The Corporations and Markets Advisory Committee last week released its report on Schemes of Arrangement (which have become a leading way of facilitating corporate takeovers in recent years). CAMAC was asked to consider whether schemes operate in an effective manner and whether they are a fair means of changing corporate control. CAMAC also considered the “headcount” rule —  which requires that 50% of shareholders to vote in favour of a scheme (this requirement is in addition to the scheme needing 75% of total votes cast in favour and approval by a court).

Traditionally, schemes were used by companies for reconstruction or reorganisations, but in the past decade, their use has become far more widespread as a means of facilitating public company acquisitions or mergers. During 2008, CAMAC noted that there were 78 takeover bids (for public companies) and 58 schemes of arrangement (for larger deals, schemes were the far more preferable option).

Schemes have grown in popularity for several reasons — most notably, they allow change of control to pass upon a lower threshold of 75% of votes being cast in favour. By contrast, to obtain complete control under the takeover provisions, at least 90% of target shares are required to accept the bid (schemes are therefore largely immune to the problem of absentee or apathetic shareholders’ non-participation). Schemes also do not face the strict rules outlined by Chapter Six of the Corporations Act, which regulate takeovers. For example, the Coles Group scheme (which allowed it to merge with Wesfarmers) provided major Coles shareholder Solomon Lew with a favorable deal compared with other Coles shareholders. This would not have been permitted under a Chapter 6 takeover due to anti-escalation rules.

Schemes are also strongly pushed by advisers. For a start, the legal costs involved with a scheme are substantially higher than in a takeover (this is due to far higher fees payable to litigation lawyers and barristers for the required court hearings as well as dealing with ASIC’s requirements). Further, investment bankers prefer schemes because they are “friendly” deals and far more likely to succeed than takeovers. Investment bankers receive far greater fees when a deal is consummated.

However, the CAMAC report is unlikely to upset many lawyers or bankers. Apart from making various predictable recommendations such as requiring clear and concise documentation, CAMAC recommended that the “headcount test” (which was initially introduced in England “to provide a check on the ability of creditors with large claims to carry the day” but has lost much of its relevance due to low voter turnout and the spectre of “share splitting”) being removed. This was a reasonable suggestion given the ability for a small minority of shareholders to prevent an otherwise popular transaction.

While overall the CAMAC report made sensible recommendations, it did little to increase minority shareholder rights in schemes. (CAMAC considered increasing the voting threshold above 75% but declined, noting that “a requirement for a higher approval threshold, say 90% by value of shares voted, would constitute a significant impediment to the implementation of schemes, for no good purpose.”)

One of the most well-known supporters of schemes of arrangements, affable Freehills M&A partner Tony Damian, supported CAMAC’s report, telling the Financial Review that “importantly, the report has ignored the misplaced calls from some quarters to restrict the use of schemes, or to even remove them altogether from the mergers and acquisitions landscape.”

Damian, who literally wrote the book on Schemes of Arrangements, also claimed that “while the [lower] approval thresholds in schemes are relevant to the question of minority protections, so too are the many protective features of schemes that are not found in takeover bids. These features include target board approval, ASIC review, court sanction, the in effect mandatory provision of an expert’s report and a shareholders’ meeting, complete with class and interest voting exclusions.”

What Damian conveniently neglected to mention was that the target board may not properly represent the interests of all shareholders (recent and regular shareholder upheavals towards remuneration reports has shown that), and it is extremely rare for ASIC or the courts to block a scheme. Independent experts almost never come up with recommendations that contradict the wishes of their client and the shareholders meeting for a scheme requires a mere 75% approval, compared with 90% for takeovers. (In fairness, schemes occasionally have valid purposes — given the certainty of timing, they are far more useful where multiple parties are involved.)

Shareholders are afforded a significant deal of protections through the takeovers provisions from the Corporations Act, largely based on the Eggleston principles of maintaining an efficient, competitive and informed market. The use of schemes may, in some cases, be designed to circumvent those provisions, sometimes at the expense of minority shareholders. Unfortunately, the CAMAC report recommends nothing that would strengthen shareholder rights to prevent transactions that may not be in their best interests (such as increasing the voting threshold above 75% or beefing up the anti-takeover avoidance provisions). Or as RiskMetrics noted in its submission, “improvements to the … scheme mechanisms will ultimately rebound to the benefit of the incumbent directors and management and may in some cases, facilitate their enrichment.”

The author is a former Mergers & Acquisitions lawyer who worked on several large schemes of arrangement between 2003 and 2005.

Peter Fray

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