Community Development Pty Ltd v Engwirda Construction Co

REASONS FOR JUDGMENT LEE J: 1 By an application filed in this Court on 18 July 2002, Niagara Mining Limited ("Niagara") applied for orders under subs 411(1) of the Corporations Act 2001 (Cth) ("the Act"), that meetings of holders of options for the acquisition of shares in Niagara be convened for the purpose of considering a proposed arrangement ("the arrangement") between Niagara and the optionholders. It also sought approval by the Court, under subs 411(1) of the Act, of the explanatory statement and, ultimately, approval of the arrangement under subs 411(6). 2 It was submitted that the aim of the arrangement was to enable the company to rearrange its capital structure to help it raise further capital. Under the arrangement Niagara proposed to: (a) cancel the options exercisable on 31 October 2003 ("the 2003 options") and on 31 March 2005 ("the 2005 options"); and (b) issue one fully paid share for every 20 options held by the holders of the 2003 options ("2003 optionholders") and 2005 options ("2005 optionholders"). 3 The number of shares to be issued under the proposed arrangement was 1,113,086. It was submitted that the 2003 options and the 2005 options had no present or foreseeable value. If exercised the options required $4 to be paid for each share acquired. Currently Niagara's shares were trading in the range of 4 to 5 cents. Therefore, the issue of shares to the 2003 optionholders and 2005 optionholders pursuant to the arrangement will dilute the capital base of Niagara, it is said by about 2.18 per cent. 4 On 29 July 2002, subject to any objection lodged by the Australian Securities and Investments Commission ("ASIC"), the Court gave leave to Niagara to convene meetings of the 2003 optionholders and the 2005 optionholders. The Court expressed doubt as to whether the optionholders came within the meaning of "creditors" as used in subs 411(1) to describe one of the two classes of persons with whom an arrangement could be made pursuant to subs 411. The Court directed Niagara to give notice to ASIC that in considering whether to approve the arrangement, the Court would be assisted by a submission from ASIC on whether optionholders were "creditors". 5 The meetings of the optionholders were held on 2 September 2002. At the 2003 optionholders meeting, 18 people cast a total of 1,557,269 votes in favour of the resolution. No persons voted against the resolution. At the 2005 optionholders meeting, 27 people cast a total of 1,215,487 votes in favour of the resolution, three people cast 2,782 votes against the resolution and one person, entitled to cast 544 votes, abstained from voting. 6 When the matter came before the Court on 11 September 2002, there was no appearance by any other party. ASIC filed a submission which addressed the question of the meaning of "creditors" as used in s 411(1). 7 Part 5.1 of the Act establishes a mechanism whereby a company may enter into a compromise or arrangement with one or more classes of its "members" or "creditors" to bind all persons within that class. 8 Section 411(1) sets out the Court's power to order meetings to consider such a proposal: "Where a compromise or arrangement is proposed between a Part 5.1 body and its creditors or any class of them or between a Part 5.1 body and its members or any class of them, the Court may, on the application in a summary way of the body or of any creditor or member of the body, or, in the case of a body being wound up, of the liquidator, order a meeting or meetings of the creditors or class of creditors or of the members of the body or class of members to be convened in such manner, and to be held in such place or places (in this jurisdiction or elsewhere), as the Court directs and, where the Court makes such an order, the Court may approve the explanatory statement required by paragraph 412(1)(a) to accompany notices of the meeting or meetings." 9 Section 411(4) of the Act sets out the circumstances in which compromise or an arrangement is binding: 'A compromise or arrangement is binding on the creditors, or on a class of creditors, or on the members, or on a class of members, as the case may be, of the body and on the body or, if the body is in the course of being wound up, on the liquidator and contributories of the body, if, and only if: (a) at a meeting convened in accordance with an order of the Court under subsection (1) or (1A): (i) in the case of a compromise or arrangement between a body and its creditors or a class of creditors - the compromise or arrangement is agreed to by a majority in number of the creditors, or of the creditors included in that class of creditors, present and voting, either in person of by proxy, being a majority whose debts or claims against the company amount in the aggregate to at least 75% of the total amount of the debts and claims of the creditors present and voting in person or by proxy, or of the creditors included in that class present and voting in person or by proxy, as the case may be; and (ii) in the case of a compromise or arrangement between a body and its members or a class of members - a resolution in favour of the compromise or arrangement is: (A) passed by a majority in number of the members, or members in that class, present and voting (either in person or by proxy); and (B) if the body has a share capital - passed by 75% of the votes cast on the resolution; and (b) it is approved by order of the Court. 10 Section 411(6) of the Act provides: 'The Court may grant its approval to a compromise or arrangement subject to such alterations or conditions as it thinks just.' 11 Therefore, optionholders would be bound by an arrangement only if they came within the meaning of "members" or "creditors". 12 In Re Compania de Electricidad de la Provincia de Buenos Aires Ltd [1980] 1 Ch 146 at 183 it was held that holders of options over unissued shares in a company were not members of the company. However, it was held that an optionholder was a "contingent creditor" as defined in earlier judgments, being "a person towards whom under an existing obligation, the company may or will become subject to a present liability upon the happening of some future event or at some future date" (Emphasis added). (See: Re William Hockley Ltd [1962] 1 WLR 555 per Pennycuick J at 558; Community Development Pty Ltd v Engwirda Construction Co (1969) 120 CLR 455 per Kitto J at 459). 13 In Re Asia Oil and Minerals Ltd (1986) 5 NSWLR 42 at 45 Cohen J applied that analysis in respect of a scheme of arrangement, stating: 'In my view an existing obligation arises when the option for shares is purchased, that is to say there comes into existence the conditional contract which, on the happening of the conditions, creates a liability on the company to allot the appropriate shares. This has an effect in the same way that any other form of contract to do an act, with conditions precedent, obliges the promisor to perform that act upon the occurrence of the conditional events. It is true that the liability is not to pay money, but to issue shares, and accordingly there are two events upon which any debt is contingent. One is the exercise of the option upon its proper terms, and the other is the failure of the company to carry out that issue. The result is a liability in damages.' 14 Subsequent cases involving schemes of arrangement have been prepared to treat optionholders as creditors on the basis of the decision in Re Compania de Electricidad. 15 However, doubts have been expressed frequently as to whether this approach is correct in law. There are obvious difficulties in treating optionholders as creditors because: (a) the ultimate contingency upon which the optionholder's status as a creditor is based, namely the failure of a company to allot and issue the shares, is likely to be a circumstance remedied by an order for specific performance; and (b) until there is a breach by the company that occasions loss to the optionholders there will be no claim from which a contingent indebtedness may arise. (See: Re Asia Oil & Minerals per Cohen J at 45.) 16 It is difficult to see how there is an "existing obligation" by the company to pay compensation to the optionholder before the time has arrived for the company to issue shares in return for payment of the sum payable for exercise of the option. Community Development involved a building contract which created an "existing obligation" on the building owner to pay the contract price, plus the value of extras, contingent upon the builder doing the relevant work to the architect's (or ultimately the arbitrator's) satisfaction. In that case Kitto J, after citing the definition of "contingent creditor" in Re William Hockley, saidat 459: 'The importance of these words for present purposes lies in their insistence that there must be an existing obligation and that out of that obligation a liability on the part of the company to pay a sum of money will arise in a future event, whether it be an event that must happen or only an event that may happen. A building contract creates, as soon as it is entered into, an obligation upon the building owner to pay the contract price, either as a whole upon a future event or, more usually, by progress and final payments each of which is to be made on a future event. The event or events may or may not happen, but if and when one of them does happen the building owner, by force of the contractual obligation, must pay the builder a sum of money…the building owner is bound from the time the contract is made to pay money to the builder upon a contingency; and that in my opinion makes the builder a contingent creditor of the owner.' (Emphasis added). 17 In Re BDC Investments Ltd (No 2) (1988) 13 ACLR 201 at 203-204, Young J expressed doubt as to whether an optionholder could be regarded as a contingent creditor before the time for the exercise of his or her option had arrived: 'Until the company has committed a breach of contract, I fail to see how there is any claim against it at all. Personally I am not at this stage attracted by the argument that there is an existing right (ie the contract and two events upon which the contract may blossom into a claim against the company viz (a) its breach and (b) an attempted exercise of the option).' 18 However, in that case his Honour did not think it appropriate to "run against the tide of decision, especially in an 'ex parte' case where it would appear that all persons involved are, in a commercial sense, completely satisfied with the result". 19 Similar doubts as to the correctness of the construction relied upon were expressed by Franklyn J in Re Austamax Resources Ltd (1986) 4 ACLC 76; Needham J in Re BDC Investments Ltd (1988) 6 ACLC 85 (referred to by Fullagar J in Re US Masters Ltd (1991) 4 ACSR 462); and Steytler J in Re Parmelia Resources NL (1994) 15 ACSR 392 at 393 where his Honour said: 'I have questioned whether option holders are creditors of the company for the purposes of s411(1) of the Corporations Law…The question whether they are creditors of the company is not by any means novel. It has been asked in a number of cases in which the courts have been prepared to accept the proposition that option holders are contingent creditors, it is, I think, the case that each was ex parte, as this application is, and in some, at least, of the cases doubt has been expressed as to the correctness of that proposition…While, like Young J in [Re BDC Investments Ltd (No 2)] I am not at present prepared to let my doubts run against the tide of decision…it seems to me that these doubts should be made known to the option holders so that if any of them desires to appear on the return date and argue the point they may do so.' 20 Since Re Compania de Electricidad, a series of cases has held that optionholders are not members. (See: Re BDC Investments Ltd; Re Parmelia Resources NL.) However, these cases have simply followed the authority of Re Compania de Electricidad, which was not a case dealing with a proposed arrangement. In Re Compania de Electricidadthe issue was whether certain warrant holders were members for the purpose of the winding up of the company. The Court found that the warrant holders were not members because they had not expressly, or impliedly, agreed to become a member of the company. In the context of dealing with their status for the purposes of winding up, the Court found that the warrant holders should "be treated as merely contingent creditors" in respect of their potential claims. 21 The term "member", in relation to a company, is defined in s 9 of the Act, "unless the contrary intention appears",as: "a person who is a member under section 231". 22 Section 231 of the Act provides: 'A person is a member of a company if they: (a) are a member of the company on its registration; or (b) agree to become a member of the company after its registration and their name is entered on the register of members; or (c) become a member of the company under section 167 (membership arising from conversion of a company from one limited by guarantee to one limited by shares).' 23 On its face the term "member" as defined in s 9, does not appear to contemplate persons who are prospective members of a company, although the definition is not exhaustive. 24 The question that arises is whether a contrary intention is to be found in the terms of s 411. That is to say could the term "member" include "contingent members", being persons who have a right to become members by exercising an option to have shares issued to them upon tendering the sum prescribed for the exercise of the option. 25 It has been said that (in the form in which it was enacted in the relevant legislation in New South Wales) the intended effect of s 411 is to provide machinery for: (a) overcoming the impossibility or impracticability of obtaining the individual consent of every member of the class intended to be bound thereby; and (b) preventing, in appropriate circumstances, a minority of class members frustrating a beneficial scheme. (See Re Norfolk Island & Byron Bay Whaling Co [1970] 1 NSWR 221 at 223.) 26 It was submitted that the term "member" appears to be defined in the Act for the purpose of identifying who are "members" of a company at a particular point in time and, therefore, those persons who are entitled to exercise the bundle of rights which attach to membership of a company. 27 As the rights members and creditors have against a company originate in contract, it was submitted that the purpose behind s 411 is to give a company a mechanism through which it can compel all persons who hold a particular class of contractual rights against the company to enter into a compromise or arrangement altering their contractual relationship with the company. 28 Optionholders are persons whom the company may want to compel to enter an arrangement to alter an existing, or potential, contractual relationship. They have a right to elect to bind the company to a contract to issue shares and have their names entered upon the company's register of members by exercising an option to purchase the shares by tendering the sum payable in exercise of the option. Clearly, optionholders are not strictly members of a company until their names are entered on the company's register, but nonetheless they may be classified as "contingent members". Membership of the company is contingent only upon the optionholder deciding to exercise the option when the time for exercise of the option arrives. 29 Optionholders have rights that may affect, or be affected by, any variation in the rights of members of a company effected by an arrangement under s 411. It should be assumed that Parliament intended that the provisions of s 411 would be broad enough to allow a company to deal with its existing obligations, including contingent rights against the company that exist in the form of the rights of optionholders. 30 It is, therefore, consistent with the purpose of s 411 that the term "member" in s 411 should be given an interpretation sufficiently broad to include "contingent members" with whom a company may wish to propose a compromise or arrangement. (See also Renard and Santamaria Takeovers and Reconstructions in Australia Butterworths at [1511]). To take a contrary approach and interpret the term narrowly would frustrate the purpose of the section. 31 Therefore, the term "member" as used in s 411, should not be read as being confined to identifying persons who are members of a company in the strict sense of the word, but as a means of identifying a class of persons who have inchoate rights to become members, and whose contractual relations with a company may be affected by an arrangement implemented under that section. 32 Such a construction of s 411 is more satisfactory than straining the meaning of "creditor" to include optionholders as "contingent creditors". Optionholders have existing rights in relation to potential membership and are part of the existing structure of the company. It is simply a matter of time and election for the right to become a member to be crystallised. On the other hand, optionholders do not have existing rights in relation to monetary claims against the company and any "rights" they may have in that regard could not arise until there had been a breach by the company of the contractual obligation to issue shares upon exercise of the option. Therefore, in no sense, can they be considered present or contingent "creditors". 33 With regard to the proposed arrangement, I am satisfied that the meetings of the 2003 optionholders and of the 2005 optionholders held by Niagara on 2 September 2002 pursuant to the orders of the Court made on 29 July 2002 were duly held and that the proposed arrangement was approved by the requisite majorities of those classes of interested parties. 34 ASIC had a reasonable opportunity to consider the explanatory statement and raised no objection to the arrangement. 35 I am satisfied that the arrangement is fair and reasonable "from the perspective of an intelligent and honest person". The arrangement provides a present benefit to the optionholders by issuing shares to them at no cost in place of the uncertain prospect that the optionholders may hold a more valuable right in the options as at October 2003 or March 2005. The arrangement enables Niagara to remove the uncertainty of the exercise of the option rights upon the capital base of the company and present a more attractive capital structure to prospective investors and financiers. 36 Orders approving the arrangement will be made in the terms of the minute submitted by counsel. I certify that the preceding thirty-six (36) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Lee.