eircom Holdings Limited, in the matter of eircom Holdings Limited [2009] FCA 1418

Federal Court of Australia|2009-12-01|Before: Lindgren J

INTRODUCTION 1 On 9 November 2009, for the reasons that appear below, I made the orders that appear at the front of these reasons for judgment. 2 The plaintiff, eircom Holdings Limited (ERC - this "ASX ticker" for the plaintiff was used in affidavits and other documents filed, in written submissions and in the form of orders submitted and made, so I will also use it rather than the acronym EHL) sought orders under s 411(1) of the Corporations Act 2001 (Cth) (the Act). Those orders were: · that ERC convene a meeting of its shareholders, other than Emerald Communications (Cayman) SPC (ECC) and any person holding shares solely on behalf of ECC, (Scheme Participants) to consider, and if thought fit agree to, with or without modification, a proposed arrangement between ERC and the Scheme Participants (Scheme and Scheme Meeting); and · that the Scheme Booklet in evidence be approved as the explanatory statement required by s 412(1)(a) of the Act to accompany the notice convening the Scheme Meeting (Scheme Booklet). The Court granted leave to ECC to be heard as an "interested person": see Federal Court (Corporations) Rules 2000 (Cth), r 2.13(1)(c). 3 As Mr T F Bathurst QC who appeared for ERC remarked, the application raised two issues calling for special note. The first is that while ERC's directors recommended that the Scheme Participants agree to the Scheme in so far as the offer made to them was for cash consideration (Cash Consideration), they did not recommend either in favour of or against an alternative form of consideration offered, namely, an issue to Scheme Participants of shares in ECC (Scrip Consideration). 4 The second issue is that the Scheme Implementation Agreement (SIA) dated 13 September 2009 between ERC and ECC provided for payment of a break fee by ERC to ECC of $4 million, which was 1.9% of the equity value of ERC. That exceeds the 1% guideline established by the Takeovers Panel's Guidance Note 7: Lock-up Devices, para 7.17. 5 I will address these two issues in due course.

The Scheme 6 ERC is a public company incorporated in Australia. Its shares are on the official list of the Australian Securities Exchange (ASX). There are currently 167,904,914 ERC shares on issue. Prior to 27 April 2009, ERC was called "Babcock & Brown Capital Limited". 7 In substance, ERC has two classes of asset: cash of approximately $32 million (which will be reduced to approximately $24 million if the Scheme becomes effective because certain contingent liabilities will become actual liabilities) and 57.1% of the shares in eircom Group Limited (eircom). In the Scheme Booklet, eircom is described as "Ireland's incumbent telecommunications provider" (para 7.1(b)). It is heavily indebted. The Scheme Booklet identifies several risks associated with ERC maintaining its shareholding in eircom. 8 ERC's shareholding is subject to a shareholders' agreement with a Trust that indirectly holds approximately 35% of the shares in eircom, namely, the eircom Employee Share Ownership Trust (the ESOT). The beneficiaries in the ESOT are current and former employees of eircom. The shareholders' agreement imposes obligations and restrictions on both ERC and the ESOT in relation to eircom. 9 The facts mentioned in the preceding paragraph form some of the special circumstances that are relevant to the break fee issue to be addressed below. 10 ECC is a special purpose unlisted company that has been incorporated in the Cayman Islands for the purpose of acquiring the capital of ERC under the Scheme. ECC is a wholly owned subsidiary of STT Communications Ltd (STTC) which is a company incorporated in Singapore and which is wholly owned by Singapore Technologies Telemedia Pte Ltd. 11 Under the Scheme, ECC will acquire all the shares in ERC that it does not already hold or which are not held on its behalf (Scheme Shares). Scheme Participants may elect to receive: · the Cash Consideration, which is $0.40 per Scheme Share; or · the Scrip Consideration which is one fully paid ordinary share in ECC per Scheme Share; or · Scrip Consideration for a specified percentage of their Scheme Shares and Cash Consideration for their remaining Scheme Shares. 12 If a Scheme Participant does not make a valid election, the Scheme Participant will be deemed to have elected to receive Cash Consideration for all Scheme Shares held. 13 Scheme Participants who are (or who are acting on behalf of) citizens or residents of a jurisdiction other than Australia, Hong Kong, the United Kingdom and such other jurisdictions as ERC and ECC may agree in writing, or whose address in ERC's Share Register is outside of those jurisdictions (and outside of Australia's external territories) may not elect to receive the Scrip Consideration. They are deemed to have elected to receive the Cash Consideration. 14 If elections for the Scrip Consideration are received from Scheme Participants in respect of less than 16,790,491 Scheme Shares, there will be no Scrip Consideration at all and all Scheme Participants will receive the Cash Consideration alone. 15 If elections in favour of Scrip Consideration would result in more than 41,976,228 ECC Shares being required to be issued, a pro rata scale back will be implemented to ensure that that number is not exceeded (Scale Back). In that case, each Scheme Participant who has elected to receive Scrip Consideration will be entitled to receive only a reduced number of ECC Shares determined by the Scale Back formula, and Cash Consideration for the remaining Scheme Shares held.

Capital Reduction 16 ERC proposes to return capital surplus to the holders of fully paid ordinary shares in ERC as at the "Record Date" (Capital Reduction). The amount to be returned is $0.145 per Scheme Share held (Capital Reduction Amount), and on the basis of 167,904,914 ERC shares on issue, the capital to be returned will be $24,346,213. The Record Date is the fifth business day following the date on which the Scheme becomes effective. The date on which the Scheme becomes effective (Effective Date) is the date when the order of the Court made under s 411(4)(b) of the Act (Approval Order) becomes effective under s 411(10) of the Act. The Approval Order becomes effective on the date when an office copy of the Approval Order is lodged with the Australian Securities and Investments Commission (ASIC) or such earlier date as the Court determines and specifies in the Approval Order. I note that I fixed the application for final approval of the Scheme for hearing on 16 December 2009. 17 The Scheme and the Capital Reduction are inter-conditional. Neither can take effect unless the other is approved by the required voting majority of, as applicable, Scheme Participants and ERC shareholders, and in the former case, also by the Court. 18 If the Scheme is not implemented, the capital that would otherwise have been returned to ERC shareholders will be needed for working capital. If the Scheme is implemented, the result of the Capital Reduction will be that in substance ECC will be acquiring ERC's shareholding in its debt laden subsidiary, eircom, but will not be acquiring any of ERC's cash reserves. 19 The aggregate sum of $0.545 per ERC share (Cash Consideration of $0.40 plus the Capital Reduction Amount of $0.145) represents a premium of approximately 26.1% of the adjusted closing price of $0.43 per ERC share on 24 June 2009 (the last close prior to the announcement of STTC's initial proposal), and 36.4% to the adjusted three-month volume weighted average price of $0.40 per ERC share on that date. The closing price and the three-month volume weighted average price have been adjusted to account for a return of capital to ERC shareholders of $0.80per ERC share that took place on 30 September 2009, that is, a return of capital which took place after 24 June 2009 (the date as at which the prices of $0.43 and $0.40 were determined).

Conditions 20 The obligations of ERC and ECC to implement the Scheme are subject to satisfaction or waiver by the date of the Approval Order (Court Approval Date) of conditions that are set out in cl 6.2 of the SIA. Those conditions include the following: (a) that the Scheme Participants approve the Scheme at the Scheme Meeting by the requisite majority under the Act and that ERC shareholders approve the Capital Reduction at the Extraordinary General Meeting of ERC to be held immediately after the Scheme Meeting by the requisite majority under the Act (as to the Scheme, see s 411(4)(a) of the Act, and as to the Capital Reduction, see s 256C of the Act); (b) that this Court approves the Scheme under s 411(4)(b) of the Act; (c) that there are no legal restraints or prohibitions preventing the implementation of the Scheme and of the Capital Reduction as at 8am on the Court Approval Date; (d) that on or before 8am on the Court Approval Date, all of the necessary regulatory approvals required to implement the Scheme and the Capital Reduction have been granted or obtained and have not been withdrawn, cancelled or revoked. I was informed on the hearing that the Foreign Investment Review Board had granted its approval under the Foreign Acquisitions and Takeovers Act 1975 (Cth); (e) that on or before 8am on the Court Approval Date no "material adverse change" has occurred or become apparent; and (f) that on or before 8am on the Court Approval Date, the restructure of the entity called GPM Classified Directory (Managing and Marketing) Ltd (Golden Pages) is completed, or ERC has otherwise disposed of its interest in Golden Pages on terms approved by ECC, and ERC has no residual liability in respect of that disposal. I was informed on the hearing that this condition has now been satisfied.

Scheme Booklet 21 ERC proposed that the Scheme Booklet would constitute the explanatory statement for the Scheme for the purposes of s 412(1) of the Act, to be registered by ASIC under s 412(6) of the Act.

Independent Expert Report 22 The proposed Scheme Booklet contains as Attachment F an independent expert report prepared by Deloitte Corporate Finance Pty Limited (Deloitte). Deloitte's opinion is that the Scheme is in the best interests of, and fair and reasonable to, ERC shareholders.

Performance risk 23 A Deed Poll has been executed by ECC and its guarantor, STTC, in favour of each Scheme Participant, in order to make ECC's obligations under the Scheme and STTC's guarantee that ECC will perform those obligations, enforceable directly by the Scheme Participants. 24 In addition, cl 4.3 of the Scheme requires that five business days after the Record Date (Implementation Date), the Cash Consideration is to be deposited by ECC in a trust account in the name of ERC, to be held on trust for the relevant Scheme Participants before their ERC shares are transferred to ECC under the Scheme. On the Implementation Date, the ECC shares constituting the Scrip Consideration must be issued to each eligible Scheme Participant, and the names of the relevant Scheme Participants entered in the ECC share register. The transfer of the Scheme Shares to ECC is made subject to that payment and to that issue of ECC shares being made: cl 4.3(b). 25 Finally, an affidavit of Stephen Geoffrey Miller, the Chief Executive Officer of STTC, confirms that STTC has the ability to fund the Cash Consideration. The ECC funding arrangements are also described in s 9.4(b) of the Scheme Booklet.

Exclusivity provisions 26 Sections 13.1 to 13.3 of the SIA included fairly common exclusivity provisions including no-shop and no-talk restrictions on ERC. The period of operation of those provisions is from the date of the SIA to the earliest of: · the date of termination of the SIA in accordance with its terms; · the Effective Date (see [16] above); and · the "Sunset Date", which is the date that is six months after the date of the SIA: see Schedule 1 (Dictionary) to the SIA. 27 There is evidence that the exclusivity provisions were agreed to following normal commercial negotiations of those terms by ERC, ECC and STTC, and that it was the view of the ERC Board that ECC and STTC would not have agreed to enter into the SIA without them. 28 The evidence of the consideration given by the ERC's Board to the constraints sought by the bidder is generally in accordance with the approach that I discussed in Re APN News & Media Ltd (2007) 62 ACSR 400 (APN)at [55].

Warranty of freedom from encumbrances 29 Clause 8.3(a) of the Scheme provides that the Scheme Participants are deemed to have warranted to ERC in its own right and on behalf of ECC that they have full power and capacity to sell and to transfer the Scheme Shares to ECC, and that their ERC shares are transferred fully paid and free from all mortgages, liens, charges, pledges, and other interests or restrictions on transfer of any kind. Clause 13.14 of the Scheme Booklet draws attention to this warranty. 30 The warranty of freedom from encumbrances is consistent with the approach taken in APN at [59]-[62], which was followed by Barrett J in Macquarie Private Capital A Limited (2008) 26 ACLC 366 at [13]-[14].

Verification 31 There is evidence of a process of verification of the correctness of the content of the Scheme Booklet.

ASIC 32 ERC's solicitors provided a draft of the Scheme to ASIC on 23 October 2009. ASIC has provided its customary form of letter confirming that based on the information provided, ASIC did not propose to appear or to intervene to oppose the Scheme at the first court hearing. 33 I was satisfied that ASIC was given sufficient notice for the purposes of s 411(2)(a) of the Act. 34 I note that ASIC has granted certain exemptions, modifications and consents in relation to the requirements of the Act and the Corporations Regulations 2001 (Cth), and that these are referred to at cl 13.15 of the Scheme Booklet. 35 I turn now to the two issues mentioned at the outset of these reasons.

The Scrip Consideration 36 While the directors of ERC have unanimously recommended that ERC shareholders agree to the Scheme and the Capital Reduction in the absence of a superior proposal, they make no recommendation about the Scrip Consideration, except that ERC shareholders who are considering taking the Scrip Consideration for all or part of their ERC shares, should: · carefully consider the issues set out in identified sections of the Scheme Booklet relating to the features of the ECC Shares that constitute the Scrip Consideration; · carefully consider the risk factors set out in s 4.8 of the Scheme Booklet in relation to eircom (see below); and · consult their financial adviser or accountant about whether an investment in ECC shares will meet their individual investment objectives. 37 According to s 4.5 of the Scheme Booklet, because ECC is not listed and is regulated by the laws of the Cayman Islands and ECC's constituent documents, and not by the laws of Australia, the protections afforded to a Scheme Participant as a minority shareholder in ECC are very different from those applicable to a company incorporated in Australia that is listed on the ASX, as ERC is. The differences relate to, inter alia: the Australian continuous disclosure regime; the right to receive information about ECC; the takeover regime; and minority shareholder protection rights. 38 Section 4.5 of the Scheme Booklet also points out that because ECC is not listed, a Scheme Participant who has elected to receive the Scrip Consideration would have difficulty in disposing of ECC Shares. 39 For the above and other reasons, the directors of ERC inform Scheme Participants in the Scheme Booklet that they do not make any recommendation in relation to the Scrip Consideration, except that ERC shareholders considering electing to receive the Scrip Consideration for all or part of their ERC shares should consult their financial adviser, accountant or stockbroker about whether an investment in ECC suits their particular investment objectives. 40 I did not consider that the absence of a recommendation from the ERC directors in relation to the Scrip Consideration alternative stood in the way of the making of an order for the convening of the meeting of Scheme Participants. I took into account the following facts: · the directors recommended in favour of the Scheme in relation to the Cash Consideration and made clear their reasons for making no recommendation in respect of the Scrip Consideration; and · in the absence of a positive election by a Scheme Participant in favour of the Scrip Consideration, the Scheme Participant is deemed to elect to receive the Cash Consideration.

Break Fee 41 Under cl 14.2 of the SIA, ERC agreed to pay to ECC a break fee of $4 million in certain circumstances where the Scheme is not implemented. Clause 14.2 states that the sum of $4 million is a genuine pre-estimate of ECC's actual costs and expenses and those of its related bodies corporate incurred in respect of the proposed Scheme, including, but not limited to: · advisory costs, including costs of advisers other than success fees; · costs of management and directors' time; · out of pocket expenses; and · reasonable opportunity costs incurred by ECC in pursuing the Scheme or in not pursuing other alternative acquisitions or strategic initiatives which ECC could have developed to further its business and objectives. 42 The circumstances in which the break fee is payable can be summarised as falling into two classes: first, where a competing transaction, that is not recommended by ERC's board, emerges by 13 March 2010 and prevails within nine months of the date of the SIA in respect of more than 50% of all ERC shares; and, second, where any ERC director fails to recommend the Scheme or withdraws his or her recommendation in favour of it, except in certain defined circumstances. 43 There are fiduciary and statutory duty and "unacceptable circumstances" "carve outs" from the circumstances in which the break fee is payable. 44 In Attachment E to the Scheme Booklet (Summary of Material Agreements), s 1.8 sets out the following background to the paragraph in the SIA that provides for the break fee as follows: (a) This paragraph has been agreed in circumstances where: (i) ECC and ERC believe that the Proposal will provide significant benefits to ECC, ERC and their respective shareholders, and ECC and ERC acknowledge that, if they enter into the Scheme Implementation Agreement and the Proposal is subsequently not implemented, ECC will incur significant costs; (ii) ECC requested that provision be made for the payments outlined in paragraph (b), without which ECC would not have entered into the Scheme Implementation Agreement; (iii) both the ECC Board and ERC Board believe that it is appropriate for both parties to agree to the payment referred to in this to secure ECC's participation in the Scheme; and (iv) both parties have received legal advice on the Scheme Implementation Agreement and the operation of this provision. 45 The $4 million break fee represents: (a) 1.9% of the equity value of ERC as at 14 September 2009, being the date when the bid was announced to the market. This percentage has been determined in accordance with para 7.17 of the Takeovers Panel's Guidance Note 7: Lock-up Devices, which Idiscussed in APN at [55]. The calculation was: $4,000,000 ÷ (167,904,914 ERC shares x the closing price of ERC shares of $1.27 as at 14 September 2009) x 100 (b) 4.4% of the total value of the proposal determined in accordance with the principles set out in APN as follows: $4,000,000 ÷ (167,904,914 ERC shares x the total consideration offered under the proposal being $0.545 per ERC share) x 100 (c) 0.06% of the enterprise value of ERC as set out in the consolidated pro forma balance sheet at s 10.5(e) of the Scheme Booklet. 46 The "total consideration offered under the proposal" referred to in (b) above is arrived at by adding to the Cash Consideration of $0.40 per ERC share, the Capital Reduction Amount of $0.145 per ERC share. 47 In relation to (c) above, it is to be noted that in its Guidance Note 7: Lock up Devices, the Takeovers Panel stated (at para 7.21): In some limited cases, the Panel accepts that it may be appropriate for the 1% guideline to apply to a company's enterprise value rather than equity value, because for instance, the target is highly geared. In such a case, as with every fee in excess of 1% of equity value, a party seeking to justify the fee must be prepared to show that the fee does not have an anti-competitive or coercive effect. [Emphasis added] The "enterprise value of ERC" referred to in 45 above was arrived at as described at [49] below. 48 ERC pointed to several circumstances, some (not all) of which make the present case unusual in relation to the break fee, and submitted that they either support an enterprise value approach or otherwise demonstrate that the break fee of $4 million does not have an anti-competitive or coercive effect. I took all of those circumstances into account, both individually and in the aggregate, when ordering the convening of the Scheme Meeting. 49 First, ERC submits, and I accept, that regard should be had not only to the consideration that ECC will be providing under the Scheme and the equity value of ERC, but also to the nature of the underlying assets and liabilities of ERC that ECC will be acquiring if the Scheme is implemented. High gearing means risk, and may require an acquirer to contribute further equity capital or otherwise inject further funds. As set out in the consolidated pro forma balance sheet of ERC in s 10.5(e) of the Scheme Booklet, ERC has net consolidated debt of $6,637.8 million (borrowings of $7,232 million less cash of $594.2 million). The enterprise value of ERC is calculated by adding its equity value and the ERC Group's net debt ($91.5 million + $6,637.8 million), which equates to $6,729.3 million. The $4 million break fee represents 0.06% of this enterprise value - well below the 1% guideline. 50 Second, an estimate of ECC's costs of pursuing the Scheme was in evidence in the order of $10 million. According to a letter dated 6 November 2009 from ECC's solicitors to ASIC, ECC's estimate of its costs was as follows: ● external adviser costs (legal, financial and accounting advisers across several jurisdictions, including Mallesons, Mathesons and Conyers (Caymans)) approximately AUD$7M; ● management time (including senior management, internal teams from various business units and intensive due diligence in commercial, operational and technical areas from May to July) approximately AUD$2M; and ● expenses and disbursements (including airfares) approximately AUD$1M. The solicitors' letter advised ASIC that, according to ECC, its external adviser costs incurred up until to 6 November 2009 alone were approximately $2,750,000. 51 Furthermore, an affidavit of Siok Lan Pek, General Counsel of STTC, states: ECC has incurred substantial costs to date in connection with the Proposed Scheme, both in terms of engaging external legal and financial advisors, and in terms of the time spent by management and the board of ECC in progressing it. If, for any reason, the Proposed Scheme were not to proceed, those costs will have been thrown away. Accordingly, the SIA includes a provision that ERC will pay ECC A$4 million in the event that the Proposed Scheme does not proceed in certain limited circumstances ("Break Fee"). To the best of my information and belief, the Break Fee is a genuine pre-estimate of ECC's costs thrown away if the Proposed Scheme were not to go ahead. [Emphasis in original] 52 A break fee of $4 million is clearly considerably less than the $10 million estimate referred to above. 53 Third, ERC engaged in a very public formal strategic review from November 2008 to September 2009 through which it invited expressions of interest in the acquisition of ERC, including by announcements to the ASX on the following dates: (i) 10 November 2008; (ii) 17 March 2009; (iii) 21 April 2009; (iv) 7 July 2009; and (v) 6 August 2009. The SIA was dated 13 September 2009 and there was a further announcement to the ASX on 14 September 2009. 54 As part of the review, several third parties engaged in "due diligence" investigations of ERC, but at the conclusion of the process in September 2009 only STTC remained interested in the acqusition. 55 Despite the market being aware of the detail of an indicative offer made by STTC, no competing offer was made or proposed by a third party to ERC at any time before the SIA was executed on 13 September 2009. 56 Fourth, the break fee is payable only "for cause", not simply because the Scheme Participants vote down the Scheme, and it is highly unlikely that a superior offer will emerge given that the result of the public strategic review was the emergence of only one interested party. 57 Fifth, the amount of the break fee was heavily negotiated. STTC "sought more extensive triggers for its payment than those finally agreed in cl 14.2 of the SIA". ECC insisted on the inclusion of the break free provision as condition of making its offer to the ERC shareholders. 58 Sixth, there is evidence that by agreeing to the break fee, ERC was able to negotiate a $2 million limit on its liability for breach of the SIA. The cap originally proposed by ECC was $10 million, including the break fee of $4 million. It should be noted that the $2 million cap is mutual: it also applies to ECC's liability in damages to ERC and does so in circumstances in which its major asset is attended by certain risks, as mentioned earlier (see [7] above). 59 Damages are recoverable from ERC only where ECC terminates the SIA for specified reasons. In some of those circumstances ERC is liable to pay ECC liquidated damages of $2 million. According to the evidence, ERC's directors viewed the result achieved as being in the best interests of ERC shareholders, in particular because of ERC's lack of control over its major asset, its shareholding in eircom. ERC has followed a practice of returning surplus capital to its shareholders. Its directors wished to have cash available to meet ERC's future working capital requirements (assuming the non-implementation of the Scheme) and did not want to expose ERC's cash reserves to substantial damages claims. 60 Seventh, the offer represents a substantial premium to Scheme Participants. 61 I note that in Re Ausdoc Group Ltd (2002) 42 ACSR 629 (Ausdoc) the Takeovers Panel found that a break fee of $3.5 million, that was 1.86% of the equity value and 1.1% of the enterprise value of the target company, was unobjectionable in the circumstances of that case. Those circumstances included the facts that: · a six-month tender process had been conducted by the target company before it entered into the scheme implementation deed, yet no other bids had emerged; · the bidder had made it clear to the board of the target company that it would not bid unless, relevantly, the break fee provision was agreed to; and · the bid would give a substantial premium to the target company's shareholders. While each case turns on its own facts and, in any event, I must make my own assessment, it is nonetheless noteworthy that there are some similarities between the circumstances of Ausdoc and those of the present case. 62 In this case, I concluded that the existence of the provision for payment of a break fee of nearly twice the "1% of the equity value of the target" should not, in the unusual circumstances, stand in the way of the making of an order for the convening of a meeting at which the proposed Scheme can be considered and voted upon by Scheme Participants.

CONCLUSION 63 It was for the above reasons that I made the orders on 9 November 2009 referred to at the outset of these reasons for judgment. I certify that the preceding sixty-three (63) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Lindgren.

Counsel for the Plaintiff: Mr T F Bathurst QC

Solicitor for the Plaintiff: Gilbert & Tobin

Counsel for Emerald Communications (Cayman) SPC: Mr K Andronos

Solicitor for Emerald Communications (Cayman) SPC: Mallesons Stephen Jaques

At a glance

Court

Decision date

Before

Source

Judgment (18 paragraphs)

Legislation Cited (4)