The ‘fiduciary out’ dilemma: risking what you have, for what might be

‘Fiduciary outs’ are standard fare in Australian public M&A transactions, allowing target company boards to appropriately manage their directors’ duties when entering into an agreed transaction that contains customary deal protection provisions.

These ‘fiduciary outs’ typically allow the target to engage with a competing proposal that emerges after the announcement of a transaction where the target board determines (in good faith and after receiving legal and financial advice) that:

• the competing proposal is, or would reasonably be expected to become, superior to the existing transaction; and
  
  
• failing to respond to the competing proposal would be reasonably likely to constitute a breach of the target board’s fiduciary or statutory obligations.

In addition to considering the price offered by the competing proposal, target boards are generally required to assess all aspects of the competing proposal when considering whether it is reasonably likely to become a superior proposal for these purposes, including:

• the conditionality of the competing proposal;
  
  
• the timing considerations associated with the competing proposal (such as delays in completion);
  
  
• the identity, expertise, reputation and financial condition of the person making the competing proposal; and
  
  
• any other matters affecting the probability of the competing proposal completing.

Whilst designed to provide target boards with flexibility to appropriately explore rival proposals in accordance with their statutory and fiduciary duties, making the wrong call on whether a ‘fiduciary out’ applies exposes the target to the risk of the existing bidder walking away, as well as potential damages for breach of contract.

The battle for control of St Barbara’s Leonora assets

The recent battle for control of St Barbara Limited’s Leonora gold assets put the spotlight on the St Barbara board’s ability to exercise a ‘fiduciary out’ in order to engage on a competing proposal.

In this instance, St Barbara entered into an asset sale agreement to sell its Leonora gold assets to Genesis Minerals Ltd for a mixture of cash and Genesis scrip (the Genesis Transaction). On announcement, the Genesis Transaction had an implied value of A$600 million, with circa A$60 million of that consideration being contingent upon certain events occurring after completion.

Completion of the Genesis Transaction remained subject to a number of conditions, including the approval of both St Barbara and Genesis shareholders. The Genesis Transaction contained reciprocal deal protection provisions (including matching rights) and were expressed to be subject to customary ‘fiduciary out’ exceptions in relation to the ‘no talk’ and ‘no due diligence’ obligations. As an asset level deal, only the material terms of the asset sale agreement were released to ASX.[1]

Shortly after the Genesis Transaction was announced to the ASX, rival Australian gold miner Silver Lake Resources Ltd submitted its own proposal to St Barbara to acquire the Leonora gold assets (the Silver Lake Proposal).

The Silver Lake Proposal offered consideration comprising a mixture of cash and Silver Lake scrip having, at the time of announcement, an implied value of A$732 million (with no contingent consideration) and was otherwise on terms broadly equivalent to the Genesis Transaction. At the time of its submission, the Silver Lake Proposal provided a 28% premium to the base consideration offered under the Genesis Transaction (if the contingent consideration was excluded), and a 14% premium if the contingent consideration was included.

Importantly, progression of the Silver Lake Proposal to a binding offer was subject to Silver Lake being satisfied with the results of a targeted two-week due diligence review of the Leonora assets. If Silver Lake was to make a binding offer to acquire the Leonora assets, then completion would have been subject to termination of the Genesis Transaction (Genesis would have a matching right prior to any termination rights arising) and otherwise subject to similar conditions to the Genesis Transaction (including the approval of both St Barbara and Silver Lake shareholders[2]).

However, the St Barbara board declined to engage on the Silver Lake Proposal on the basis that it was not assessed to be a ‘superior proposal’ to the Genesis Transaction.

In reaching this position, the St Barbara board noted that it had considered a range of factors, including that:

• the Silver Lake Proposal only provided a 9% premium in value to the Genesis Transaction (after taking into account the break fee that it would need to pay to Genesis);
  
  
• the Silver Lake Proposal remained conditional upon completion of due diligence, whereas the Genesis Transaction did not[3];

• the Silver Lake Proposal provided St Barbara with less cash with which to fund its remaining operations than that provided by Genesis;
  
  
• the independent expert’s report requirement created significant risk for St Barbara, given that the expert’s conclusions were uncertain; and
  
  
• there was perceived to be significant time risk associated with any engagement with Silver Lake, noting that the Silver Lake Proposal was likely to complete in mid-to-late August 2023 compared to the Genesis Transaction (which was expected to complete around 30 June 2023). St Barbara noted that its financiers had only waived compliance with certain financial ratios in its debt facility until 30 June 2023.

Not to be deterred, Silver Lake restructured and re-submitted its proposal, which did away with the requirement for an independent expert’s report so as seek to enable the transaction to be completed by the end of July 2023 (as opposed to mid-to-late August). This sought to address St Barbara’s concerns about the risks associated with the independent expert report process and the time delay in completing a transaction on its Leonora assets.

Before responding on Silver Lake’s restructured proposal, St Barbara announced that Genesis had improved the terms of the Genesis Transaction by increasing the scrip component, paying a A$25 million cash deposit (which would not be refundable if Genesis shareholders did not approve the Genesis Transaction in due course) and waiving the conditions attaching to the contingent consideration (subject to St Barbara shareholders approving the Genesis Transaction on or before 30 June 2023, thereby incentivising St Barbara shareholders to approve the Genesis Transaction quickly).

Genesis also subsequently announced that shareholders representing 49% of its issued capital had indicated support for the Genesis Transaction, so as to highlight the low completion risk associated with that transaction.

Having regard to the improved terms offered by Genesis, St Barbara then formed the view that it was still “not entitled to engage with Silver Lake” in respect to the Silver Lake Proposal, and that a breach of the ‘no talk’ and ‘no due diligence’ obligations under the Genesis Transaction would give rise to a Genesis termination right.

Silver Lake remained determined to test the St Barbara board’s mettle on its ‘fiduciary out’ right and submitted a further, improved proposal representing (at the time) a 16% premium to the value offered by the improved terms of the Genesis Transaction. Silver Lake also obtained the commitment of St Barbara’s largest shareholder to vote against the Genesis Transaction if the St Barbara board continued to refuse Silver Lake due diligence access to seek to progress its proposal to a binding offer stage.

Whilst acknowledging the premium offered by the improved Silver Lake Proposal over the Genesis Transaction, the St Barbara board remained steadfast in its position and pointed to the conditionality of the Silver Lake Proposal compared to the Genesis Transaction. In considering its ‘fiduciary out’ rights, St Barbara noted that its board would need to have overwhelming confidence that the Silver Lake Proposal could be completed on the terms proposed for it to place the Genesis Transaction at risk.

Given the conditionality associated with the Silver Lake Proposal, the St Barbara board re-iterated that it was not permitted to engage with Silver Lake on its proposal without breaching the deal protection undertakings entered into with Genesis. This was despite it being undisputed that the Silver Lake Proposal had the potential to provide a materially higher value outcome for St Barbara and its shareholders.

Where to from here

The risk/return equation that a target board needs to consider when determining whether to exercise a ‘fiduciary out’ is always a judgment call. Courts are generally loath to second-guess the business judgment of a director unless no reasonable director could have reached a similar conclusion.

The St Barbara board’s determination that the ‘fiduciary out’ did not apply to the proposed sale of its Leonora assets to Genesis deprived St Barbara and its shareholders of the potential opportunity to consider a materially higher value proposal, and potentially also testing whether Genesis would be prepared to offer more for its Leonora assets through the matching right process, However, by not seeking to exercise such rights, St Barbara avoided the risk of the existing Genesis Transaction evaporating as a result of investigating a competing proposal.[4]

In essence, the value of a ‘fiduciary out’ may very well just come down to the risk profile of the target board and how far out on the limb they are prepared to go to facilitate the progression of competing proposals for the benefit of their shareholders.

Corrs acted for Silver Lake Resources Ltd in relation to its competing proposals to acquire the Leonora gold assets from St Barbara Limited.