21 Aug 2014

The benefit of going along the Country Road

by Rory Moriarty, Yasmin Hogan

This case presented a difficult and unique set of circumstances for the court to navigate while the scheme clock was ticking.

The recent approval of the David Jones scheme of arrangement demonstrates how, in the absence of shareholder opposition, the inexorability of a scheme timetable can cause problems for a court when there is a major development after the first court hearing.

In David Jones Limited, in the matter of David Jones Limited (No 3) [2014] FCA 753, Justice Farrell approved the David Jones' scheme because, although alerted to the possibility that Mr Lew might be receiving a collateral benefit, no David Jones shareholder had sought to adjourn the scheme meeting or to oppose court approval on the grounds that that benefit was not quantified.

How did Country Road get involved in the David Jones Scheme?

Woolworths and David Jones agreed that Woolworths would make a section 411 scheme bid for David Jones. David Jones got a court order to hold the scheme meeting and to dispatch the scheme booklet. Mr Solomon Lew was a shareholder in David Jones.

Subsequently, Mr Lew increased his David Jones holding to almost 10%, potentially giving him the power to block the scheme. Mr Lew was also a minority shareholder in Country Road (a company which competed with David Jones), of which almost 90% was owned by Woolworths. Woolworths announced a takeover bid for Country Road at $17 per share which was conditional on the success of the David Jones bid.

Impact of Country Road takeover bid on the David Jones Scheme

David Jones reacted to this by asking the independent expert who had adjudged the Woolworths bid for David Jones to be fair to produce a report on Woolworths's bid for Country Road.

The independent expert reported back that:

  • Country Road shares were thinly traded, but $17 per share was above any recent trading price for Country Road;
  • it could not assess whether the Country Road bid conferred a collateral benefit on Mr Lew because it did not have access to Country Road's internal financials and management;
  • even if it did have access to Country Road, a report would take three to six weeks to prepare (ie. long after the scheme meeting);
  • the Woolworths bid for David Jones was still fair.

On the basis of this, David Jones prepared a supplementary disclosure for its shareholders. Basically, this told the shareholders that the purpose of the Country Road bid was to improve the chances of success for the David Jones bid and that Mr Lew was being paid over the odds for his Country Road shares (even if the exact amount of that benefit was not known).

David Jones went back to court for a section 1319 order allowing it to send out this supplementary disclosure. ASIC opposed the application, arguing that David Jones shareholders should be provided with a full independent expert's report on the Country Road bid, so that they could see just how much of a collateral benefit Mr Lew was getting.

No independent expert report required for the Woolworths' Country Road bid

Justice Farrell rejected ASIC's objections. She held that, although an independent expert's report might be best or market practice, it wasn't feasible in this case because:

  • Country Road's directors owed a duty to their own shareholders, not DJs or Woolworths, and so did not have an obligation to open their books to an independent expert; and
  • the time needed to prepare an independent expert's report would adversely impact the DJ scheme timetable.

Accordingly, the supplementary material was sent to David Jones shareholders. Of those who voted at the meeting, the overwhelming majority voted in favour of the takeover. Mr Lew or his representatives apparently attended the meeting with what would have been a blocking stake, but abstained from voting.

The scheme then went back to Justice Farrell to get court approval. ASIC withheld the section 411(17) letter and then put in an appearance at the hearing. It said that it was not opposed to the scheme, but it thought that the Court should take the Country Road bid and the alleged collateral benefit to Mr Lew into account before it decided whether to approve the scheme.

ASIC's concerns

ASIC agreed that the scheme had not been proposed for the purposed of avoiding Chapter 6. However, it was concerned that the alleged collateral benefit to Mr Lew offended the equal opportunity principle in section 602(c) and would have breached section 623 if it had happened in a Chapter 6 bid.

Justice Farrell pointed out that section 623 does not apply to section 411 schemes. Section 602 is relevant to the extent that the Court has to determine the fairness of the scheme and "the desirability of there being, as far as relevant and possible, neutrality between 'acquisition' schemes and Chapter 6 takeovers". The fairness or otherwise of differential benefits is determined by:

  • whether the "collateral" benefits on offer to some shareholders make those shareholders a separate class;
  • whether those shareholders' votes were tagged; or
  • whether there were arrangements under which those shareholders would abstain from voting (although Justice Farrell doesn't refer to it, this is what happened in Aston Resources Limited, in the matter of Aston Resources Limited [2012] FCA 229).

The only remaining issue was whether, before voting on the takeover, David Jones shareholders had had sufficient information about the benefits that Mr Lew would receive under the Country Road bid. Justice Farrell discussed whether Mr Lew would receive a benefit within the meaning of Takeovers Panel GN 21 and laid down the following principles:

"There may be 'inducement' arising from collateral benefits which should be taken into account where there is no material 'net benefit' but a shareholder is offered the opportunity to acquire or dispose of an asset for which there is no ready market or easily ascertainable value."

Justice Farrell rejected the contention that, to be relevant, the "benefit" must be offered to a shareholder in its capacity as such and also rejected the contention it may be more acceptable if the collateral benefit is something related to the scheme company (such as full payment of a convertible note or debt facility owed by a questionably solvent scheme company) as opposed to a transaction unrelated to the scheme company but nonetheless dependent on the scheme being approved. Approval of the scheme "unlocks" both benefits.

Without shareholder concern, scheme timing trumps adjournment

Justice Farrell expressed some disappointment that the target's statement for the Country Road bid, with its independent expert's report, was not released before the David Jones scheme meeting and thus available for David Jones shareholders to read before voting. Justice Farrell contemplated, but rejected, adjourning the second court hearing until that report was available and, if it revealed that Mr Lew would receive a significant net benefit, requiring DJs to re-run the scheme meeting. In the end, however, Justice Farrell decided to approve the scheme because:

  • the supplementary scheme disclosure drew the Country Road bid and Mr Lew's possible (albeit not precisely quantified) benefit to the attention of David Jones shareholders, thus giving them the opportunity to move an adjournment of the scheme meeting or to oppose Court approval – and no-one had done so; and
  • the scheme had been approved by an overwhelming majority of those who had voted at the meeting.

Implications for schemes

This case presented a difficult and unique set of circumstances for Justice Farrell to navigate while the scheme clock was ticking. Should a shareholder have sought to adjourn the scheme meeting or to oppose court approval on the grounds that that benefit was not quantified, it is possible that a court would have adjourned the second court hearing until such time the Country Road independent experts result was available to enable David Jones shareholders to consider the alleged benefit to Mr Lew.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.