TGIF 12 November 2021 – Formula for success: schemes of arrangement and variable consideration

This week’s TGIF considers In the matter of PM Capital Asian Opportunities Fund Limited [2021] FCA 1380, a decision of the Federal Court that provides guidance on its approach to the supervision of schemes of arrangement, and specifically the role of the Court during the application to convene a meeting to consider a scheme.

Key Takeaways

• The Court’s function at the convening hearing is primarily supervisory in nature and it will generally not usurp the shareholder’s or creditor’s commercial decision whether or not to approve the scheme.
  
  
• Proper and adequate disclosure of the nature and terms of a scheme in the scheme booklet is critical.
  
  
• The use of a variable consideration mechanism, where the final amount to be paid will not be calculated until a date after the scheme is approved, is acceptable when the formula for the calculation has been disclosed and when the timing minimises any disadvantage to the scheme participants.

The Court’s role in scheme of arrangement

Under section 411 of the Corporations Act 2001 (Cth), the Court’s supervisory role is engaged in two key phases of the scheme of arrangement process. The first is during the application to call a meeting of creditors to approve a scheme – when the primary focus is on the disclosure made in any scheme booklet. The second follows the approval of the scheme by the creditors or members, when the Court exercises a final discretion whether or not to approve the scheme in all the circumstances.

This case concerned the Court’s role in the first stage of the process.

What happened?

The Court was asked to grant orders convening a meeting of shareholders of PM Capital Asian Opportunities Fund Limited (PAF) to consider a scheme of arrangement under which PM Capital Global Opportunities Fund Limited (PGL) would acquire PAF.

PAF and PGL had a common investment manager, PM Manager Limited, and shared two common directors.

Following the announcement of the proposed scheme of arrangement, PAF received an off-market bid from WAM Capital Limited.

Beach J gave guidance on the Court’s role at the convening stage of a scheme of arrangement and, in that context, examined the disclosures made regarding the off-market bid, various class and voting issues and the formula for calculating the variable consideration that would be received before granting the orders sought.

The Court’s approach at the convening stage

Beach J reiterated that the Court’s role at this convening stage is supervisory and should be largely limited to ensuring the procedural and substantive requirements, particularly those related to disclosure, have been satisfied.

At this first stage, Beach J observed that the Court may also give limited consideration to the proposed scheme’s merits and fairness. This is to ensure that a scheme containing a feature or term blatantly unfair or inappropriate may be halted before being presented to shareholders or creditors. In this process, the Court will initially address whether the scheme meets the relevant statutory considerations (such as ASIC’s lack of objection) and, where this threshold is met, the Court’s discretionary jurisdiction to order a meeting will be enlivened.

In deciding whether to exercise this discretion the Court will ask two questions. The first question is whether the scheme is fit for consideration by shareholders or creditors. In effect, this inquiry will involve the judge evaluating whether the scheme is of such a nature and is cast in such terms that if it were agreed to by shareholders or creditors at the meeting, the Court would be likely approve it.

The second question the Court will consider is whether shareholders are properly informed of the nature of the scheme.

Variable consideration mechanisms

Under the proposed scheme, the PAF shareholders were to receive shares in PGL in exchange for the PAF equity they held. The precise number of PGL shares they would receive was to be determined by a formula under which certain inputs were variable (such as the share price of the listed company on a future date).

This variable formula meant that PAF shareholders would not know the exact number of equities they would receive under the scheme when voting on it.

The use of such ‘variable consideration mechanisms’ have previously been approved in the context of listed investment companies and Beach J was ultimately untroubled by this arrangement, particularly in the context of the prominent disclosure in the scheme booklet. Another factor in support of approval of the variable consideration was timing – the final calculation and exchange was to made shortly following the Court’s final approval of the scheme, which minimised the prospect of PAF shareholders being disadvantaged.

Comment

A scheme of arrangement is a useful and flexible tool to allow companies to reorganise their share capital or restructure debt repayment arrangements with creditors under the supervision of the Court.

Justice Beach reiterated in this decision that the Court’s role is to accommodate a commercial decision by the shareholder or creditor by first ensuring proper and adequate disclosure has been made to them.

At the first assessment stage, the Court will generally not seek to supplant that commercial decision by, for example, intervening to assess the level of consideration. But it will take a very active interest in ensuring that the implications of the scheme and all relevant facts have been fulsomely disclosed to the decision makers.