The announcement of a change of control transaction, such as a scheme of arrangement, creates uncertainty in the minds of executives and employees about where they will stand under new ownership and results in a significant additional workload. Needless to say, it heightens the risk of losing key staff.
To minimise the disruption of a scheme and to motivate employees to focus on, and remain with, the business, it is not unusual for a target company to make additional payments to employees identified as fundamental to the organisation and the transaction (which are sometimes made at the direction of the bidder).
In the past, retention payments to executive directors have not prevented those directors from making a recommendation to shareholders on how to vote on a scheme. For instance, in the 2017 SMS Management & Technology scheme, the Court permitted the company’s managing director to make a recommendation in favour of the scheme despite being entitled to a bonus upon the scheme becoming effective. The Court went on to say “it is important that the managing director, who in this case is the main moving force behind the company, give his reasons for putting forward the scheme”.
However, four recent scheme of arrangement Court decisions highlight a shift in attitude. In these decisions, the Court has questioned whether it is appropriate for a director to recommend how to vote on a scheme where the director has an additional interest in the scheme proceeding by reason of a bonus or similar benefit not provided to all shareholders.
A shift in attitude
Re Gazal Corporation Ltd  FCA 701
In the recent Gazal Corporation scheme, Gazal Corporation agreed to pay its managing director a cash bonus upon the scheme becoming effective.
In considering the scheme, Justice Farrell required Gazal Corporation to increase the prominence of the disclosure in its scheme booklet relating to the managing director’s bonus, and revisited whether it was appropriate for the director to make a recommendation in that circumstance.
Justice Farrell considered the SMS decision, before opining that:
“… directors who are interested in the outcome of [a] scheme because they stand to receive a bonus or benefit (other than as a shareholder) only if the scheme proceeds should exercise caution in making recommendations and, in my view, generally should not do so.” [emphasis added]
While Justice Farrell ultimately ordered the despatch of the scheme booklet and made orders approving the scheme, she noted “scheme proponents cannot count on that always being the outcome where an interested director elects to make a recommendation”.
Re Nzuri Copper Ltd; Ex Parte Nzuri Copper Ltd  WASC 189; Re Nzuri Copper Ltd; Ex Parte Nzuri Copper Ltd [No 2]  WASC 214
In the current Nzuri Copper scheme, two executive directors of Nzuri Copper are entitled to receive a cash bonus if the scheme is approved by shareholders.
At the first Court hearing, Justice Vaughan refused to make an order appointing those executive directors as the chairperson and alternative chairperson of the scheme meeting for the reason that shareholders may have a reasonable apprehension of bias due to the additional interests those executive directors have in the scheme proceeding.
However, Justice Vaughan ordered the despatch of the scheme booklet and the convening of the scheme meeting on the basis the scheme booklet contained fulsome and prominent disclosure of the executive directors’ additional interests. In making those orders, Justice Vaughan noted that “in the future it would be better practice for scheme proponents to take heed of the observations of Farrell J in [Gazal Corporation]”.
Re RuralCo Holdings Limited  FCA 878
In the current RuralCo Holdings scheme, the company’s managing director is entitled to a cash payment under an incentive plan and a retention bonus. The cash payment is payable upon the scheme becoming effective. With the retention bonus, half of the bonus is payable upon the scheme being implemented and the other half is payable six months after implementation.
At the first Court hearing, Justice Farrell did not accept RuralCo Holdings’ submissions that the payments could be distinguished from those in the Gazal Corporation scheme. However, Justice Farrell did approve the despatch of the scheme booklet on the basis it disclosed the managing director’s interests next to every reference to the directors’ recommendation (other than the cover page). Nevertheless, Justice Farrell cautioned that:
“The bare statement of the directors’ recommendation (without reference to [the managing’s director]’s interests) in other communications with shareholders, such as in telephone canvassing, might be a circumstance which might lead a Court at the second court hearing to decline to approve the scheme because the Court could not be assured of the integrity of the outcome of the shareholder vote.”
Re Navitas Ltd; Ex Parte Navitas Ltd [No 2]  WASC 218
As a point of comparison, in the recent Navitas scheme (that is now effective), Justice Vaughan considered a retention structure where the managing director was entitled to the acceleration of certain retention payments upon shareholder approval of the scheme. The managing director recommended the scheme alongside his fellow directors.
Despite the managing director’s recommendation, Justice Vaughan made orders approving the scheme as he considered there was adequate disclosure of the retention payments in the scheme booklet. It was particularly significant that Navitas’ scheme booklet was publicly released prior to the decision in Gazal Corporation. While Justice Vaughn acknowledged past examples of executive directors making a recommendation despite benefiting from retention payments, he again noted that “in the future… practitioners should have regard to the observations of Farrell J in [Gazal Corporation]”.
Navitas also raised with the Court that the company’s non-executive directors were paid special exertion fees to compensate them for their additional duties as a result of the scheme, as disclosed in the scheme booklet. Justice Vaughan concluded that such fees were permissible as they were not conditional on the scheme proceeding and could not operate as an inducement to recommend the scheme.
What can we take away from these decisions?
- For directors: Executive directors who are entitled to a retention payment (or any other benefit not provided to other shareholders) that is conditional on a scheme proceeding need to think carefully, and take advice, before making a recommendation on the scheme.
- For target companies: When negotiating a scheme implementation agreement, target companies should carefully consider whether it is appropriate for all directors to make a recommendation. To the extent necessary, the implementation agreement should have flexibility to allow a target director to withdraw (but not adversely change) his or her recommendation if the Court considers it necessary or desirable (given a change in recommendation will typically trigger a break fee or termination right in favour of the bidder).
- For companies making a takeover: It is interesting to note that, in contrast to the position taken by the Court in these four recent decisions, in the context of a takeover bid neither ASIC nor the Corporations Act requires an executive director to refrain from making a recommendation on the basis of a retention payment the director will receive if the bid is successful (provided appropriate disclosure is made).
- A recent market example of this structure is the current off-market takeover bid for Automotive Holdings Group by A.P. Eagers– the target’s statement discloses that the managing director of AHG is the beneficiary of a retention payment, but the managing director has recommended alongside all other directors that shareholders accept the bid.
- Where to from here: These four recent decisions demonstrate a shift in the Court's attitude and turn the spotlight on the nature of any benefits given to executive directors in the context of a scheme.Time will tell if this is a passing focus or a sign of things to come.