Cape Alumina Limited, in the matter of Cape Alumina Limited [2013] FCA 1212

IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY GENERAL DIVISION NSD 2150 of 2013

IN THE MATTER OF CAPE ALUMINA LIMITED CAPE ALUMINA LIMITED ACN 107 817 694

JUDGE: FARRELL J DATE: 18 November 2013 PLACE: SYDNEY

REASONS FOR JUDGMENT 1 These are my reasons for making orders on 4 November 2013 under s 411(1) of the Corporations Act 2001 (Cth) (Corporations Act) and ancillary directions under s 1319 to convene a meeting of certain members of the plaintiff company, Cape Alumina Limited (ACN 107 817 694) (CBX), to consider approving a scheme of arrangement as described in these reasons (Scheme) (Scheme Meeting). 2 The proposed Scheme is an "acquisition" scheme and therefore within the concept of an "arrangement" which has often been approved by Australian courts. Unless otherwise indicated, in these reasons references to provisions of a statute are references to provisions of the Corporations Act, terms defined in the Scheme Booklet which is Exhibit 1 (Scheme Booklet) bear the same meaning and those terms are used in the way they are commonly used in "acquisition" schemes of arrangement.

background 3 The proposal for the Scheme was announced on 25 September 2013 under a joint announcement (Joint Announcement) to Australian Securities Exchange Limited (ASX) by CBX and the proposed acquiring company, MetroCoal Limited (MTE). On 24 September 2013 the parties signed a Merger Implementation Agreement which is Annexure B to the Scheme Booklet and it was amended and restated on 28 October 2013 (Implementation Agreement).

CBX 4 CBX is a Brisbane based Australian public company whose securities are listed for quotation on ASX following an initial public offering in January 2009. CBX describes itself as a "pure play" bauxite company which controls approximately 1,900 square kilometres of exploration tenements in western Cape York. Its business model is based on the establishment of an independent bauxite supply business to feed the growing market for traded bauxite in China. It has two projects in advanced development stages: the Pisolite Hills and Bauxite Hills mines, and associated port projects. Of these, the Pisolite Hills project is the more advanced.

MTE 5 MTE is also a Brisbane based Australian public company, securities in which are listed for quotation on ASX following an initial public offering in December 2009. Its focus is the development of thermal coal projects in the Surat Basin region of south-east Queensland and it holds coal exploration permits covering over 3,500 square kilometres.

Commercial impact of the proposed Scheme 6 The proposed merger will create a Queensland based diversified bulk commodities group with a portfolio of major bauxite (200 million tonnes) and thermal coal projects (4 billion tonnes). The short to medium term priority will be to develop CBX's bauxite assets, in particular the Pisolite Hills mine and port project near Mapoon to capitalise on the global market for bauxite and generate positive cash flow. The merged group would develop MTE's Bundi and Columboola coal projects in the Surat Basin in the medium to long term. It is expected that on implementation of the Scheme the merged group will have $9 million, the bulk of which would be available to advance the Pisolite Hills project. 7 As a result of the Scheme and on the assumption that the Scheme Consideration is 1.11 MTE Share for each CBX Share: MTE will own all CBX Shares and former CBX Shareholders will hold 55% of MTE Shares then on issue; Metallica Minerals Limited (Metallica) will hold 21% of MTE Shares (it currently holds 16.51% of CBX Shares and 30.78% of MTE Shares); and in conjunction with the transactions relating to the RCF Note and their existing shareholding in CBX, Resource Capital Funds III and IV (RCF) will hold 23.6% of MTE Shares and approximately 16,500,000 options to subscribe for MTE Shares. 8 It is proposed that the Boards of CBX and MTE will merge if the Scheme is implemented, reflecting the general equality of the merger. Section 7.4 of the Scheme Booklet also discloses in relation to the post-merger MTE Board that Mr Stephen Everett will remain the Chairman of MTE, Mr Graeme Sherlock (currently Managing Director of CBX) will become Managing Director of MTE, CBX's current Chairman, Mr George Lloyd will become a non-executive director of MTE, Mr Ronald (Rennie) Fritschy (currently a non-executive director of CBX) will become a non-executive director of MTE and Mr Dongping Wang will remain a non-executive director of MTE as will his alternate Mr Robert Finch. Mr Barry Casson will be appointed as a non-executive director of MTE; he is a director of Metallica. MTE's head office will be at CBX's current office in Brisbane.

CBX capital structure 9 CBX has on issue 183,181,133 shares (CBX Shares).

Performance Rights 10 3,310,973 CBX Performance Rights have been issued to CBX group employees.

RCF Note 11 On 19 October 2011, CBX issued a convertible note to RCF with a face value of $5 million and a term of 36 months (maturing on 19 October 2014). Its purpose was to fund drilling and assaying of CBX's Bauxite Hills project and other corporate activities (RCF Note). The issue of the RCF Note and its conversion to CBX Shares was approved by CBX shareholders at the 2011 annual general meeting. The RCF Note can be converted at any time before maturity at the election of RCF at a price calculated (relevantly) by reference to the price at which CBX raised equity in the future. CBX could redeem the RCF Note by payment of interest and principal at any time not later than 60 days before it matured. If CBX redeems the RCF Note, CBX is obliged to grant RCF options to subscribe for CBX Shares. The number of options would be calculated by dividing the principal advanced under the RCF Note by the conversion price set out in the RCF Note terms, and the options would expire on 19 October 2014. 12 On 24 September 2013, RCF and CBX entered into a Deed of Undertaking (early conversion) (Deed of Undertaking) by which they agreed that all principal moneys owing under the RCF Note would be satisfied by CBX issuing to RCF 41,666,667 CBX Shares (a conversion price of $0.12), subject to the Court making orders to convene the Scheme Meeting. It is not a condition of the conversion of the RCF Note that CBX Shareholders or the Court approve the Scheme. Conversion must occur before the Scheme Meeting and RCF's security over CBX's assets will be released. Interest will accrue on the principal of the RCF Note until conversion and CBX's payment obligations will be satisfied by issuing CBX Shares. 13 In consideration of RCF agreeing to early conversion, CBX has agreed to grant 14,706,000 options to RCF (RCF Options) at an exercise price of $0.17 per CBX Share and a term of 2 years. It is a condition precedent to the Implementation Agreement that by 8 am on the day of the second court hearing, RCF and MTE agree to exchange the RCF Options for equivalent options to subscribe for MTE Shares, expected to be approximately 16,500,000 MTE options.

MTE Notes 14 By means of a Secured Loan and Convertible Note Deed entered into at the same time as the Implementation Agreement, MTE will make cash injections of up to $3 million (MTE Advance) in two tranches to CBX for working capital which will allow CBX to progress the technical and environmental studies required for the Pisolite Hills project to gain the necessary government approvals. The MTE Advance is for 24 months from 24 September 2013 and MTE Notes will bear interest at the rate of 10% from 1 January 2014. While there are moneys owing under the MTE Advance, MTE has a right to appoint a director to CBX's board. 15 The first tranche of $1 million has been advanced (Initial Loan Note). Subject to CBX shareholder approval at its annual general meeting on 19 November 2013, a further tranche of up to $2 million will be available to be drawn down any time before 31 December 2013 and secured by a charge over CBX's assets (which will also secure the Initial Loan Note) (Subsequent Loan Note). If CBX shareholder approval is not obtained, no moneys will be advanced in relation to the Subsequent Loan Note and MTE will have the right to call for payment of the Initial Loan Note. 16 The MTE Advance is not conditional on the Scheme being approved. CBX can elect to convert the MTE Notes into CBX Shares until the Scheme becomes Effective. The conversion price is between $0.12 and $0.06 per CBX Share calculated on a volume weighted average over the 20 days before the conversion notice is issued. The MTE Notes are summarised at Section 10.9 of the Scheme Booklet.

Scheme 17 If the Scheme is approved, all of the shares in CBX held by Scheme Shareholders, that is, members of CBX on the Record Date, will be transferred to MTE.

Scheme Consideration 18 The Scheme Consideration is approximately 1.11 MTE Shares for every CBX Share held on the Record Date. An entitlement to a fraction of an MTE Share will be rounded up or down to the nearest whole number, with an entitlement to one half of an MTE Share being rounded up. 19 The approximation arises because the Scheme Consideration will be calculated according to a formula set out at clause 4.2 of the Implementation Agreement and on page 4 of the Scheme Booklet under "Scheme Consideration". The calculation assumes that: RCF will convert the RCF Note to 41,666,667 CBX Shares at a conversion price of $0.12 per CBX Share; CBX will issue a further 1,369,863 CBX Shares to RCF as payment of interest on the RCF Note to the date of conversion. However the exact number of CBX Shares issued to RCF as payment of interest on the RCF Note will depend on the timing of conversion and the volume weighted average price of CBX Shares prior to conversion; and CBX will issue a further 3,310,973 CBX Shares on exercise of CBX Performance Rights. 20 MTE proposes to undertake a consolidation of its share capital for which approval will be sought at MTE's upcoming annual general meeting on 29 November 2013. If the consolidation is effected before the Implementation Date of the Scheme, CBX Shareholders will receive fewer MTE Shares, but the Scheme Booklet at page 5 notes that it will not affect the value of the Share Consideration. The MTE Board anticipates that the consolidation will occur after the Implementation Date of the Scheme.

Ineligible Foreign Shareholders 21 Ineligible Foreign Shareholders are shareholders of CBX at 4 pm on the Record Date with a registered address outside Australia, New Zealand, Cyprus and any jurisdiction determined by the board of MTE to be eligible in accordance with the Implementation Agreement. 22 MTE Shares which would have been issued to Ineligible Foreign Shareholders will be issued to a Nominee who will sell the shares and account to the Ineligible Foreign Shareholders proportionately to their holding for the proceeds (after payment of costs, including brokerage). 23 This is usual method of addressing this issue: Re Rural Press Ltd (2007) 61 ACSR 373 at [20].

Directors recommendation and directors' interests 24 The CBX Board recommends that, in the absence of a superior proposal, CBX Shareholders vote in favour of the Scheme. All of the directors have indicated their intention to vote all of the CBX Shares they control in favour of the Scheme. 25 Section 5.5 of the Scheme Booklet discloses in relation to the CBX Board that: Mr George Lloyd, the non-executive Chairman of CBX, will become a non-executive director of MTE after the merger. He has interests in 242,766 CBX Shares. Mr Graeme Sherlock, CBX's Managing Director, will become the Managing Director of MTE after the merger. He holds 2,130,000 CBX Shares and 978,876 Performance Rights. Mr Rennie Fritschy, a non-executive director of CBX, will become a non-executive director of MTE after the merger. He has interests in 112,000 CBX Shares. Mr Peter Nicholson, a non-executive director of CBX, is an employee of Resource Capital Funds Management Pty Limited, an entity associated with RCF which holds 55,570,236 CBX Shares. Mr Jijun Liu, a non-executive director, holds no CBX Shares. He is an employee of China Xinfa Group Corporation Limited which, together with associated entities, holds 29,342,960 CBX Shares. Mr Ken Xiao, alternate director to Mr Jijun Liu, is a consultant to China Xinfa Group Corporation Limited. Mr Xiao holds 41,572 CBX Shares. 26 Section 11.2 of the Scheme Booklet indicates that neither MTE nor any of its directors have any interests in CBX Shares other than Mr Arthur Gillies who has 600,000 CBX Shares. 27 CBX will tag the votes cast by Mr Gillies and Messrs Lloyd, Sherlock and Fritschy, given their current and potential relationships with the MTE, and the Court will consider the impact of these votes at the second court hearing.

Independent Expert 28 The CBX Board commissioned InterFinancial Corporate Finance Limited (Independent Expert) as the Independent Expert to provide a report in relation to the Scheme. The report forms Annexure A to the Scheme Booklet. 29 I note that the Independent Expert discloses at paragraph 12.3 of the report that it has prepared two previous valuation reports for CBX. One of those valuations related to an assessment of the RCF Note and the issue of Performance Rights to directors of CBX in connection with approval resolutions at the November 2011 annual general meeting. The Independent Expert says that before accepting the engagement to provide its report in relation to the Scheme it considered its independence with respect to CBX and its associates with reference to the Australian Securities and Investments Commission's (ASIC) Regulatory Guide 112 and in the Independent Expert's opinion, it is independent. Counsel for CBX submitted that it is open to any party who has concerns about this issue to raise them at the second court hearing. I accept that submission.

Independent Expert's conclusion 30 The Independent Expert concluded that the Scheme is fair and reasonable and as a result in the shareholders' best interests. 31 The Independent Expert assessed the fair value of the Share Consideration as in the range of $0.10 to $0.12 and the fair value of a CBX Share as $0.09 to $0.12 and concluded that the Scheme was fair. The Independent Expert did not apply a premium for control. At Section 7.3 of the report, the Independent Expert said: When valuing a controlling interest, an appropriate allowance should be made for the premium for control, given the strategic benefit that a controlling interest would provide. Empirical evidence on premiums for control indicate that these premiums tend to range between 15% and 40%. Given the nature of the transaction we do not consider that it is appropriate to apply a premium for control to the Cape Alumina shares: the Cape Alumina major shareholders will be the major shareholders post the Merger; there will be no shareholder with outright control of the merged group; and the post-Merger board of directors will have equal representation from both Cape Alumina and MetroCoal. 32 On a balance of the advantages and disadvantages associated with the Scheme (which are set out on pages 4 - 6 of the Independent Expert's report) and the alternatives if it does not proceed, the Independent Expert also concluded that it was reasonable.

Implementation Agreement 33 The Implementation Agreement is summaried at Section 10.1-10.6 of the Scheme Booklet. CBX and MTE each undertake to use their best endeavours to procure that conditions precedent relevant to them are satisfied. The End Date is 31 December 2013.

Conditions precedent 34 Satisfaction or waiver of the conditions precedent in the Implementation Agreement is a condition of the Scheme in accordance with clause 3 of the Scheme of Arrangement set out at Annexure C of the Scheme Booklet. Many of the conditions precedent are common in acquisition schemes: see Section 10.2 of the Scheme Booklet. Conditions peculiar to this Scheme (insofar as they have not been satisfied yet) include: MTE Shareholders agreeing to the Scheme for the purpose of Listing Rules 11.1, 10.1 and 7.1 (if required) before the Scheme Meeting; Conversion of the RCF Note in accordance with the Deed of Undertaking; MTE and RCF enter into arrangements for the transfer of the RCF Options to MTE in consideration of MTE issuing MTE options to RCF (referred to as the RCF Note Commitment Arrangement) by the second court hearing; The Performance Rights vesting and being exercised by the holders by the second court hearing; and RCF giving relevant consents in relation to the Scheme and the MTE Note.

Exclusivity arrangements and break fees 35 The Implementation Agreement sets out so called deal protection measures: There is a prohibition on CBX directors from changing or withdrawing their favourable recommendation of the Scheme unless required to do so by virtue of their fiduciary duties after having obtained a written opinion from a Queen's Counsel or Senior Counsel acceptable to MTE and providing a copy of the advice to MTE. There are reciprocal "no shop" and "no talk" arrangements and "notification" requirements which apply during the Exclusivity Period (which started on 24 September 2013 and will end on 31 December 2013). The "no talk" arrangement is subject to a fiduciary carve out based on a Queen's Counsel or Senior Counsel opinion which must be provided to the other party before any action is taken. The "notification" requirement applies in relation to negotiations or discussions and any approach, attempt or intention to initiate negotiations or discussions; it requires details of the person making the approach and the details of any proposal. There is a reciprocal break fee of $250,000, said to be a genuine pre-estimate of costs. It is payable if a superior proposal results in the proponent getting acceptance for 50% of the shares in the target or the target is in material breach of the Implementation Agreement. 36 The affidavit of Mr Fritschy sworn on 31 October 2013 contains what has become highly formulaic evidence that: negotiation of the exclusivity arrangements has had regard to Takeovers Panel Guidance Note 7, the exclusivity arrangements were agreed after arms-length negotiations in which the parties were represented by legal advisors, he believes that the arrangements were a requirement of the parties, that they do not operate to the detriment of CBX, and they are reasonable and appropriate because of the fiduciary carve outs (where relevant). 37 It is concerning that exclusivity provisions appear to have become a standard feature of transactions: they add weight and complexity to documentation and cost to transactions which it is sometimes difficult to see the justification for unless it is their anti-competitive effect, which the Takeovers Panel guidance suggests is not a virtue. I do not doubt Mr Fritschy's sincerity. However, it is difficult to find persuasive those statements in affidavits which are in almost the same form in transactions whose circumstances vary widely. 38 While the exclusivity arrangements are more simply drafted in this case than many of their type, it is concerning that they seek to proscribe the manner in which directors of a target company establish and act on their fiduciary duty (especially in relation to change of recommendations which requires MTE to approve counsel). Further, the notification requirements are very widely drawn and it is not difficult to imagine circumstances in which they would have an inappropriate deterrent effect. The Independent Expert's report indicates that CBX has actively looked for capital raising alternatives as major shareholders have declined to provide additional capital. A capital raising through stock brokers would have required a discount of 30% to its current share price. Without additional capital, CBX will not be able to exploit its bauxite tenements. However, it is not clear that CBX has sought other merger or acquisition opportunities and it was submitted that this transaction resulted from an approach from MTE. Having said that, Section 3.1 of the Scheme Booklet indicates that CBX has not received any superior proposals since the Implementation Agreement was announced on 24 September 2013 and CBX is ASX listed which should have brought the announcement to the attention of any interested parties. 39 Accordingly, in all of the circumstances of this company, and in the absence of a proponent of the contention that these factors should prevent the convening of the Scheme Meeting, I will simply note these matters at this stage of the process. However, directors should carefully consider whether it is consistent with their fiduciary duty to accept arrangements which so fetter their ability to exercise their fiduciary duties. 40 As CXB's market capitalisation is $13 million, the break fee is greater than 1%, and therefore outside the Takeovers Panel's guidance. In submissions from the bar table, Mr Hansel (a director of MTE and a partner in the law firm HopgoodGanim) indicates that MTE's actual costs to date are $240,000 with expected expenditure of a further $60,000 so that the pre-estimate of MTE's costs appears reasonable. No break fee is payable to MTE if CBX shareholders vote against the Scheme so it cannot have a coercive effect on their voting intentions. It is a reciprocal agreement, and it may be regarded as in CBX's interests to procure the same undertaking from MTE: CBX's cash holdings as at 30 September 2013 was $1.7 million only, so that if MTE were to walk away from the transaction, it would have a material financial effect on CBX. CBX relied on People Telecom Limited, in the matter of People Telecom Limited [2009] FCA 180 at [3]-[6] in which similar factors weighed in favour of Jacobson J making orders under s 411(1) notwithstanding that the break fee exceeded the 1% guideline. 41 For these reasons, the exclusivity arrangements should not be an obstacle to the Court making orders under s 411(1) in this case.

RCF 42 Mr Pocock, a partner at McCullough Robertson Lawyers who has carriage of this matter, swore an affidavit dated 1 November 2013 (Pocock Affidavit) to which he exhibited correspondence with ASIC. ASIC had raised the question of whether RCF should be treated as a separate class having regard to its rights under the Deed of Undertaking in relation to the RCF Note and whether these arrangements gave rise to a collateral benefit. Based on Mr Pocock's email to ASIC on 30 October 2013 and the matters set out at [11]-[13], I am satisfied that at this stage there are no class creating circumstances of concern or concerns about the nature of any benefit conferred on RCF by the Deed of Undertaking because: (a) RCF has agreed to truncate its right to convert the RCF Note to CBX Shares, a right it always had which was approved by CBX Shareholders in November 2011. The exercise price of $0.12 is above CBX's current trading price of $0.07; (b) RCF Options are fewer than it was entitled to, with a higher exercise price at $0.17 although the exercise period has been extended to November 2015; (c) RCF's rights under the Deed of Undertaking are conditional on the Court making orders under s 411(1) to convene the Scheme Meeting, not on the outcome of the Scheme Meeting or the Court making orders under s 411(10); (d) CBX will tag RCF's votes at the Scheme Meeting and the issue of fairness of the Scheme in the interest of all CBX Shareholders will be finally determined at the second court hearing at which any interested person will have the right to appear.

Ineligible Foreign Shareholders 43 The provision of a share sale facility for Ineligible Foreign Shareholders of the common kind (as here) does not give rise to the need to treat these shareholders as a separate class: Straits Resources Limited, in the matter of Straits Resources Ltd [2010] FCA 1466 at [28] per Jacobson J; Re Hills Motorway Ltd (2002) 43 ACSR 101 at [10]-[13] per Barrett J.

Formal and usual matters 44 In Associated Advisory Practices Limited, in the matter of Associated Advisory Practices Limited [2013] FCA 761 at [19]-[24], I set out a summary of the relevant law on applications such as that under consideration here. The relevant principles and specific matters concerning the proposed Scheme which Counsel considered should be drawn to the Court's attention are set out in the written submissions provided to me by Counsel for CBX. I have marked the submissions as MFI-1 and supplementary submissions as MFI-2. I have marked as MFI-3 a copy of the index to the Court Book which sets out each of the affidavits which were read and exhibits tendered in these proceedings. ASIC has provided the "usual letter" in relation to the Scheme indicating that it has had the opportunity to review drafts of the Scheme Booklet within the required timeframes and that it does not intend to attend the first court hearing. ASIC's letter is included in Mr Pocock's affidavit. 45 Counsel for CBX has also taken me through the Scheme Booklet and the evidence supporting the application in some detail. On the basis of these materials, I am satisfied of the formal matters relevant to an application to convene a scheme meeting under the Corporations Act and that issues such as performance risk and deemed warranties have been dealt with in accordance with common practice.

Orders 46 Based on the material provided to the Court and the matters referred to in these reasons, there is no evidence at this stage to suggest that the Scheme is not bona fide or proposed for an improper purpose. The formal requirements of s 411 for the Court to make orders to convene the Scheme Meeting and to approve the Scheme Booklet for circulation to CBX Shareholders appear to have been met. I have therefore made the orders sought by CBX. I certify that the preceding forty-six (46) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Farrell.