence” in an affidavit sworn by a director of CBX in support of the exclusivity provisions. Although not doubting the director’s sincerity, Farrell J said “…it is difficult to find persuasive those statements in affidavits which are in almost the same form in transactions whose circumstances vary widely.”
• Notification provisions which required a party to provide the other party with details of any person they entered into negotiations or discussions with (including any approach, attempt or intention to initiate negotiations or discussions) as well as provide details of any proposal. Farrell J noted that this provision was “very widely drawn” and in many circumstances would have an inappropriate deterrent effect.

Given the financial circumstances of CBX and the lack of any opposition to the convening of the scheme meeting, Farrell J ordered the meeting, but commented that “directors should carefully consider whether it is consistent with their fiduciary duty to accept arrangements which so fetter their ability to exercise their fiduciary duties.”

The decision signals a clear warning from the Court that it is incumbent on the scheme company to convince the court that the exclusivity arrangements are justifiable in the particular circumstances.

Break Fee

The Scheme Implementation Agreement also included a reciprocal break fee of $250,000 (which was expressed to be a “genuine pre-estimate of costs”). This exceeded the Takeovers Panel’s 1% guideline given CBX’s market capitalisation of $13 million. However, Farrell J accepted that the break fee was not an obstacle to convening the scheme meeting, noting that:

• the fee appeared to be a reasonable estimate of MTE’s total costs ($240,000 actual costs to date plus $60,000 in further costs estimated);
• the fee was not payable if shareholders voted against the scheme so it would not have a coercive effect on voting intentions; and
• the fee was a reciprocal arrangement with obligations for both parties (and CBX’s limited cash holdings meant that MTE walking away would have a material financial effect on CBX).

Collateral Benefits And Classes

ASIC raised a question in correspondence provided to the Court as to whether one shareholder, Resource Capital Funds III and IV (RCF), should be treated as a separate class having regard to its rights under a deed which modified RCF’s rights under a convertible note issued by CBX to RCF in 2011. The deed provided for CBX to satisfy the amount owing under the notes by issuing CBX shares to RCF, subject to the court order being made to convene the scheme meeting. In consideration of RCF agreeing to this early conversion, CBX also granted options in CBX (which were then intended to be cancelled and exchanged for MTE options) to RCF.

Farrell J accepted that there were no class-creating circumstances of concern, or collateral benefit concerns, given that CBX proposed to “tag” RCF’s votes, allowing the issue of fairness of the scheme in the interests of all CBX shareholders to be finally determined at the second court hearing. This is consistent with the approach in Re Aston Resources. However, it is interesting to note that ASIC continues to question whether these circumstances give rise to class issues. Postscript It is disappointing that there will be no second court hearing to explore these issues further – four days after the judgment was handed down, CBX and MTE agreed not to proceed with the scheme due to commercial factors.

For further information, please contact:

Murray Wheater, Partner, Ashurst
[email protected]

Leslie de Bruyn, Ashurst
[email protected]

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