Innamincka Petroleum Limited, in the matter of Innamincka Petroleum Limited [2010] FCA 1421

REASONS FOR JUDGMENT 1 Innamincka Petroleum Limited (Innamincka) has applied to the Court under s 411 of the Corporations Act 2001 (Cth) (the Act) for orders convening a meeting of its members for the purpose of considering a proposed scheme of arrangement. Under the proposed scheme of arrangement, all shareholders in Innamincka will transfer their shares to Drillsearch Energy Limited (Drillsearch) in consideration for which the shareholders in Innamincka will receive 2.5 shares in Drillsearch for each share in Innamincka held. 2 Innamincka was established, following the opening up of the Cooper-Eromanga Basin, to focus on both oil and gas exploration and development opportunities. It is listed on the Australian Securities Exchange (the ASX). Since its establishment, Innamincka has discovered several hydrocarbon fields. The Flax field in the Cooper-Eromanga Basin is currently in production. Innamincka's business involves exploration, drilling, development through to production and ultimately, commercialisation of oil and gas assets. Its exploration permits are surrounded by existing oil and gas fields and are in close proximity to production facilities and major pipelines. 3 Drillsearch is also listed on the ASX and is engaged in oil and gas exploration and production in the Cooper-Eromanga Basin. It has over 20 years' experience in the field of petroleum exploration and production. The Cooper/Eromanga Basin spans south-west Queensland and north-east South Australia. Drillsearch is the largest net exploration acreage holder in that region, and has a portfolio consisting of high impact exploration, development and production interests. It pursues growth through organic exploration, development activities and strategic acquisitions in areas that complement its key businesses. The business of Drillsearch can be divided into four parts, namely the mature oil business, new oil business, wet gas business and unconventional business. Drillsearch intends to sell or farm out its non-core assets as part of an ongoing portfolio rationalisation process. 4 Under the proposed scheme, Innamincka shareholders will transfer their shares to Drillsearch, in return for which they will receive shares in Drillsearch, which will continue to be listed on ASX. The result of the scheme is that Innamincka will be a wholly owned subsidiary of Drillsearch and will cease to be listed on ASX. The directors of Innamincka have unanimously recommended that, in the absence of a superior proposal, the Innamincka shareholders should vote in favour of the proposed scheme. 5 In connection with the proposal, the directors of Innamincka have retained BDO Corporate Finance Queensland Limited (BDO) to assess the scheme and provide a report as to whether the scheme is fair and reasonable and in the best interests of the shareholders of Innamincka. BDO have prepared such a report, an abridged version of which is to be included in the explanatory memorandum to be sent to the shareholders of Innamincka in connection with the proposed scheme. In preparing their report, BDO have relied on three valuation reports by technical specialists as follows: First, a valuation of Innamincka's oil and gas exploration and production assets by RISC Pty Limited (RISC). Second, a valuation of Drillsearch's production, development and exploration assets by Gaffney Cline & Associates Pty Limited (GCA). Third, a evaluation of Drillsearch's early stage assets by MBA Petroleum Consultants Pty Limited (MBA). 6 BDO's valuation of Innamincka and Drillsearch relies on financial information and instructions provided by those two companies and their directors as well as the technical specialists to whom I have just referred. They have not completed a review audit or due diligence in relation to the information that has been provided; nor have they provided any legal, accounting or taxation advice. In addition, in their report, BDO recommend that Innamincka's shareholders consult their own professional advisers. BDO also recommends that shareholders consider carefully the information contained in the proposed explanatory memorandum. 7 In order to assess whether the proposal is in the best interests of Innamincka's shareholders, BDO consider that it is appropriate to consider the fairness of the proposal as well as the reasonableness of the proposal. BDO have also taken into account other considerations in order to assess whether the proposal is fair. First, they calculated the value of each Innamincka share to be in the range of 11.08 cents to 19.88 cents, on the basis of the acquisition of all issued shares. In calculating that value, BDO had regard to the valuation of Innamincka's assets by RISC. Second, they calculated the value of the consideration, being shares in Drillsearch, to be received by each Innamincka shareholder on a minority interest basis. In calculating the value of Drillsearch shares, BDO had regard to the valuation of the assets of Drillsearch carried out by GCA and MBA. BDO calculated the value of each Drillsearch share to be within the range 4.37 cents to 6.68 cents. Third, BDO compared the value of each Innamincka share with the value of the proposed consideration. Fourth, BDO carried out an analysis of certain metrics of the merged entity, in order to cross check the appropriateness of the valuation at which they arrived. BDO concluded that the value of the consideration being offered under the proposal overlaps with the valuation range for Innamincka shares, although the higher end of the Innamincka share valuation range is outside the value of the consideration range that they calculated. 8 BDO considered that the following matters were relevant to their assessment of the fairness of the proposal: (a) The control premium implied by the consideration, assuming a consideration valuation range of 10.93 cents to 16.7 cents over the volume weighted average share price of Innamincka shares over varying periods, is within the range of 11 per cent to 120 per cent. The prices considered were for the periods nine months and three months prior to the announcement of the proposal. BDO considered that the control premium implied by the consideration is broadly consistent with recent market evidence of control premiums in the oil and gas exploration and production sector. (b) The number of new Drillsearch shares that Innamincka will receive as consideration equates to approximately 30.62 per cent of Drillsearch shares that traded in the 12 months prior to 30 September 2010. However, BDO warned that the trading in Drillsearch shares, following the implementation of the proposal, may differ materially from prior trading levels. (c) The percentage interest that Innamincka shareholders will hold in the merged entity, of approximately 24.11 per cent, is broadly consistent with the contribution of Innamincka to the net assets of the merged entity, in the range of 19.27 per cent to 23.22 per cent. That analysis, however, does not include any allowance for potential synergies. (d) The most current share trading prices of both Innamincka and of Drillsearch are consistent with the valuation ranges that BDO have adopted for the purposes of their assessment. They expressed the view that the current share price of Innamincka includes some control premium in anticipation of the proposal being given effect, and therefore on a controlling interest basis, the value of the consideration is consistent with the value of the Innamincka shares. After considering all of the matters that they have set out in detail in their report, BDO expressed the view that, in the absence of a superior offer, the proposal is fair. 9 BDO assessed the reasonableness of the proposal, having regard to other significant factors to which Innamincka shareholders may give consideration prior to deciding whether to vote for or against the proposal. Those factors included comparing the likely advantages and disadvantages of the proposal with the position Innamincka shareholders would be in if the proposal were not approved. After considering the advantages and disadvantages, which they summarised and set out in detail in the report, BDO concluded that, in the absence of a superior proposal or any other information, the proposal is reasonable. 10 Based on that opinion they consider that the proposal is in the best interests of Innamincka shareholders. However, BDO strongly recommend that, before making a decision in relation to the proposal, Innamincka shareholders should consult their own professional advisers, carefully read all the relevant material, including the detail of the report, and consider their own specific circumstances and the way in which those circumstances might impact on a decision to vote for or against the proposal. 11 An abridged version of the BDO report will be included in the proposed explanatory memorandum. Their report includes abridged versions of the three valuations received from RISC, GCA and MBA. However, the proposed explanatory memorandum will contain a reference to a website on which shareholders will be able to obtain unabridged versions of the BDO report and all appendices to it, together with full versions of the three valuations. 12 On 7 September 2010, Drillsearch and Innamincka entered into a Merger Implementation Agreement. The Merger Implementation Agreement was amended on 22 October 2010 and 4 November 2010. In its final form, the Merger Implementation Agreement recites that Drillsearch and Innamincka have agreed that Drillsearch will acquire all of the ordinary issued shares of Innamincka by means of a scheme of arrangement under Part 5.1 of the Act, to be proposed by Innamincka at the request of Drillsearch. Further, Drillsearch and Innamincka have agreed to act in good faith to implement the scheme upon the terms and conditions of the Merger Implementation Agreement. 13 By clause 1 of the Merger Implementation Agreement, Innamincka agrees to propose the scheme to its members, upon and subject to the terms and conditions of the agreement. Clause 5.1 requires Innamincka to take all necessary steps to implement the scheme in accordance with the timetable set out, including a number of specific steps outlined in that clause. Under clause 1, Drillsearch also agrees to comply with its obligations under the scheme and provide reasonable assistance to Innamincka in proposing and implementing the scheme, upon and subject to the terms and conditions in the Merger Implementation Agreement. By clause 5.2, Drillsearch undertakes an obligation to take all necessary steps within its power to implement the scheme in accordance with the timetable, including taking a number of specific steps outlined in that clause. 14 Clauses 13 and 14 of the Merger Implementation Agreement are of significance. Clause 13 imposes restrictions on Innamincka, in terms of engaging in discussions with other parties and providing information to other parties that could possibly give rise to a competing transaction. A competing transaction is one where a person other than Drillsearch would acquire all or a substantial part of the assets or business of Innamincka, or would acquire a relevant interest, or become a holder of 10 per cent or more of Innamincka shares, or acquire control of Innamincka. A takeover bid, scheme of arrangement, or other merger or transaction involving the formulation of other structures would also be competing transactions. 15 There is, however, an exception to the restraint contained in clause 13, to the extent that a competing transaction is bona fide, is made in writing by or on behalf of a person that the directors consider is of reputable commercial standing and if the directors determine, in good faith and acting reasonably, after taking appropriate advice, that failing to respond to such a bona fide competing transaction would be likely to constitute a breach of their fiduciary duties or statutory obligations. 16 Clause 14 is concerned with the payment of a break fee. In certain circumstances, Innamincka would be required to pay to Drillsearch a break fee of $400,000. The circumstances include where any Innamincka director makes a public statement that he or she no longer supports the scheme or fails to recommend the scheme, other than because BDO, as independent expert, has concluded that the scheme is not in the best interests of Innamincka shareholders. If any Innamincka director publicly recommends, promotes or otherwise endorses a competing transaction, the break fee could become payable. If the Court fails to approve the proposed scheme, as a direct result of a material non-compliance by Innamincka, or if the effective date under the scheme has not occurred prior to an end date, by reason of failure by Innamincka to perform or satisfy its material obligations under the agreement, the break fee might become payable. Similarly, if Drillsearch terminates the agreement because of a breach by Innamincka of the restraints in clause 13, the break fee could become payable. However, mere rejection of the scheme by the shareholders of Innamincka would not give rise to an obligation to pay the break fee. There is also provision in clause 14 for a similar break fee to be paid by Drillsearch to Innamincka, where Drillsearch is in breach of its obligations under the agreement. 17 Mr David Kinsman is the Chief Executive Officer of Innamincka. Mr Kinsman swore an affidavit in support of the present application, in which he says that the exclusivity restraints contained in clause 13 and the provisions for the payment of the break fee in clause 14 were included in the Merger Implementation Agreement as a result of normal commercial negotiations between Drillsearch and Innamincka. Drillsearch required that Innamincka grant exclusivity and agree to pay the break fee in the circumstances that are provided in those two clauses. Mr Kinsman believes that neither the exclusivity provisions in clause 13 nor the provision for the payment of the break fee in clause 14 operate against the interests of Innamincka shareholders. He also believes that it was in the interests of Innamincka shareholders to include those provisions in the Merger Implementation Agreement. He has also been informed by the other directors of Innamincka that they share those beliefs. Mr Kinsman considers that the break fee is reasonable and appropriate, having regard to two matters. First, there is a corresponding obligation for Drillsearch to pay the break fee. Second, the break fee is payable only in the limited circumstances to which I have referred. 18 The amount of the break fee of $400,000 represents a genuine estimate of the transaction costs of Drillsearch that would be incurred in the event that the break fee was to become payable. The parties acknowledged that circumstance in the Merger Implementation Agreement. Further, the amount of the Innamincka break fee represents less than one per cent of the aggregate values of all classes of equity securities issued by Innamincka, having regard to the value of the consideration to be given to Innamincka shareholders. That observation is consistent with the views expressed by the Takeover Panel. 19 The current issued capital of Innamincka is 261,548,890 shares, all of which, as I have said, are listed for quotation on ASX. Innamincka presently has 106 overseas shareholders, of which 45 are ineligible foreign shareholders. The total number of shares held by ineligible foreign shareholders as at 2 November 2010 represented approximately 5.28 per cent of the total number of issued shares. As at 2 November 2010 there were 1,739 shareholders who would receive less than a respectable parcel of Drillsearch shares, representing 2.55 per cent of the issued capital of Innamincka. Four of those shareholders are also ineligible foreign shareholders. 20 Two classes of shareholders are dealt with separately under the proposed scheme. Where the shares in Drillsearch that would be allotted to an Innamincka shareholder would constitute less than a marketable parcel under the trading rules of ASX, that Innamincka shareholder will have the option of either receiving less than a marketable parcel or have the shares dealt with under a sale facility arrangement, to which I shall refer. If an Innamincka shareholder who holds such a parcel does not elect one way or the other, the shareholder will be deemed to have elected the sale facility. Further, there are some 45 ineligible foreign shareholders, being shareholders who may not take up the shares in Drillsearch. Those shareholders will also have their shares dealt with in accordance with the sale facility. 21 Under the scheme, Drillsearch will be under no obligation to issue shares to any ineligible foreign shareholder, or to a shareholder of a small parcel who elects not to receive them, or to a shareholder of a small parcel who does not make an election. In relation to those shares, Drillsearch will, as soon as practicable after the scheme implementation date, procure an appropriately licensed agent appointed by Drillsearch to sell under the proposed sale facility shares which would otherwise have been allotted to the relevant shareholder. 22 The shares will be allotted to the sale facility agent in such a manner, at such a price and on such other terms as the sale facility agent determines in good faith. Promptly after the last sale of the shares and in accordance with that arrangement, Drillsearch will ensure that the sale facility agent pays to the relevant shareholder an appropriate fraction of the gross proceeds received, without deducting any brokerage costs, out of pocket expenses, stamp duty or taxes, other than any applicable withholding tax or deductions of tax required by law or any revenue authority. A proposed election form will be sent to holders of small parcels. The form makes clear the consequences of failing to complete the election. 23 The explanatory memorandum discloses that some Drillsearch directors already hold shares in Innamincka although Drillsearch itself has no shareholding in Innamincka. It is not proposed to treat Drillsearch directors as a separate class. 24 The pivotal provision of the proposed scheme is clause 4, which provides that on the implementation date, as defined, and subject to Drillsearch entering in the register of members of Drillsearch the name of each scheme participant entitled to receive new Drillsearch shares, the Innamincka shares registered in the name of scheme participants will be transferred to Drillsearch without the need for any further act by any scheme participant. Innamincka will either effect a transfer or transfers of the Innamincka shares to Drillsearch under s 1074D of the Act or deliver to Drillsearch duly completed and executed share transfer forms in respect of the shares in accordance with s 1071B of the Act. Upon receipt of the appropriate documents, Innamincka will enter the name of Drillsearch in the register as the holder of all Innamincka shares. Drillsearch is required to issue the new shares to each scheme participant in accordance with those provisions. To the extent permitted by law, the Drillsearch shares to be transferred to Innamincka will be transferred free from all charges, liens, etcetera. 25 From the time of allotment of shares in Drillsearch to the scheme participants, the scheme participants are taken to have appointed Innamincka and its directors as their attorneys and agents to appoint the chairman of Drillsearch to act as sole proxy in respect of the Innamincka shares. There is also an obligation imposed on scheme participants whereby they warrant that the shares held by them are free from any encumbrance. 26 On 20 October 2010 Innamincka's solicitors wrote to the Australian Securities and Investments Commission (the Commission) providing a proposed draft of the explanatory memorandum and scheme booklet. By letter of 4 November 2010 to Innamincka, the Commission indicated that it does not currently propose to appear to make submissions or intervene to oppose the scheme at the hearing today. That intention was based on the information provided by Innamincka in its solicitor's letter of 20 October 2010. In that letter the solicitors drew attention to the treatment of ineligible foreign shareholders and holders of small parcels. 27 There is evidence that Innamincka is a Part 5.1 body and, therefore, that s 411 of the Act would apply to a scheme of arrangement between Innamincka and its shareholders. The proposal is clearly a scheme within the meaning of s 411. I am also satisfied that the proposed scheme booklet including the explanatory memorandum, notice of meeting and other enclosures with the material involve a proper disclosure to members of the proposal. 28 The explanatory memorandum contains detailed factual information concerning both Innamincka and Drillsearch. Regimes were established by both companies to ensure that the information contained in respect of the companies is correct. The procedures that were adopted indicated that there is good ground for concluding that the factual material contained in the scheme booklet is accurate and is not misleading. The relevant officers of BDO and of the three valuers have confirmed by affidavits that the opinions expressed in their respective reports were held by them and that they have no reason to doubt the accuracy of the statements contained in their reports. 29 In all of the circumstances I consider that it is appropriate to accede to the present application by Innamincka for orders that it convene a meeting of its members pursuant to s 411 of the Act for the purpose of considering the proposed scheme. I certify that the preceding twenty-nine (29) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Emmett.