Birch v Cropper; Re Bridgewater Navigation Co Ltd

DECISION : Order for the convening of meeting of members refused

CATCHWORDS : CORPORATIONS - arrangements and reconstructions - scheme of arrangement coupled with reduction of capital - holders of cancelled shares entitled to cash or new shares designated redeemable preference shares - adequacy of information to be given to shareholders as to availability of cash and capacity of company to redeem new shares - CORPORATIONS - corporate finance - redeemable preference shares - concept of "preference share" - need for preference or priority over other shares - inability of company to redeem except out of profits or proceeds of new issue

LEGISLATION CITED : Corporations Act 2001 (Cth) ss.254A, 254K 256C, 411(1), 411(4)

Birch v Cropper; Re Bridgewater Navigation Co Ltd (1889) LR 14 App Cas 525 CASES CITED : Re Powell-Cotton's Resettlement [1957] 1 All ER 404

PARTIES : Capel Finance Limited - Plaintiff

SOLICITORS : Cowley Hearne Lawyers Pty Limited - Plaintiff

IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION CORPORATIONS LIST

1 The plaintiff seeks an order under s.411(1) of the Corporations Act 2001 (Cth) for the convening of a meeting of those of its shareholders designated "scheme shareholders" for the purpose of considering and, if thought fit, agreeing to a proposed arrangement between the company and those shareholders. 2 The company was formerly on the official list of the Australian Stock Exchange but was delisted in September 2003. It is not at present conducting any business and has no current plans to undertake any new business activity. A share buy back was undertaken during 2002 to give shareholders an opportunity to realise their investments. Few chose to do so. The arrangement now proposed is a new opportunity for shareholdings to be liquidated. 3 The essence of the proposed arrangement is cancellation of all existing shares other than those held by two nominated members on a specified future date called the "record date". There are currently on issue 21,873,887 shares and the two members in question currently appear to hold about 7 million shares. The number of shares those two shareholders will hold on the specified future date is, of course, potentially subject to change. At all events, the shares other than the excluded shares of the two named shareholders are referred to as the "scheme shares" and the holders of those shares are the "scheme shareholders". 4 It is recognised that the cancellation of the scheme shares involves a reduction of capital governed by Division 1 of Part 2J.1 and that it is a "selective reduction". In order to comply with the provisions of that division, two special resolutions are proposed for adoption at meetings separate from the meeting the court is asked to order under s.411(1). One of those special resolutions will be a resolution in accordance with s.256C(2)(a) and the other will be a resolution in accordance with the concluding part of s.256C(2), that is, the part that comes after s.256C(2)(b). The reduction of capital will be to the extent of 8.4 cents multiplied by the number that in due course turns out to be the number of the scheme shares, and the capital liberated by the reduction, whatever it turns out to be, will be applied in accordance with the scheme. 5 It is envisaged that before the scheme becomes binding under s.411(4), holders of scheme shares may deliver election forms to the company which, if they meet certain criteria set out in the scheme as it eventually takes effect, will have significance to the working of the scheme. Basically, a form lodged by a particular holder of scheme shares will determine how the part of the liberated capital referable to that holder's shares will be applied. There are three possibilities: that the sum referable to the particular holder's shares will be applied in paying up new shares in the company itself to be issued to the holder on the basis of one new share for each cancelled share; or that that sum will be paid to the holder in cash; or that the sum will be applied partly in one of these ways and partly in the other. A member who makes no election will receive new shares. That will be the default position. 6 On the figures I have mentioned, the consequence, if all holders of scheme shares elected for cash, would be that the company would be required to pay out about $1.2 million, while if all elected for new shares, there would be an issue of about 15 million new shares. These are the extremes. The result that actually comes to pass will very likely be somewhere between those extremes. 7 The proposed explanatory statement says that, if the maximum cash outlay becomes payable, it will be funded from the company's "cash resources". There is no further explanation of the source of funds. The balance sheet as at 30 June 2004 (now more than nine months ago) shows cash of only $129,947, but a loan (designated a current asset) of $1,417,097. There is evidence that, since that date, that loan has been repaid and that the proceeds are held in cash, so that cash on hand at this point may be of the order of $1.5 million or a little more, depending on what else has happened since 30 June 2004. In my opinion, the explanatory material needs to be amplified in this area to identify clearly the arrangements that are in place to ensure the availability of the maximum cash requirement. Where one company puts before the shareholders of another a proposal to acquire their shares by off-market takeover bid, it must make detailed disclosures about the availability and source of the necessary cash in conformity with s.636(1)(f): "In relation to the cash consideration (if any) offered under the bid - details of: (i) the cash amounts (if any) held by the bidder for payment of the consideration; and (ii) the identity of any other person who is to provide, directly or indirectly, cash consideration from that person's own funds; and (iii) any arrangements under which cash will be provided by a person referred to in subparagraph (ii)."

There is no reason why a company embarking upon an analogous transaction in relation to shares in itself should not be required to make the same disclosure. 8 The new shares to be made available to members in substitution for their scheme shares are described as "redeemable preference shares". The proposed terms of issue which it is intended will be approved by special resolution to satisfy s.254A(2) are set out in schedule 1 to the scheme: " 1. REDEMPTION OF PREFERENCE SHARES 1.1 The holders of Capel Finance Preference Shares are entitled to a cash payment of A$0.084 for each Capel Finance Preference Share on redemption ( Redemption Consideration ). The holders of Capel Finance Preference Shares can redeem their holdings of Capel Finance Preference Shares by notice in writing to Capel Finance at any time after the Implementation Date ( Redemption Notice ). 1.2 In calculating the redemption entitlement of Capel Finance Preference Shareholder any entitlement to cash will be rounded down to the nearest whole cent. 1.3 Following receipt of a Redemption Notice pursuant to clause 9.1, Capel Finance will endeavour within 30 Business Days to pay or procure payment of the cash for the redemption by way of cheque payable in Australian Dollars and drawn on a bank in Australia and crossed 'Not Negotiable' to a Capel Finance Preference Shareholder. 1.4 All cheques payable to a Capel Finance Preference Shareholder will be despatched at the risk of the Capel Finance Preference Shareholder entitled thereto by pre-paid post addressed to the Capel Finance Preference Shareholder. 1.5 The redemption cheque will be sent to an address detailed in a Redemption Notice from a Capel Finance Preference Shareholder to Capel Finance or in the event that no address is specified, the address of the Capel Finance Preference Shareholder on the Register. 1.6 (a) Capel Finance may require Capel Finance Preference Shareholders to return to it all share certificates held by them in respect of Capel Finance Preference Shares. (b) The return to Capel Finance of the share certificates in respect of Capel Finance Preference Shares shall not be a pre-condition to the payment of the Redemption Consideration. 2. NO PRIORITY 2.1 Capel Finance Preference Shares will not be entitled to receive any priority as against the holders of any existing or future classes of shares in Capel Finance in relation to the: (a) repayment of capital by Capel Finance; or (b) during the winding up of Capel Finance. 2.2 A Capel Finance Preference Share does not confer on its holder any rights to participate in the profits of Capel Finance. 3. WINDING UP 3.1 On the winding up of Capel Finance, Capel Finance Preference Shareholders are entitled to receive the Redemption Consideration, with all Capel Finance Preference Shares ranking in all respects pari passu with each other. 4. VOTING RIGHTS 4.1 Capel Finance Preference Shares do not entitle the holder to vote at or attend or address general meetings of Capel Finance." 9 Several things need to be said about the schedule 1 provisions. First, they show a basic misconception by saying that the holders of the shares "can redeem" those shares. It is the company, not the shareholder, which redeems a redeemable share. Literally, the company buys back, and this is reflected in the s.9 definition of "redeemable preference share": "'redeemable preference share' means a preference share in a body corporate that is, or at the body's option is to be, liable to be redeemed."

The same concepts are reflected in s.254A(3): "Redeemable preference shares are preference shares that are issued on the terms that they are liable to be redeemed. They may be redeemable: (a) at a fixed time or on the happening of a particular event; or (b) at the company's option; or (c) at the shareholder's option."

If, as here, the redemption is to be instigated by the holder, the case is one within s.254A(3)(c), that is, a case of redemption by the company at the shareholder's option. The terms of issue must be framed in that way. 10 Second and fundamentally, a share issued on the terms set out in schedule 1 will not be a redeemable preference share at all. This is because it will not have one of the two characteristics made essential by the s.9 definition: it will not be a "preference share". The Corporations Act does not attempt to define "preference share", but the concept is well entrenched in company law. Preference shares can only exist by way of juxtaposition with other shares. As Roxburgh J observed in Re Powell-Cotton's Resettlement [1957] 1 All ER 404, "preferred stock" is stock which has some preference or priority over ordinary or common stock and, in logical analysis, there is no difference in that context between the words "preferred" and "preference". 11 The base from which such things are measured is that identified by the House of Lords in Birch v Cropper; Re Bridgewater Navigation Co Ltd (1889) LR 14 App Cas 525, namely, that members of a company participate and enjoy entitlements according to the numbers of the shares they hold. That was the principle there applied in relation to a surplus on winding up but it has long been recognised as the basic rule applicable to all forms of shareholder participation and entitlement in the absence of contrary provision. Any departure from that rule of proportionate equality according to shares held must arise from the company's constitution or from terms of issue capable of displacing or modifying the general rule. Provisions of that kind affording some priority or superior position to the holders of particular shares are the thing that causes those shares to be "preference shares". It is not possible for "preference shares" to exist except as a result of a process of differentiation from shares which are not "preference shares" which sees the "preference shares" entitled to some comparative advantage, commonly with respect to one or more of the matters referred to in s.254A(2) to be mentioned presently. 12 Shares issued upon the terms in schedule 1, set out above, will, on this basis, not be "preference shares". Clause 2.1 says in explicit terms that the so-called redeemable preference shares "will not be entitled to receive any priority as against the holders of any existing or future classes of shares" in relation to repayment of capital or during a winding up. Clause 2.2 says that no right to participate in profits attaches to the shares in question, while clause 3.1 confers a right to a fixed sum of 8.4 cents per share upon a winding up, which right is not expressed to exist in priority to the rights and claims of holders of other shares. Clause 4.1 denies voting rights and the right to attend and speak at general meetings. The so-called redeemable preference shares do not attract any preference or priority, compared with other shares. 13 Section 254A(2) requires, as a condition of the ability to issue preference shares, that the rights attached to the preference shares with respect to certain matters be set out in the constitution or be approved by special resolution. Section 254A(2) is as follows: "A company can issue preference shares only if the rights attached to the preference shares with respect to the following matters are set out in the company's constitution (if any) or have been otherwise approved by special resolution of the company: (a) repayment of capital; (b) participation in surplus assets and profits; (c) cumulative and non-cumulative dividends; (d) voting; (e) priority of payment of capital and dividends in relation to other shares or classes of preference shares."

Shares issued on the terms in schedule 1 would carry no priority in respect of any of these (or any other) matters and it is for that reason that they would not properly be regarded as "preference shares" and so could not be issued as redeemable preference shares. 14 It was faintly suggested on behalf of the company that the right of the holder to require redemption by the company makes the shares preference shares. That cannot be so. That feature makes them redeemable shares, which represents one of the two attributes contemplated by the s.9 definition of "redeemable preference share". The characteristics that make a share a "preference share" are distinct from those that make it redeemable 15 The consequence of the shares not being redeemable preference shares is, of course, that they cannot be redeemed, except by future and separate compliance with either the capital reduction provisions or the share buy-back provisions. Either course would require separate decisions on each occasion of proposed redemption and the necessary corporate decisions might or might not be forthcoming on any particular occasion. 16 If the shares were redeemable preference shares, s.254K(b) would preclude redemption except out of profits or the proceeds of a new issue of shares made for the purpose of the redemption. This is the third matter to which I wish to refer. The requirement under s.254K(b) to which I have referred is the subject of brief comment in the draft explanatory statement: "Section 254K of the Corporations Act requires that Capel Finance Preference Shares be redeemed out of the profits of Capel Finance or from the proceeds of a new issue of shares made for the purpose of the redemption. There is a risk that there may be no available profits when a Scheme Shareholder elects to redeem any Capel Finance Preference Shares that they hold." 17 This bland statement is made in a context where the company is inviting members to take the supposed redeemable preference shares in place of their ordinary shares on the basis that those members will have an option to have the new shares redeemed at any time after issue. It is also made in a context where the company states that it is not carrying on business and has no plan to commence any new business - and where, moreover, there is an absence of past years' profits to which resort might be had for the purposes of redemption. Indeed, the balance sheet at 30 June 2004 shows accumulated losses of more than $48 million at that date. The prospects of profits being available to cover the redemption of redeemable preference shares in the foreseeable future must therefore be regarded as highly problematic. That reality must be, in my opinion, spelled out in the explanatory statement. 18 The passage I have quoted is, to my mind, not sufficiently explanatory of this matter. On present indications, the company will have no (or very little) capacity to redeem. If a shareholder requires redemption and the company cannot redeem because it lacks the capacity under s.254K(b) to do so, questions will arise as to the rights of that shareholder. The questions are discussed at paragraph 24.650 of the current loose-leaf edition of "Principles of Corporations Law" by H A J Ford, R P Austin and I Ramsay: "The legislation provides no clear guidance for the case where shares are redeemable by a certain date and the company does not redeem them. On principle, enforced redemption cannot occur if creditors would be prejudiced. … Possibly, the protection of creditors may be put so high as to require the company to have profits available for dividend before there can be redemption. It would seem that, at least if profits are available, the holders of the redeemable preference shares could apply for a winding up order as contributories: Re Marra Developments Ltd (No 2) (1978) 3 ACLR 798. However, in Commissioner of Taxation v Coppleson (1981) 6 ACLR 428 the Federal Court was of the view that, failing the availability of profits or the proceeds of a new issue, a company would not be in default under its contract with holders of redeemable preference shares if it failed to redeem. The contract would have been made in the light of the legislation. Nor would there be any basis for winding up on the just and equitable ground (see Ch 11 ); the company would not have been misusing its legal rights and so the court's power to apply equity would not come into the matter. The court explained Re Marra Developments Ltd (No 2) (1978) 3 ACLR 798 as a case where profits were available. The New Zealand Court of Appeal in Mutual Life and Citizens' Assurance Company Ltd v Mosgiel Ltd [1994] 1 NZLR 146 at 152 thought, with O'Loughlin J in TNT Australia Pty Ltd v Normandy Resources NL (1989) 53 SASR 184; 1 ACSR 1 at 21 ; 7 ACLC 1090, that where a company undertook to redeem on a particular event it is for the company to organise its affairs so as to ensure that it will have appropriate profits out of which to meet its obligations and that if it seems apparent that it will not be able to meet its contractual commitments on redemption then the company faces the prospect of being wound up before the redemption date on the 'just and equitable' ground."

19 There are thus no easy or clear answers; nor is the present application the occasion for any attempt to provide them. Shareholders invited to take up redeemable preference shares in a context such as the present where profits to cover redemption are not presently available and may well never become available deserve a proper explanation of the consequences of their taking those shares in those circumstances. There is a need for amplification of the explanatory statement accordingly so that the position they are invited to accept and the risks and uncertainties attaching to it are fully explained. 20 For the reasons I have stated, the scheme as presently formulated is not one in respect of which an approving order might be expected upon an unopposed application under s.411(4), even if the necessary majority of the votes of relevant shareholders had been achieved. Nor is the disclosure adequate to ensure that affected shareholders are able to obtain an informed understanding of all the implications of the scheme. An order for the convening of a meeting under s.411(1) will therefore not be made in relation to the proposal as it stands. 21 It has been indicated, however, that the matters I have mentioned will be the subject of attention by the company with a view to amendment and I will stand the matter over for further hearing on the basis that the intervening time may be taken to see whether appropriate revision can be made. The originating process is stood over to 9.30am on Wednesday 6 April 2005 before me. **********

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