How options held by Essential's directors will be dealt with
60 ASIC has raised with Essential queries arising from the manner in which options for the acquisition of shares in Essential will be dealt with if the Scheme is implemented. Those options are held by each of the directors, and in number they total 3,700,002. They are not listed.
61 Each of the directors has entered into an Option Cancellation Deed under which, if the Scheme becomes effective, the options will be cancelled. In return, the directors will receive shares in Develop equivalent to the 'Intrinsic Value' of the options. The calculations for this in the Option Cancellation Deed are complicated, but notionally they work in the following way. For each option the Intrinsic Value is, in effect, an implied price for the Essential Share that would be received if the option were exercised, less the exercise price. The implied price is calculated on the basis of the closing price of shares in Develop on the day on which trading resumed after announcement of the Scheme, which is multiplied by the ratio to be effected by the Scheme (0.1618, being 1 divided by 6.18). The exercise price of the options is deducted from that implied value, and the cash Intrinsic Value is converted to Develop shares, once again at the closing price on the day on which trading resumed after the announcement of the Scheme.
62 For illustrative purposes only, shares in Develop closed at a price of $3.45 on the day when trading resumed after announcement of the Scheme. If a director holds 500,000 options over shares in Essential with an exercise price of $0.25, then the Intrinsic Value of each of those options will be calculated at $3.45 x 0.1618, giving an implied price for Essential Shares of $0.56 (being the tranche value), less the exercise price of $0.25, leading to an Intrinsic Value of $0.31 per option. Calculated over a tranche of 500,000 options that gives an Intrinsic Value for the tranche of $155,000. On cancellation the director will receive 44,927 shares in Develop, being the $155,000 divided by the $3.45 Develop share price (actual figures may differ due to differences in rounding in this illustrative calculation).
63 As a result, the number of Develop shares that the directors will receive in return for the cancellation of their options is pegged to a fixed number, being the price at which Develop Shares traded immediately after the announcement of the Scheme. If the calculation was instead based on Develop's fluctuating share price, and the shares dropped in price between the date of the announcement of the Scheme and the date of its implementation, the directors will be comparatively worse off, because the Intrinsic Value of their options will be calculated at a lower Develop share price. So if shares in Develop drop below the price at which they closed on the day after the announcement it will, perhaps, arguably, be in the interests of the directors qua option holders to see that the Scheme goes ahead with their options notionally valued on the basis of a higher price for Develop shares. However, the directors are not locked in to this cancellation consideration until the second court date. Under the Option Cancellation Deed, they are free to exercise their options in the usual way at any time before 8.00 am on that date.
64 ASIC has asked Essential whether these arrangements give rise to a collateral benefit to directors which may mean that the directors should vote in a separate class to the rest of the shareholders. It has also suggested that the value provided to the directors under the option cancellation arrangements is different to the scheme consideration provided to shareholders, so that the option holders may be protected from any adverse movements in Develop's share price.
65 As to the first of these points, Essential submits, and I accept, that the existence of the options or any particular arrangements for their cancellation does not create a separate class. That is because voting classes are to be identified by reference to the rights they have as shareholders, not by reference to other rights they may also have in other capacities, such as because they also hold options. The fact that the directors hold options will not lead to them being treated differently in relation to the shares they also hold: see Re Excelsior Gold Limited [2018] FCA 2064 at [36] (McKerracher J); Re Firefly Resources Ltd [2021] WASC 376 at [66] (Strk J). Nor do they give rise to a collateral benefit: Re Firefly Resources at [68]. Of course, the Scheme is not going to operate on the options as such, for example by providing for their transfer to Develop; the point of the cancellation arrangements is that there will be no more options at the time at which the Scheme becomes effective, so there is no question of a separate vote by option holders in that capacity.
66 There are also performance rights on issue which, for the same reasons, are not class-creating: Re Firefly Resources at [68].
67 As to ASIC's query as to whether the option cancellation arrangements give the directors the benefit of a 'floor price' on their options, I infer that the concern is that this might be an incentive to vote in favour of and to recommend the Scheme, given that this protection will only apply if the Scheme goes ahead: see Re Firefly Resources at [64]. And according to the BDO Report, since the announcement of the Scheme the price of Develop shares has fluctuated between a low of $2.80 and a high of $3.47. But whether the price will be lower than $3.45 when the directors come to vote is not known. Also, the directors have in any event committed to vote their shares in favour, as is common in schemes of arrangement. Further, the number of shares held by the directors is relatively small and unlikely to make any difference to the outcome of the vote.
68 In relation to the directors' recommendations, they unanimously recommended the Scheme at the time at which it was announced, without knowledge of where Develop's share price would go. And there is no basis in the evidence to suggest that they might have changed that recommendation since then but for the incentive provided by the cancellation of the options.
69 So the option cancellation arrangements are not, in my view, an impediment to convening the Scheme meeting. If the Scheme is approved, and if ASIC or any person wishes to submit at the second hearing that the arrangements materially influenced the vote or recommendation of any director, that can be considered then.
70 Counsel for Essential also appropriately brought to the Court's attention the approval by the Board of the payment of special exertion fees for each non-executive director in recognition of the increased and sustained workload and time commitment resulting from this period of heightened activity. The fees are relatively modest in light of the undoubted additional work that the Scheme has required of non-executive directors and they do not provide a reason not to convene the Scheme meeting.