In the matter of McGrath Limited [2024] NSWSC 555

Affidavit evidence

1. McGrath reads the affidavit dated 11 April 2024 of Mr Luke Hastings, a solicitor acting for McGrath, which annexes the ASX announcement made by McGrath in respect of the proposed scheme and a company search for McGrath obtained from the Australian Securities and Investments Commission ("ASIC") on 11 April 2024, which establishes that McGrath is a Part 5.1 body. By a second affidavit dated 6 May 2024, Mr Hastings provides further information concerning electronic access to scheme documents.
2. McGrath also the affidavit dated 3 May 2024 of Mr Howard Herman, who is the Chief Financial Officer of McGrath, which addresses the business and capital structure of McGrath; the verification of the factual information relating to McGrath in the proposed scheme booklet; the notification to ASIC of this hearing and provision to ASIC of a draft of the proposed scheme booklet and the scheme more than 14 days ago; the consents to act as chair or alternate chair of the proposed scheme meeting, for the purposes of r 3.2 of the Supreme Court (Corporations) Rules 1999 (NSW) ("Rules"); retention payments and fees proposed to be paid to certain McGrath employees or directors including Mr McGrath; the basis on which McGrath shareholders who make a valid Election to receive the Rollco Scrip Alternative will become bound by Rollco's constitution and the Rollco Shareholders' Deed and, to the extent that their Rollco Scrip Alternative is issued to a nominee to hold as bare trustee on their behalf, the Nominee Deed (as defined). Mr Herman also refers to the current intent of the McGrath board to pay a fully franked Permitted Dividend (as defined) prior to implementation of the scheme; the amount of the break fee contemplated by the SID as a percentage of the equity value of McGrath; the length of the exclusivity period applicable to the exclusivity provisions in the SID; the proposed treatment of McGrath Equity Incentives (as defined) if the scheme becomes effective; and the proposed manner of dispatch of materials to McGrath shareholders and other communications in relation to the scheme.
3. McGrath also reads the affidavit dated 6 May 2024 of Mr Alastair Corrigall, a solicitor acting for the Consortium, which addresses the verification of the factual information relating to the Bidder in the proposed scheme booklet and the funding for the scheme consideration, the verification of the statements of intention attributable to the Bidder's board in the proposed scheme booklet and the execution of a deed poll dated 3 May 2024 in favour of McGrath shareholders ("Deed Poll").
4. McGrath also tenders a letter dated 6 May 2024 from ASIC in customary form, reserving its position as to s 411(17) of the Act to the second Court hearing and indicating that it does not propose to appear at the first Court hearing, and a second letter also dated 6 May 2024 from ASIC granting a waiver sought by McGrath in respect of certain information contained in the scheme booklet on specified conditions.

Applicable principles

1. Mr Wood points out and I accept that the principles governing an application for orders to convene a meeting of members under s 411(1) of the Act are well settled, and the Court has a discretion to make an order under that section if a compromise or arrangement is proposed between a Part 5.1 body and its members (or any class of them); the application for the order is made in a summary way by the body; the procedural requirements of the Rules have been met; the scheme booklet provides proper disclosure to shareholders; 14 days' notice of the hearing of the application, or such lesser period as the Court or ASIC permits, has been given to ASIC. The Court will also wish to be satisfied that ASIC has had a reasonable opportunity to examine the terms of the proposed compromise or arrangement to which the application relates and a draft explanatory statement relating to the proposed compromise or arrangement; and make submissions to the Court in relation to the proposed compromise or arrangement and the draft explanatory booklet; and that there is no apparent reason why the scheme should not, in due course, receive the Court's approval if the necessary majority of votes is achieved.
2. I accept that each of these requirements is met here, subject to the specific issues which I note below. McGrath is a Part 5.1 body and the scheme is an acquisition scheme, and an "arrangement" within the scope of the section. The chair and the alternate chair nominated for the proposed scheme meeting have each confirmed the matters required by r 3.2(b) of the Rules; McGrath will give notice of the second Court hearing by an ASX announcement in accordance with current scheme practice; and the proposed draft orders convening the scheme meeting are otherwise consistent with the Rules. ASIC has had appropriate notice of and the opportunity to consider the scheme, as evidenced by Mr Herman's affidavit and ASIC's customary letter in respect of the first Court hearing, to which I referred above.
3. Mr Wood also submits that the principles which apply to the exercise of the Court's discretion are well‑understood, and he refers to my observations in Re Villa World Ltd (2019) 139 ACSR 550; [2019] NSWSC 1207 at [17]-[19] that: "The Court will not ordinarily convene a scheme meeting unless the scheme is of such a nature and cast in such terms that, if it receives the statutory majority at the meeting, the Court would be likely to approve it on the hearing of an application that is unopposed: F T Eastment & Sons Pty Ltd v Metal Roof Decking Supplies Pty Ltd (1977) 3 ACLR 69 at 72, approved in Australian Securities Commission v Marlborough Gold Mines Ltd (1993) 177 CLR 485 at 504. In Re Foundation Healthcare Ltd [2002] FCA 742; (2002) 42 ACSR 252 at [36] and [44], cited with apparent approval in Re CSR Ltd [2012] FCAFC 34; (2010) 183 FCR 358 at [58], French J observed that: '… It is however important to bear in mind that, by granting leave to convene the meeting, the court does not give its imprimatur to the proposed scheme. If the arrangement is one that seems fit for consideration by the meeting of members or creditors and is a commercial proposition likely to gain the court's approval if passed by the necessary majorities, then leave should be given: Re ACM Gold Ltd (1992) 34 FCR 530 ; 107 ALR 359; 7 ACSR 231; 10 ACLC 573 (O'Loughlin J). The court is not required to give close consideration to the effects of the scheme upon individual members of the classes of members or creditors affected. So to do would be to "introduce burdensome and to a large extent ineffectual consideration at this interlocutory stage": Re Jax Marine Pty Ltd [1967] 1 NSWR 145 at 148 (Street J). The court at the stage of ordering a meeting to approve a scheme does not ordinarily go very far into the question of whether the arrangement is one which warrants the approval of the court … That question is to be answered when the scheme returns to the court for final approval. That is not to exclude the possibility that a scheme may appear on its face so blatantly unfair or otherwise inappropriate that it should be stopped in its tracks before going any further.' At the first Court hearing, the Court is concerned not with whether final approval should be given to the scheme, but whether the scheme is one which is adequately explained to those who have a financial interest in it, and whether there is any obvious flaw in the scheme, such that it would be inappropriate even for it to be submitted for shareholders' consideration: Re Abacus Funds Management Ltd [2005] NSWSC 1309; (2006) 24 ACLC 211 at [23]. [Counsel] also points out that the Court is not required to be satisfied that no better scheme could have been proposed, and the question is instead whether it is reasonable to suppose that sensible business people might consider the arrangement proposed is of benefit to members: Re Centrebet International Ltd [2011] FCA 870 at [29]; Re SAI Global Ltd [2016] FCA 1312 at [18]. [Counsel] also refers to Farrell J's summary of the manner in which the Court's discretion to convene a scheme meeting will be exercised in Re Associated Advisory Practices Limited [2013] FCA 761 at [22], which reflects a number of the principles to which I have referred above: 'The court will not ordinarily convene a meeting of members to consider a scheme of arrangement unless the court is satisfied that the scheme is of such a nature and cast in such terms that, if it receives the statutory majority at the meeting of members, the court would be likely to approve the scheme on the hearing of an unopposed application: Re Central Pacific Minerals NL [2002] FCA 239 at [8]; Re CSR Ltd (2010) 183 FCR 358 at [12]; Australian Securities Commission v Marlborough Gold Mines Ltd (1993) 177 CLR 485 at 504. By granting leave to convene the meeting, the court does not give its imprimatur to the proposed scheme or foreshadow its approval at the second court hearing for the purposes of s 411(4)(b): Re Foundation Healthcare Ltd (2002) 42 ACSR 252 at [36]; Australian Securities Commission v Marlborough Gold Mines Ltd at 504-505. The question for the Court is whether it is reasonable to suppose that sensible business people might consider the arrangement proposed as being beneficial to members: In Re Alabama, New Orleans, Texas and Pacific Junction Railway Co [1891] 1 Ch 213 at 243; Re CSR Ltd at [80]. The court does not need to be satisfied that no better scheme could have been proposed: Re Foundation Healthcare Ltd at [44]. Ultimately, the question is for the members themselves: see FT Eastment & Sons Pty Ltd v Metal Roof Decking Supplies Pty Ltd (1977) 3 ACLR 69 at 72.'"
4. This scheme is an acquisition scheme in largely common form. Although the scheme consideration is more complex, by reason of the Rollco Scrip Alternative, that alternative takes a form that has been accepted in several previous cases, including Re Aveo Group Ltd [2019] NSWSC 1348; Re BINGO Industries Ltd [2021] NSWSC 798; Re Healthia Ltd [2023] NSWSC 1296 and Re Millennium Services Group Ltd [2024] NSWSC 307. An appropriate verification procedure has been adopted for the information contained in the scheme booklet.
5. As Mr Wood points out, the McGrath board unanimously recommends that McGrath shareholders vote in favour of the scheme, in the absence of a superior proposal, and subject to the independent expert continuing to conclude that the scheme is fair and reasonable and in the best interests of McGrath shareholders and, subject to the same qualifications, each McGrath director intends to vote all McGrath shares held or controlled by them in favour of the scheme. The McGrath board's recommendation is based on the quantum of the All-Cash Alternative, and it makes no recommendation in relation to the Rollco Scrip Alternative. I accept that approach is common where a scheme includes alternative consideration in the form of "stub equity", where that alternative consideration will likely have greater risk than a cash alternative and whether it is an appropriate investment will likely depend on the characteristics and risk profile of individual shareholders. I recognise that this approach was accepted in the cases to which I referred above. An independent expert's report of Ms Planinic and Mr Resende of Lonergan Edwards & Associates Ltd ("LEA") indicates their opinion that the scheme is fair and reasonable and in the best interests of McGrath shareholders in the absence of a superior proposal, on the basis that the All-Cash Alternative is within their assessed valuation range for McGrath shares on a 100% controlling interest basis, and the All-Cash Alternative is fair and also in the best interests of McGrath shareholders on that basis.
6. I recognise that the independent expert report evaluates the scheme by reference to the value of the All-Cash Alternative only, although LEA's report also provides McGrath shareholders with a comparison between the All-Cash Alternative and the Rollco Scrip Alternative options, which indicates that the midpoint value of the Rollco Scrip Alternative is less than the All-Cash Alternative. Mr Wood submits and I accept that it is not uncommon for independent experts to make no recommendation in relation to a "stub equity" alternative, due to the difficulty of accurately valuing stub equity, and that approach has been adopted is several of the cases to which I referred above. I see no difficulty with it and it will be plain to McGrath shareholders from the scheme booklet that the Rollco Scrip Alternative involves additional risks to the All-Cash Alternative.
7. For these reasons, and subject to that additional matters that I address below, I am satisfied that the scheme is fit for consideration by the proposed scheme meeting, in the sense that it is of such a nature and cast in such terms that, if it achieves the statutory majority at the meeting, the Court would be likely to approve it on the hearing of a petition which is unopposed; and there is no reason to doubt that McGrath shareholders are to be properly informed as to the nature of the scheme. I accept that there is nothing in the terms of the scheme, or in its effect on McGrath shareholders, that would warrant the Court declining to permit its consideration by those shareholders.

Additional matters

1. Consistent with the ex parte nature of the application, Mr Wood also draws attention to several particular aspects of the scheme.
2. First, he refers to the scrip component of the scheme consideration, comprising the Rollco Scrip Alternative to which I referred above. He points out that the scrip consideration option takes a form that is colloquially referred to as "stub equity", meaning a minority equity interest offered to shareholders of a scheme company or a takeover target by an acquiring entity or bidder, and submits that the rationale for the offer of "stub equity" is to allow existing shareholders the opportunity of retaining an equity interest in the target, although the acquirer maintains control over the target. Mr Wood notes, as previous case law has also recognised, that ASIC has previously expressed concern about offers of "stub equity" consideration in control transactions where the consideration offered is shares in an Australian proprietary company and where accepting shareholders are required to hold the offered scrip consideration through a custodial arrangement, and he refers in this respect to ASIC Consultation Paper 312 Stub equity in control transactions and ASIC Corporations (Stub Equity in Control Transactions) Instrument 2020/734 ("Instrument"). He points out that the Instrument permits bidders to make "stub equity" offers using an Australian public company with compulsory custodial arrangements on specified conditions, which the form of the Rollco Scrip Alternative satisfies. He also points out that a summary of the rights, liabilities, and risks relating to the Rollco shares is set out in the Rollco shareholders' deed and in sections 7.4 and 8 of the scheme booklet.
3. Mr Wood submits, and I accept, consistent with previous case law, that the offer of the Rollco Scrip Alternative would not warrant the Court declining to convene the scheme meeting, where the scheme booklet contains detailed and prominent disclosure of the risks involved in McGrath shareholders choosing that alternative. I accept, again consistent with the earlier case law, that there is no public policy reason why an acquirer ought not be able to offer scrip consideration in the form of shares in an unlisted public company, provided adequate disclosure is made of the terms of issue and the risks of an investment in those securities.
4. Second, Mr Wood notes that Ineligible Foreign Shareholders (as defined) will receive the All-Cash Alternative under the scheme and cannot validly elect to receive the Rollco Scrip Alternative and that matter is prominently disclosed in the scheme booklet. That approach is also common practice and I accept that "Ineligible Foreign Shareholders" do not constitute a separate class for that reason: Re Hills Motorway Ltd (2002) 43 ACSR 1010 at 104; [2002] FCA 973.
5. Third, Mr Wood addresses the position as to "McGrath Equity Incentives". Section 10.2 of the scheme booklet indicates that McGrath operates a long-term incentive plan ("LTI Plan") and an agent share plan ("Agent Share Plan"), under which it has issued equity incentives ("McGrath Equity Incentives"), and also operates a short term incentive plan which is cash settled and does not entitle the holder to McGrath shares. Under cl 6.6(b) of the SID, McGrath is required to ensure that all McGrath Equity Incentives which are not McGrath shares have been cancelled or vested and converted to McGrath shares, as at the Scheme Record Date (as defined), and the manner in which this will occur is again in common form and is set out in section 10.2(b) of the scheme booklet. Mr Wood submits and I accept that holders of performance rights or similar rights to receive McGrath shares who are also McGrath shareholders are not in a separate class of members by reason only that they also hold such rights: Re Foster's Group Ltd (No 2) [2011] VSC 547 at [38]-[43]; Re Cashcard Australia Ltd (2004) 48 ACSR 738; [2004] FCA 223 ("Cashcard"). For completeness, section 10.1 of the scheme booklet notes that none of the McGrath directors have a relevant interest in any McGrath Equity Incentives, and no further issue of disclosure arises in that regard concerning their recommendation to shareholders as to the scheme.
6. Fourth, Mr Wood points out that retention payments are being paid to certain McGrath employees in order to retain their services during the scheme process. These include Mr John McGrath, who as I noted above is McGrath's Managing Director and Chief Executive Officer, who will be entitled to receive a cash bonus payment of up to $250,000 for the financial year ending 30 June 2024. Mr McGrath's entitlement to that payment is disclosed in the chair's letter and in sections 1.2(a), 2, 4.8(a), and 10.3(f) of the scheme booklet. Mr Wood also addresses the position in respect of a consulting fee previously paid to a non-executive director of McGrath, and additional fees of $4,000 per month payable to several non-executive directors from 1 February 2024 until the implementation date of the scheme in respect of their services in connection with the scheme.
7. Mr Wood rightly recognises that, where a director will receive a substantial benefit in relation to a scheme which other shareholders will not receive, that benefit should be disclosed as a matter for shareholders to take into account if that director makes a recommendation as to the scheme, and a director may generally make such a recommendation if sufficient disclosure of the relevant director's interest in the scheme is provided to shareholders: Re Kidman Resources Ltd (2019) 139 ACSR 112; [2019] FCA 1226 at [115]; Re DWS Ltd (2020) 148 ACSR 616; [2020] FCA 1590 at [41]-[49]. I am satisfied that Mr McGrath's interest and that of other directors is sufficiently disclosed in the proposed scheme booklet to allow shareholders to take it into account in respect of their recommendation as to the scheme. I also accept that the fact that directors, officers or employees of a scheme company who are also shareholders receive additional payments or other benefits in connection with, but not under the terms of, a scheme of arrangement, will not of itself result in those directors, officers or employees forming a separate class at the scheme meeting: Cashcard at [11] - [13]; Re Webster Ltd [2019] NSWSC 1907 at [33]; Re Nzuri Copper Ltd [2019] WASC 189 at [37].
8. Fifth, Mr Wood points out that, under cl 15.2 of the SID, McGrath must pay the Bidder a break fee of $955,065 in specified circumstances. No break fee is payable merely because the resolution submitted to the scheme meeting is not approved by the required majorities, and that break fee represents just under 1% of the equity value of McGrath implied by the transaction consideration, consistent with the Australian Takeovers Panel's guidance in this respect. This matter gives rise to no reason not to convene the scheme meeting.
9. Sixth, Mr Wood addresses the questions of funding of the scheme consideration and performance risk, which is of particular significance where a bidder is a special purpose entity and the acquisition is to be funded by a consortium. The harmonised scheme practice note, as reflected in Supreme Court Practice Note, SC Eq 4, Supreme Court Equity Division- Corporations List ("Practice Note"), [28(b)], notes that: "Where a special purpose vehicle with minimal assets is to acquire securities of substantial value under a scheme, a risk of a scheme not completing is likely to be material to securityholders, irrespective of the fact that their securities are not transferred to that special purpose vehicle until the consideration is paid. Disclosure of such a risk is also important to maintaining a fully informed market. Evidence should be led at the first Court hearing of the availability of the funding or other financial support on which the special purpose vehicle will rely to complete the scheme."
10. The approach adopted in the Practice Note addresses a risk that has also been recognised in the case law: Re Spark Infrastructure RE Ltd [2021] NSWSC 1564; Re Sydney Airport Ltd and Trust Co (Sydney Airport) Ltd as responsible entity for Sydney Airport Trust 1 [2022] NSWSC 25; Re ELMO Software Pty Ltd [2023] NSWSC 12 ("ELMO"). Even where the mechanism of a scheme protects shareholders in a scheme company against the risk that their shares are transferred to a bidder which has not paid for them ("Transfer Risk"), a bid by a special purpose vehicle exposes those shareholders to a second risk of a loss of economic opportunity ("Opportunity Risk") if a scheme does not proceed, because the special purpose vehicle and its ultimate shareholders do not have the financial resources to acquire their shares. The requirement in the Practice Note for evidence of the funding available to the bidder, where it is a special purpose company, mitigates that Opportunity Risk, as distinct from the Transfer Risk which is addressed by the usual conditions to the transfer of scheme shares.
11. Mr Wood points out that, here, the Bidder is a wholly owned subsidiary of Rollco, which is owned in equal shares by KFA and BCL. The Bidder is an Australian proprietary company incorporated on 22 March 2024 for the purpose of acquiring all of the McGrath shares, and Rollco is an unlisted Australian public company which was also incorporated on 22 March 2024 and became the holder of all of the shares in the Bidder on that date. The Bidder will fund the cash consideration through equity committed by the Consortium, using existing cash reserves available to KFA and BCL, and KFA and BCL will subscribe for additional Rollco shares prior to implementation of the scheme to provide the equity funding required for the All-Cash Alternative. Under cll 2 and 3 of the SID respectively, each of KFA and BCL unconditionally and irrevocably guarantees to McGrath the due and punctual performance by the Bidder of the Bidder's obligations under the SID or the Deed Poll, including in respect of the payment of the All-Cash Alternative, and each indemnifies McGrath against 50% of losses suffered or incurred by McGrath arising from any default or delay in the performance of such obligations.
12. Consistent with the requirements of the Practice Note, Mr Corrigall gives evidence of the cash reserves available to Knight Frank LLP and Bayley Corporation Ltd to fund their respective half shares of the maximum amount of the All-Cash Alternative and confirms that amount has not been reserved for any other purpose. Mr Wood also points out that, as disclosed in section 6.4(a) of the scheme booklet, the maximum amount of cash consideration that the Bidder may be required to pay to McGrath shareholders under the scheme is $74.49 million; and, as I noted above, KFA and BCL have guaranteed payment of the All-Cash Alternative under cll 2 and 3 of the SID. These matters address the Opportunity Risk. Mr Wood also points out that the scheme adopts the conventional mechanism of making the transfer of McGrath shares to the Bidder conditional on the provision of the total scheme consideration, and that avoids the risk that shareholders' McGrath shares are transferred without receiving the scheme consideration. He points out that McGrath shareholders have the further protection of the Deed Poll entered into by the Bidder in their favour and governed by NSW law. I accept that these are well-established means of managing performance risk, and specifically the Transfer Risk: ELMO at [27]-[28]. I accept that the approach adopted to these issues here gives rise to no reason not to convene the scheme meeting.
13. Seventh, Mr Wood deals with the manner of dispatch of scheme documents to McGrath shareholders, which is in conventional form, reflecting shareholders' election to receive communications in hard copy or electronic form, and the means by which shareholders can elect to receive the Rollco Scrip Alternative, if they wish to do so, and exercise a proxy vote at the scheme meeting. That mechanism also gives rise to no reason not to convene the scheme meeting.
14. Eighth, Mr Wood notes that McGrath will send a "reminder to vote email" to shareholders and no difficulty arises with the form of that communication. He also draws attention to McGrath's proposed inbound shareholder information line, to be operated by a third party, and a draft of the "Inbound Q&A script" for calls to the shareholders, and of associated "scheme banner messages", which is in evidence. Consistent with current scheme practice, McGrath did not need to seek and did not seek the Court's approval for that communication. I note that, as Mr Wood submits, the inbound call script and associated messages did not travel beyond the information in the proposed scheme booklet; present information in a balanced manner; and draw attention to advantages and disadvantages of the scheme and encourage shareholders to read the scheme booklet in its entirety. There is no reason to think they will give rise to any difficulty at the second Court hearing.

Orders

1. For the reasons set out above, I made the orders sought by McGrath at the conclusion of the first Court hearing.

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