Following a recent review, the Takeovers Panel (Panel) has affirmed its decision in Smoke Alarms Holdings Limited [2020] ATP 2 (which can be read here), and maintained its firm stance on the disclosure requirements in relation to a section 611 item 7 (Item 7) meeting.

Background

The takeover provisions in Chapter 6 Corporations Act 2001 (Cth) (Act) apply to companies with over 50 shareholders, listed companies, and listed managed investment schemes. These provisions are primarily interested in circumstances where a person’s holding in a company increases from 20% or below to more than 20% or, if the person’s holding is already above 20% and below 90%, it further increases from that position. An Item 7 exception allows for such an acquisition to occur, without a takeover bid or scheme, with the approval of shareholders of the target company (subject to certain disclosure requirements being met).

Whilst the Act contains a list of items that must be disclosed to the shareholders of the target company, the Australian Securities and Investments Commission (ASIC) Regulatory Guide 74 (available here) (Guide) goes further by proposing that an independent expert’s report, to determine if the transaction is fair and reasonable, should be provided to the shareholders.

Application

Smoke Alarms Holdings Limited (Smoke Alarms) is an unlisted public company with more than 50 shareholders and entered into an agreement with Fast Future Pty Ltd as trustee for Fast Future Trust (Fast Future) (an entity associated with a director of Smoke Alarms) to issue convertible notes (Agreement). Those notes, once converted, would cause the transaction to be caught by the Chapter 6 prohibition. 

If all the notes subject to the Agreement were converted, and the options attached exercised, it would result in the noteholder’s voting rights in Smoke Alarms increasing from 5.7% to up to 80.04%. The directors issued a notice of meeting and explanatory statement proposing an Item 7 resolution to approve the issue of shares pursuant to the Agreement.

Upon receiving the notice, an application was made to the Panel seeking a declaration of unacceptable circumstances. The application, in essence, stated that the board had not provided the shareholders with enough information (including an independent expert’s report) about the proposed transaction or possible alternatives. The applicants sought interim orders deferring any resolution regarding the Item 7 resolution until an independent expert determined the proposal was fair and reasonable. 

In the explanatory statement to the notice of meeting, the directors’ reasons for not obtaining an independent expert report were that, due to the company’s financial position, the preparation and distribution of an independent expert’s report would be too costly and the delay caused by the preparation may jeopardise the transaction and lead to an insolvency event. 

The Panel held that these reasons were not acceptable in the circumstances. Smoke Alarms claimed that, based on verbal advice, it would take six to eight weeks to prepare a report at a cost of $25,000 to $35,000. The Panel observed that there was approximately 10 weeks between the signing of the term sheet regarding the transaction and the holding of the meeting and as such ‘there was sufficient time for Smoke Alarms to obtain an independent expert report and the cost of such a report was not prohibitive’. The Panel further stated ‘without such a report, shareholders did not have the benefit of independently assessing the transaction in light of potential or actual conflicts of interest.’

Original Decision

The Panel ordered, taking into account the financial position of Smoke Alarms, that all the convertible notes pursuant to the agreement be subscribed for and converted immediately thereafter, and that no options attached to the notes could be exercised without Smoke Alarms’ shareholders’ approval at a further general meeting. The Panel’s reasoning for the immediate conversion was that it would eliminate the accumulation of interest under the convertible notes and thus minimise the potential control position on later conversion.

The Panel further ordered that the notice and explanatory statement to the further meeting must contain adequate disclosure including an independent expert’s report and that the notice, explanatory memorandum, and the report be provided to ASIC 10 business days prior to its dispatch to Smoke Alarms’ shareholders.

Review Decision

Whilst the review panel maintained its decision regarding the unacceptable circumstances that would have arisen from the performance of the Agreement, mainly, the potential control issues, it also acknowledged that forcing Fast Future to go through with the Agreement on the new terms decided by the Panel could unfairly prejudice Fast Future. 
Fast Future, at the review hearing, submitted that a better result for all parties would be to terminate the Agreement and order Fast Future to loan to Smoke Alarms the money that would have otherwise been subject to the Agreement. Smoke Alarms submitted that orders of that type would be unnecessary and the same outcome could be achieved by the parties agreeing to terminate the Agreement upon Fast Future giving an undertaking that it would make the funds available to Smoke Alarms by way of a loan. 

The review panel considered the submissions, including taking into account Smoke Alarms’ financial situation and the benefits Fast Future may obtain from being a major creditor should Smoke Alarms become insolvent, and decided that the undertaking would be sufficient to alleviate the change of control issues that gave rise to the unacceptable circumstances at first instance.

Key observations

  • Be aware of how many members your company has. 
    This decision shows that ASIC and the Panel will closely monitor what companies, including public unlisted companies with over 50 members, are doing and will raise objections to their actions where they believe shareholders’ rights will be unfairly affected.
  • While obtaining an independent expert’s report is not mandated by law, it is clearly the expectation.
    This decision confirms the market approach that the Panel and ASIC will require a high level of disclosure if a company wishes to rely on an Item 7 exception, and that it will be difficult for companies to avoid obtaining an independent expert report pursuant to ASIC’s Guide.
  • Not obtaining an independent expert’s report may cost you more.  
    A company relying on the Item 7 exception without first obtaining an independent expert’s report should first consider the time and cost of potentially responding to regulatory intervention if ASIC, the Panel or another stakeholder consider the level of disclosure is insufficient. It is important, in light of this decision, to factor the timing and cost of obtaining an independent expert report into the transaction timetable.

We have worked on numerous regulated transactions, including for a number of unlisted public companies, and our team are happy to assist with navigating the applicable processes for those currently looking at such a transaction.

For further information, please reach out to our team below.