What happened
CSR Limited applied to the Federal Court on 8 October 2009 for orders under s 411(1) of the Corporations Act 2001 (Cth) convening a meeting of its ordinary shareholders to consider a scheme of arrangement and approving the accompanying explanatory statement ([1]). The scheme involved the demerger of CSR's sugar and renewable energy business so that shareholders would receive shares in a new listed company (Sucrogen) while the residual building-products and aluminium business would remain in a renamed New CSR ([2]). Implementation required both shareholder approval of the scheme at a meeting convened under s 411 and passage of a separate Capital Reduction Resolution at a general meeting held immediately afterwards; if the capital reduction was not approved the demerger would not proceed ([14]).
A number of parties sought and were granted leave to intervene because of concerns that the capital reduction would diminish the assets available to meet CSR's asbestos-related liabilities. Those interveners were ASIC, the Attorney-General for New South Wales, the James Hardie parties and the Asbestos Injuries Compensation Fund Limited (the Fund) ([3]). CSR had ceased manufacturing asbestos products in 1977. Its half-year 2009 accounts showed a provision of $446.8 million for known and probable future asbestos claims, representing 10 per cent of CSR's total assets but 18 per cent of the pro-forma assets of New CSR ([19]-[20]). Actuarial estimates of the net present value of liabilities ranged from CSR's provision of $446.8 million to worst-case figures of $661 million (CSR's advisers) and $896.5 million (KPMG for the Fund). CSR's evidence was that New CSR's projected cash flow would be sufficient to meet liabilities as they arose over the next 40 years without asset sales, although bank covenant breaches were possible in extreme scenarios ([21]).
The interveners emphasised the long-tail nature of asbestos claims (20-50 years), the uncertainty of actuarial projections (evidenced by 57-89 per cent increases in estimates over the preceding five years) and the social cost if claimants were left without adequate assets ([23]). The primary judge (Stone J) dismissed the application on 3 February 2010. Her Honour was not satisfied that the scheme was consistent with commercial morality or that it would not produce an unfair or oppressive result for future asbestos claimants. She also held that the explanatory statement could not give shareholders adequate disclosure of New CSR's ability to meet future liabilities ([4], [35]-[36]).
CSR sought leave to appeal. The Full Court (Keane CJ, Finkelstein and Jacobson JJ) heard the application for leave and the appeal together. On 23 April 2010 the Full Court granted leave, allowed the appeal, set aside the primary judge's order, directed that a meeting of ordinary shareholders be convened under s 411(1) and remitted the proceedings to a single judge ([70], Orders 1-4).
Why the court decided this way
The Full Court held that the primary judge had erred in the exercise of the s 411(1) discretion. Keane CJ and Jacobson J (with whom Finkelstein J substantially agreed) identified three principal errors. First, her Honour proceeded on an incorrect understanding that CSR's actuarial models omitted the category of persons who had not yet manifested asbestos-related disease; the reports in evidence quantified the present value of all future long-term exposure and there was no basis for concluding that any category of claimant had been omitted ([32], [56]). Second, the primary judge invoked an undifferentiated concept of public policy and commercial morality without tying it to the text, subject matter and purpose of the Corporations Act ([33], [51]).
Third, and most critically, the only discretionary factor capable of justifying refusal at the convening stage was whether the associated capital reduction would materially prejudice New CSR's ability to pay its creditors, including all past, present and future asbestos claimants ([34]). The Court held that s 256B(1)(b) supplies the relevant statutory policy: a company may reduce capital if the reduction "does not materially prejudice the company's ability to pay its creditors" ([15]). "Material prejudice" means a material, as opposed to merely theoretical, increase in the likelihood that creditors will not be paid ([45]). The evidence, including that led by the interveners, did not establish that New CSR would be unable to meet liabilities even in worst-case stress scenarios; the projected cash flows, asset base and ability to cure minor covenant breaches meant any risk remained theoretical ([21], [46]-[49]).
Finkelstein J added that the convening hearing is "emphatically not" the occasion to weigh the merits or fairness of the scheme ([72]). Only schemes that on their face are so blatantly unfair or raise issues that would unquestionably lead to refusal should be stopped at that stage ([76]). The voluminous competing actuarial reports raised complex questions unsuitable for summary determination without cross-examination; such disputes should be left for the approval hearing or s 1324 proceedings ([78]). Because the primary judge had not found material prejudice, and because the Act expressly contemplates capital reductions that may increase abstract risk provided they do not materially prejudice creditors, the discretion miscarried ([66]). The Court therefore granted leave, allowed the appeal and ordered that the meeting be convened so that shareholders could vote and objectors could, if so advised, pursue more focused challenges later ([67]-[69]).
Before and after state of the law
Before this judgment the law governing the convening stage under s 411(1) (and its predecessors) was drawn from a line of cases that emphasised limited judicial scrutiny. The Full Court cited Australian Securities Commission v Marlborough Gold Mines Ltd (1993) 177 CLR 485 at 504-505 for the proposition that the convening application is interlocutory and does not determine whether the scheme ultimately falls within the section ([57]). Emmett J's synthesis in Re Central Pacific Minerals NL [2002] FCA 239 at [8]-[11] was accepted by all parties as stating the guiding principles: the court asks whether the scheme is of a nature that it would likely be approved if passed by the majorities, pays paramount attention to disclosure, and considers commercial morality and public policy, but does not finally resolve contested merits ([12]).
French J in Re Foundation Healthcare Limited (2002) 42 ACSR 252 at [36] and [44] had said that leave should be given if the arrangement is fit for consideration by the meeting and is a commercial proposition likely to gain approval; only schemes that appear on their face "so blatantly unfair or otherwise inappropriate" should be stopped ([58]). Santow J in Re NRMA Insurance Ltd (No 1) (2000) 156 FLR 349 had noted two streams of authority—one favouring limited procedural review and the other more merits-based—and expressed preference for the former ([75]). English authorities such as Re Hawke Insurance Co Ltd [2002] BCC 300 and Re T & N Ltd [2006] EWHC 1447 (Ch) were cited for the proposition that an applicant should not be required to accept the risk that an unopposed convening order will later be held pointless ([61]).
The judgment alters the landscape in two respects. First, it firmly ties the content of "public policy" and "commercial morality" to the statute itself. Keane CJ and Jacobson J held that the policy on capital maintenance is not single-minded; s 256B expressly permits reductions that satisfy the three conditions in s 256B(1), and the court must take instruction from that balanced text rather than pursue capital preservation at all costs ([52]-[53]). Finkelstein J went further, stating that "notions of commercial morality should be jettisoned" because they are ill-defined and subjective; fairness and reasonableness to members, creditors and third parties (as discussed in Re Alabama and Re National Bank Ltd) are sufficient ([82]-[86]).
Second, the judgment clarifies the threshold for refusal at the convening stage. The court should not use the convening hearing to conduct a mini-trial of complex factual issues (such as actuarial uncertainty) that do not clearly demonstrate the scheme is bound to fail ([64], [76]). After the decision, convening applications are to focus on whether the scheme is blatantly unfair on its face or raises incontrovertible jurisdictional bars; contested merits and disclosure disputes that can be cured by qualified statements are to be deferred to the approval hearing or separate s 1324 proceedings. The judgment therefore narrows the occasions on which a convening order will be refused and reinforces the two-stage nature of the statutory process.
Key passages with plain-English translation
Paragraph [45]: "One is, we think, on safe ground, however, in treating 'material prejudice' to a company's ability to pay its creditors as relating to the creation of a material as opposed to theoretical increase, in the likelihood that the reduction in capital will result in a reduced ability to pay creditors."
Plain-English translation: The law does not stop every possible risk that creditors might not be paid. Only a real, noticeable extra chance that creditors will go unpaid counts as "material prejudice". A small or purely theoretical risk is not enough to block the transaction at this early stage.
Paragraph [51]: "The particular content of 'commercial morality' and 'public policy' relevant to the exercise of the discretion in s 411(1) of the Act is to be discerned from the text and subject matter of the Act: Project Blue Sky Inc v Australian Broadcasting Authority (1998) 194 CLR 355 at [69]-[70]; Attorney-General (Cth) v Alinta Limited (2008) 233 CLR 542 at [147]."
Plain-English translation: Judges cannot invent their own ideas of what is morally right in business. They must read the Corporations Act itself to discover what Parliament has decided is acceptable. The statute, not vague community standards, sets the boundaries.
Paragraph [64]: "The Court should not promote the waste of resources and the raising of false hopes or the creation of unnecessary concern and anxiety by promoting a process which will clearly not proceed to consummation under s 411(4)(b)."
Plain-English translation: It is pointless and unfair to make shareholders and everyone else go through the expense and stress of a meeting if it is obvious the court will never approve the scheme at the end. But if the scheme might be approved, the meeting should be held.
Paragraph [76]: "Thus an enquiry into the merits at the convening stage will only be warranted if there is a clear indication that the scheme will not be approved. The indication may appear from the terms of the scheme. Or it may arise out of an incontrovertible fact."
Plain-English translation: At the first hearing the judge should not try to decide who is right in a complicated argument. Only if the scheme is obviously doomed—either from its own wording or from an undisputed fact—should the judge refuse to let the meeting go ahead.
Paragraph [86]: "In my opinion, notions of commercial morality should be jettisoned from the matters to be considered in approving a scheme. It is dangerous to bring to decision-making an ill-defined and largely subjective set of criteria purporting to represent the views of the community when, in reality, no one can be sure of that."
Plain-English translation: The phrase "commercial morality" is too vague and changes over time. Judges should stop using it. They should instead ask whether the scheme is fair and reasonable to the people it affects, using the rules set out in the Act.
What fact patterns trigger this precedent
This judgment is triggered when a company seeks to implement a demerger or other restructuring by a members' scheme of arrangement that is conditional on a simultaneous capital reduction, and one or more classes of long-tail or contingent creditors (particularly asbestos or product-liability claimants) assert that the reduction will leave insufficient assets or cash flow to meet their claims. The precedent applies with particular force where actuarial or expert evidence shows genuine uncertainty about the quantum of future liabilities but does not establish that the post-restructure entity will be unable to meet those liabilities even in worst-case scenarios ([21], [46]).
It is engaged whenever an objector invites the court at the convening stage to refuse relief on the basis of "commercial morality" or "public policy" untethered to the statutory text. The decision makes clear that such objections will fail unless the court can be satisfied that the scheme is blatantly unfair on its face or that material prejudice within the meaning of s 256B(1)(b) will occur ([58], [76]). The fact pattern also includes cases in which the primary judge has attempted to resolve contested expert evidence without cross-examination and without making an explicit finding that the statutory test for material prejudice has been breached ([32], [78]).
The precedent is not confined to asbestos; any contingent or unliquidated claim that gives rise to a theoretical rather than material risk of non-payment after a capital reduction will engage the same reasoning. Conversely, if credible evidence demonstrates that the reduction will create a material (i.e. more than fanciful) increase in the probability that creditors will go unpaid, and that the scheme is therefore unlikely ever to obtain final approval, the convening order may still be refused ([64]).
How later courts have treated it
The judgment itself reviews and synthesises earlier authorities, and therefore indicates how subsequent courts should treat the cases it cites. It applied the statement in Australian Securities Commission v Marlborough Gold Mines Ltd (1993) 177 CLR 485 that the convening application is interlocutory and does not finally determine the scheme's merits ([57]). It treated Re Central Pacific Minerals NL [2002] FCA 239 as correctly stating the general principles but qualified the breadth of the "commercial morality" limb by reference to the statutory text ([12], [51]). Project Blue Sky and Carr v Western Australia were used to anchor public-policy analysis in the statute rather than free-standing notions of fairness ([51], [53]).
Re Foundation Healthcare Limited and Re T & N Ltd were considered and preferred to the extent that they limit merits review at the convening stage to cases that are blatantly unfair or would unquestionably fail ([58], [74]-[76]). The judgment disapproved, at least impliedly, any broader use of "commercial morality" that is not grounded in the Act, as illustrated by its favourable citation of Re Avram Investments Pty Ltd (1992) 10 ACLC 1747 where Heerey J declined to apply the concept to a tax-loss scheme ([85]).
Because the present judgment is the source text, it cannot cite its own subsequent treatment. However, the principles it lays down—particularly the insistence that s 256B supplies the exhaustive creditor-protection policy for capital reductions and that only material (not theoretical) prejudice engages that policy—now govern how later courts must approach similar applications. The rejection of subjective commercial-morality tests and the emphasis on deferring complex factual disputes to the approval hearing or s 1324 proceedings represent the binding framework for future convening applications involving contingent liabilities.
Still-open questions
The judgment leaves open exactly how a court should quantify "material" prejudice in borderline cases. While it adopts the explanatory memorandum's statement that materiality is a question of judgment in all the circumstances ([45]), it does not prescribe a numerical threshold or a precise methodology for weighing cash-flow projections against worst-case actuarial tails. Future courts must therefore decide on a case-by-case basis whether a projected covenant breach that can be cured by cutting $6 million in costs or raising $20 million in equity crosses the materiality line ([21]).
A further open question is the precise role of disclosure when the underlying dispute concerns the fairness of the scheme itself. Finkelstein J noted that deficient disclosure can sometimes mask a substantive unfairness argument and that, where possible, the explanatory statement should contain appropriately qualified statements or competing views rather than force a final resolution at the convening stage ([77]). The boundaries of that approach—when a dispute is so intractable that disclosure cannot be adequate without deciding the merits—remain for later decisions.
The judgment also leaves unresolved the interaction between s 411 convening orders and parallel s 1324 proceedings brought by contingent creditors. It observes that s 1324 may be a more suitable vehicle for testing material prejudice because the company bears the onus of proving a negative ([55]), yet it does not decide whether a court should stay or adjourn a convening application while such proceedings are on foot. Finally, although Finkelstein J would jettison "commercial morality" entirely ([86]), the joint judgment retains the term but confines its content to the statute. Whether later courts will treat that concept as wholly subsumed within fairness and reasonableness, or continue to invoke it in a narrower statutory sense, is not settled by this decision.
The Gotchas most practitioners miss are that the convening hearing is not a dress rehearsal for the final approval hearing. Objectors who succeed in persuading a primary judge to conduct a mini-trial on actuarial uncertainty may find the Full Court reverses on the basis that such an enquiry was premature. Equally, companies that treat the capital reduction as irrelevant to the scheme because it is voted on separately risk the court correctly treating it as a condition precedent that must satisfy s 256B before the s 411 process can advance ([14]). Finally, the judgment warns that an applicant who refuses reasonable requests (such as a deed poll from the new sugar entity) may inadvertently strengthen the perception that the risk of prejudice is material rather than theoretical ([42]). These forensic realities, grounded in the reasons at [14], [32], [55], [64] and [78], explain why experienced counsel now front-load disclosure qualifications and focus their evidence on cash-flow sufficiency rather than debating the concept of commercial morality.