13 April 2006
Key Points:
Regardless of whether there is an appeal, industry players who are looking at takeover plays and institutions who may offer swaps should still exercise caution.
The use of cash-settled equity swaps in takeover activity involving Australian listed companies received considerable media attention during the events leading up to the making of a declaration of unacceptable circumstances by the Australian Takeovers Panel on 1 July 2005.
The declaration was made in relation to the non-disclosure by Glencore International Ag of cash-settled equity swaps it had entered into regarding shares in Austral Coal Limited, which was the subject of a takeover bid by Centennial Coal Limited at the time.
This article summarises the events leading up to the making of the declaration of unacceptable circumstances on 1 July 2005 and updates the position since our earlier article.
Summary of background facts
The takeover bid by Centennial for Austral Coal commenced on 23 February 2005, when Centennial and Austral Coal announced a recommended scrip bid of 10 Centennial shares for 37 of Austral Coal's shares, which valued Austral Coal shares at $1.10. The bid was conditional on 90 percent minimum acceptance (and was subsequently declared unconditional). The bid would extend to Austral Coal's 40 million convertible notes, if they converted to shares after the bid was declared unconditional.
Between 21 March and 4 April, Glencore acquired cash-settled equity swaps over shares in Austral Coal. Together with the Austral Coal shares that Glencore held, the Glencore swaps amounted to over 5 percent of Austral Coal. This "combined holding" was made public by Glencore on 4 and 5 April (by which point Glencore had physically acquired approximately 5 percent of Austral Coal and the Glencore swaps were covered by hedge shares totalling more than 5 percent of Austral Coal).
On 5 April, Centennial announced to the market that it had reached 34.34 percent of Austral Coal.
The status of the ownership of shares in Austral Coal at that time can be demonstrated by the below diagram.
At this point, Glencore had a combined direct and economic interest of 13.91 percent in Austral Coal consisting of 7.42 percent of shares which Glencore actually owned and 6.49 percent by way of the Glencore swaps with CSFB and ABN AMRO N.V. Glencore's combined direct and economic interests exceeded the 10 percent threshold required to block compulsory acquisition by Centennial of the outstanding shares in Austral Coal under the Corporations Act.
By early June 8, Centennial held 85.19 percent in Austral Coal but was still unable to satisfy the 90 percent compulsory acquisition requirement. If Glencore continued to hold its 5 percent stake, and the counterparties to the Glencore swaps continued to fully hedge their position, it was clear to Centennial that it would not be able to reach the 90 percent compulsory acquisition threshold.
History of earlier Panel decisions
On 3 June 2005, Centennial applied to the Panel seeking a declaration of unacceptable circumstances in relation to Glencore's use of cash-settled equity swaps. Centennial alleged that unacceptable circumstances existed in relation to the failure by Glencore to make timely disclosure of the combined holding of swaps and shares increasing beyond 5 percent of the issued voting shares in Austral Coal.
Centennial asked the Panel to unwind the Glencore swaps and to order the banks to dispose of their hedging shares either into Centennial’s bid or on-market to persons other than Glencore, so that the underlying shares could be accepted into the offer.
The Panel agreed with Centennial and ruled that it had been unacceptable for Glencore not to have disclosed its combined holding of swaps and shares as soon as it equated to 5 percent of Austral Coal (ie, beginning on 21 March). The Panel ordered that:
The Panel also made a supplementary order that if Glencore received acceptances for more shares than it actually held, those excess acceptances were to be met by Glencore's buying the required shares from the hedging shares held by the two banks at the initial price under the swaps. The size of the equity swaps was to be reduced in proportion to the number of shares acquired from the banks.
Glencore appealed the decision to a Review Panel, but the Review Panel came largely to the same conclusions. However, the Review Panel did not continue the disclosure order (apparently because the market was now sufficiently informed) and did not make the supplementary order that if Glencore did not have sufficient shares to restore the shareholders, Glencore could acquire them from the banks. Instead, the Review Panel made a similar order that Glencore sell its Austral Coal shares to anyone who had sold Austral Coal shares on the ASX during the time (between 22 March and 5 April) that Glencore's combined holding of swaps and shares had not been disclosed to the market, at the same price that the person had sold those shares.
The Review Panel also ordered the banks not to sell their shares until it was clear whether Glencore would be able to discharge its obligations under the Review Panel's orders solely by reference to Glencore's direct shareholding.
In response, Glencore applied to the Federal Court for judicial review of the Review Panel's decision, at which point the above orders were stayed, pending a review of this decision.
This application was successful. The Federal Court quashed the Review Panel's declaration and orders and sent the matter back to the Review Panel for rehearing.
On 28 October 2005, after reconsidering Glencore's application, the "Review Review" Panel announced that it had made a declaration of unacceptable circumstances in relation to the failure by Glencore to disclose its combined holding of swaps and shares between 22 March 2005 and 4 April 2005, during the takeover bid by Centennial for Austral Coal. Its reasons were published on 15 November 2005.
The "Review Review" Panel's reasons
The reasons and orders given by the "Review Review" Panel were quite different to the reasons and orders that had been given by earlier Panels. Provided that doing so is in the public interest, section 657A(2) of the Corporations Act empowers the Panel to make a declaration of unacceptable circumstances where the circumstances relate to the "affairs of a company" and appear to the Panel:
The earlier Panels had held that Glencore's non-disclosure of its acquisitions of cash-settled equity swaps was unacceptable because of its effect on the control of Austral Coal. In making this finding they had relied on section 657A(2)(a)(i) of the Corporations Act. The decision announced on 28 October 2005 focussed instead on whether non-disclosure was unacceptable having regard to the "acquisition … of a substantial interest in" Austral Coal, this time in reliance of section 657A(2)(a)(ii) of the Corporations Act.
The Panel concluded that there was an acquisition of a substantial interest by both Centennial and Glencore. The repeated non-disclosure of Glencore's combined holding as it moved from 5 percent to over 10 percent was unacceptable because, on the Panel's analysis, disclosure would have pushed up the price of Austral shares. Non-disclosure, therefore, allowed both Centennial and Glencore to acquire their substantial interests more cheaply than would otherwise have been the case. The disclosure would also have reduced the liquidity of Austral Coal, as Austral Coal holders withheld their shares to see what was going to happen. Therefore, non-disclosure also allowed Centennial and Glencore to acquire their substantial interests more quickly.
Interestingly, although the Panel was quite prepared to find that Glencore's combined holding of swaps and shares constituted a substantial interest, it stopped short of finding that the combined holding constituted a relevant interest for the reason that:
"Despite the strong commercial incentive to retain the hedge shares, the exposures were not large ones for institutions as large as CSFB and ABN AMRO, it was always within their power to dispose of their hedge shares at any time during the Non-disclosure Period and they would have disposed of them, had they perceived it as being in their own interest to do so."
Another interesting aspect was the Panel's holding that Glencore and the investment banks with whom it entered into the swaps were not associates.
Under section 12(2)(b) of the Corporations Act, a person’s associates include anyone with whom that person has or proposes to enter into an agreement in relation to the control of the management or affairs of another a company or its board. Under section 12(2)(c) of the Corporations Act, a person’s associates include anyone with whom that person is acting in concert in relation to the control of the management or affairs of another a company or its board (whether or not there is a formal agreement to that effect).
The banks and Glencore were not "parties to a relevant agreement for the purpose of controlling or influencing the composition of the board or the conduct of the affairs of Austral Coal" (section 12(2)(b)) - this was because, at the relevant time, Glencore didn't intend to bid for Austral.
Section 12(2)(c) was a much more close-run thing: were the banks and Glencore "acting in concert in relation to the affairs of" Austral Coal? The Panel apparently interpreted this as meaning that the parties must share the same objective. It concluded:
"The evidence is in the end insufficient to establish that CSFB shared Glencore’s inferred objective, namely to block compulsory acquisition. It was aware of Glencore’s objective and that its provision of hedged swap exposure contributed materially to achieving that objective, but there is no direct evidence that CSFB agreed to assist, agreed or accepted instructions to hedge the swap with Austral Coal shares, or otherwise stepped outside the ordinary course of its business to oblige Glencore."
The "Review Review" Panel's orders
Because Centennial was now at just under 90 percent and had made an unconditional scrip bid, it was far too late to put everyone back in their starting places. Accordingly, the Panel restricted itself to calculating the price benefit that Glencore had gained by its non-disclosure. This came to just over 5 cents per share. Accordingly, the Panel ordered Glencore to pay that amount to everyone who'd sold on market during the non-disclosure period (this to be done by giving ASIC a cheque for $1.3 million and ASIC to distribute the money).
Glencore goes back to the Federal Court
Glencore appealed to the Federal Court against the new orders made by the Panel. The case was heard in February 2006 and in March this year Justice Emmett handed down his decision. Once again, he ruled that the Panel's reasons and orders were defective. There were two key elements in the Court's reasons.
(1) A substantial interest
Because the swaps were cash-settled, Glencore had no power over the hedging shares that the counterparties acquired. On this basis, the "Review Review" Panel had concluded, Glencore had no relevant interest in the hedging shares. However, the "Review Review" Panel also concluded that the swaps had given Glencore a "substantial interest" in Austral (within the meaning of section 657(2)(ii)).
Justice Emmett said that these two conclusions could not be reconciled. In his view, a "substantial interest in the company" must relate to the control of the company. This does not mean that it must be an interest in shares, but:
"it may involve the power to exercise or control voting of the shares or power to dispose of or control the disposition of shares, however ephemeral or unenforceable the power or control might be. The interest must be such that it can be a step on the path of control of the company, in the sense of having a say in the decision making processes of the company."
Glencore's holding of cash-settled equity swaps didn't satisfy this test.
(2) The unacceptable circumstances
Section 657A allows the Panel to declare circumstances to be unacceptable having regard to, inter alia, the acquisition of a substantial interest. The Panel found that Glencore's non-disclosure of the swaps was unacceptable because:
The Federal Court dismissed all three conclusions:
On this point, therefore, the Court concluded (as it did in the first case) that the Panel had committed jurisdictional error "in concluding that the relevant circumstances had an effect on control of the Company or on the acquisition by Centennial of a substantial interest in the Company".
Conclusion
The Federal Court decision was handed down only recently, so it is too soon to say that we have closure on the issue of swaps in takeovers.
For example, the Panel may lodge an appeal. That would throw everything back into the melting pot.
However, regardless of whether there is an appeal, industry players who are looking at takeover plays and institutions who may offer swaps should still exercise caution. Even if the Court decision against the Panel is left untouched, it does not follow that the swap floodgates have been opened. The Glencore case involved two relatively unusual facts:
Also, given the Panel's close scrutiny of whether Glencore and the bank counterparties were associates or had relevant interests in each other's shares, it is quite possible that a different case with slightly different facts might see a declaration that the association and/or relevant interest provisions had been triggered by a combination of swaps and understandings between the two sides of the swap.
For further information, please contact John Elliott and Louise McCoach.
