Director benefits and director recommendations
99 Clause 10.1.1 of the Scheme Implementation Deed provides that the "Kidman Public Announcement" (as defined) must state that the Kidman Board unanimously considers the Scheme to be in the best interests of shareholders and recommend that shareholders approve the scheme resolution, in the absence of a superior proposal and provided that the Independent Expert's Report has concluded that the Scheme is in the best interests of shareholders.
100 Clause 10.1.2 of the Scheme Implementation Deed provides in substance that Kidman must use its reasonable endeavours to procure that the Kidman Board and each of the Kidman Directors:
(a) does not withdraw the statements and recommendations set out in the Kidman Public announcement issued in accordance with clause 10.1.1; and
(b) in the Scheme Booklet state that the Kidman Board unanimously considers the Scheme to be in the best interests of shareholders and recommends that shareholders approve the Scheme resolution, in the absence of a superior proposal and provided that the Independent Expert's Report has concluded that the Scheme is in the best interests of Shareholders.
101 Mr Donohue has joined with the other directors of Kidman and made a recommendation to shareholders that they vote in favour of the Scheme. The incentive payment to him if the Scheme becomes effective and the proposed treatment of his performance rights are set out in the body of the Chairman's letter in the Scheme in the following terms:
If the Scheme becomes Effective, members of Kidman's senior management will receive incentive payments by way of a cash bonus in recognition of the additional personal efforts required by these Kidman employees to complete Kidman's obligations under the Scheme Implementation Deed and other activities required to implement the Scheme. Mr Donohue (Kidman's Managing Director and Chief Executive Officer) will receive an incentive payment of $550,000. Further details of the bonus payments are set out in Section 7.1.5. As discussed at Section 7.1.5, no similar bonuses, agreements or arrangements exist with any other Kidman Director.
In addition, Mr Donohue holds or controls 3,915,000 Kidman Shares and holds 972,954 Performance Rights (as described in Section 7.1.6) which, if the Scheme becomes Effective, will convert into that number of Kidman Shares. Therefore, subject to the Scheme becoming Effective, Mr Donohue will on the Record Date (and after conversion of his Performance Rights) hold a total of 4,887,954 Kidman Shares for which he will receive the Scheme Consideration.
102 Information to this effect is also set out throughout the Scheme Booklet in footnotes where reference is made to the directors' recommendation that shareholders vote in favour of the Scheme, and in sections 7.1.5 and 7.1.6.
103 Counsel for Kidman raised the question of the role that directors should play in making a recommendation to shareholders who are to receive a substantial financial benefit if a scheme is approved.
104 Counsel drew my attention to the decisions of Farrell J in Re Gazal Corporation Limited [2019] FCA 70, in particular at [29]-[32], and Re Ruralco Holdings Ltd [2019] FCA 878 at [26], which stand for the proposition that directors who are to receive a substantial financial benefit if a scheme is approved do and should as a general rule decline to make a recommendation to the shareholders as to how they should vote. The relevant passages from Re Gazal are as follows ([29]-[30] and [32]):
With respect to Robson J, it is possible for a board to put forward reasons why a shareholders might approve a scheme (along with reasons why they might not), without the need for a director who has a clear pecuniary incentive for the scheme to proceed making a recommendation concerning voting. It is, of course, appropriate for each director to say what their own voting intentions might be.
In my view, it would have been better practice for Mr Robinson to adopt the common practice of declining to make a recommendation to shareholders as to how they should vote, and to explain that the reason for that is that he will receive a substantial benefit depending on the outcome of the scheme which other shareholders will not receive. While it is most important that there be prominent disclosure in a scheme booklet of those matters which might, realistically, affect a director's judgment in making a recommendation about whether shareholders should vote in favour of approving a scheme, directors who are interested in the outcome of the scheme because they stand to receive a bonus or benefit (other than as a shareholder) only if the scheme proceeds should exercise caution in making recommendations and, in my view, generally should not do so. As demonstrated in this case, the disclosure did not carry over in summary statements of the directors' recommendation. Both the front of the Scheme Booklet and the script used for telephone canvassing of shareholders contained the directors' recommendation without reference to the fact that Mr Robinson would receive a bonus.
…
In my view, the question of whether it is appropriate for all directors to make a voting recommendation should be considered at the time a scheme implementation agreement is executed and conditions crafted appropriately. While it may be true that it has become a common practice for a bidder to require unanimous and unqualified recommendations from the directors of the target company, that "practice" does not justify the bidder and the directors of the target failing to address the circumstances of each individual case. As I said at the second court hearing, I am satisfied that Gazal, the bidder and Mr Robinson all acted honestly. Nonetheless, the "usual practice" (as it was described by counsel) does not eliminate the director's individual obligation to consider whether he or she has an interest different from other shareholders which would properly preclude them from making a voting recommendation. Where a director has an interest in the outcome of a scheme which is plainly different from other shareholders, the issue of whether it is appropriate for that director to make a recommendation should be confronted. It is difficult to see how the success of a scheme is prejudiced by a recommendation made only by those directors who are not interested in the outcome otherwise than as a shareholder. It is common and appropriate for the recommendation to be made only by independent directors. It remains open for the scheme implementation agreement to be subject to a condition that an interested director who declines to make a voting recommendation does not decide to make an adverse recommendation.
(Emphasis added)
105 For the reasons set out below, I respectfully disagree with her Honour's views set out above, and in particular in the highlighted parts of those passages. In my respectful view, the correct position is that explained by Robson J in Re SMS Management & Technology Ltd [2017] VSC 257.
106 Section 412(1)(a) of the Corporations Act provides that the scheme company must send an explanatory statement:
(i) explaining the effect of the compromise or arrangement and, in particular, stating any material interests of the directors, whether as directors, as members or creditors of the body or otherwise, and the effect on those interests of the compromise or arrangement in so far as that effect is different from the effect on the like interests of other persons; and
(ii) setting out such information as is prescribed and any other information that is material to the making of a decision by a creditor or member whether or not to agree to the compromise or arrangement, being information that is within the knowledge of the directors and has not previously been disclosed to the creditors or members.
107 Regulation 5.1.01(b) of the Corporations Regulations in turn provides that, for a members' scheme of arrangement, the explanatory statement must state the matters in Part 3 of Schedule 8. The explanatory statement must state the matters in Part 3 of Schedule 8 (and have attached to it the reports and copies of any documents mentioned in that part of Schedule 8).
108 Regulation 8301(a) of Schedule 8 provides that the explanatory statement must set out:
(i) whether the director recommends the acceptance of the Scheme or recommends against acceptance, and in either case, his or her reasons for so recommending; or
(ii) if the director is not available to consider the Scheme - that the director is not so available and the cause of his or her not being available; or
(iii) in any other case, that the director does not desire to make, or does not consider himself or herself justified in making a recommendation, and if the director so requires, his or her reasons for not wishing to do so …
109 Regulation 8302 further provides that the explanatory statement must set out:
(a) the number, description and amount of marketable securities of the company the subject of the Scheme held by or on behalf of each director of the company or if none are held, a statement to that effect; and
(b) for each director of the company by whom or on whose behalf shares in the company are held, whether:
(i) the director intends to vote in favour of, or against, the Scheme; or
(ii) the director has not decided whether he or she will vote in favour of, or against, the Scheme …
110 It is apparent that of the universe of possibilities contemplated by those regulations as to when a director should make a recommendation to shareholders about a scheme, no reference is made to the circumstance that he or she may receive a substantial financial benefit if a scheme is approved. Given the comprehensive nature of those regulations, if such a fetter on the ability of a director to make a relevant recommendation to shareholders of that nature had been intended, one would expect it to be contained in terms in those regulations.
111 In my view, shareholders, absent an explanation as to why any director is not "available", does not "desire" or is not "justified" in making a recommendation (reg 8301(a)), or "has not decided" whether he or she will vote in favour of or against the Scheme (reg 8302), would ordinarily expect directors to make such a recommendation, even when they may receive a substantial financial benefit. And in my view, the statutory and regulatory regime applicable ordinarily requires them to make a recommendation, one way or the other, whether they stand to gain if the scheme is approved or not.
112 As Robson J said in Re SMS Management & Technology Ltd [2017] VSC 257 (at [25]-[27]) (with reference to reg 8301(a)), it is appropriate for such a director (in that case, the managing director, one Mr Rostolis) to make such a recommendation:
What is now footnote 3 to the chairman's letter addresses Mr Rostolis receiving the $600,000. It states:
With respect to Rick Rostolis' recommendation, SMS shareholders are advised that Mr Rostolis will receive a $600,000 cash incentive conditional upon the Scheme becoming Effective. Despite this fact, Mr Rostolis considers that it is appropriate to make a recommendation on the Scheme. SMS has also agreed to tag the votes of Mr Rostolis at the Scheme Meeting at the request of ASIC. Further details of the incentive payment are set out in Section 8.11, and further details of the vote tagging are set out in Sections 4.1 and 7.10(a). As discussed in Section 13.3(b), no similar incentives, agreements or arrangements exist with any other SMS director.
In my view, it is appropriate for Mr Rostolis to make the recommendation that he proposes. I think it is important that the managing director, who in this case is the main moving force behind the company, give his reasons for putting forward the scheme. In my opinion, the footnote to the chairman's letter satisfies the concerns raised by ASIC [whether it was appropriate in the circumstances where Mr Rostolis was to be compensated with the payment of $600,000 if the scheme were implemented, to provide a recommendation].
Shareholders are able to discern that one of the benefits of the scheme could be seen to be that Mr Rostolis receives $600,000, but on the other hand, he may no longer be involved in management.
(Emphasis added).
113 It seems to me that in the ordinary case a shareholder would expect each director, whether or not any one or more of them was "the main moving force" behind the company, to make their recommendation. Such an expectation is clearly reflected in the regulations. As I said, reg 8301(a) obliges "each" director make a recommendation, unless they are unavailable to do so, or they do not desire to do so, or they are not justified in doing so (and, if so in any such instance, to explain why). As counsel for Kidman submitted, and I agree, each director is required to engage actively with the proposed scheme that is to be put before the shareholders, so that the shareholders have the benefit and guidance of the knowledge and expertise of the directors - who, after all, are the persons responsible for the operation and management of the scheme company and who, by reason of their position, ought to be best placed to express a view whether or not the scheme is in the shareholders' best interests. They are, in my view, ordinarily obliged to do so even if they stand to gain personally in the form of some specific benefit if the scheme is approved, provided the benefit is sufficiently explained to shareholders.
114 Although Farrell J in Re Gazal referred (at [30]) to the "common practice" of a director declining to make a recommendation to shareholders as to how they should vote and explaining the reason for so declining by reference to the substantial benefit to be received by that director if the scheme proceeds, I am, with great respect, unaware of any such practice. (See also Re Navitas Ltd (No 2) [2019] WASC 218 (at [38]) per Vaughan J, doubting whether such a common practice exists).
115 As Vaughan J said in Re Nzuri Copper Ltd [2019] WASC 189, the critical consideration for the court in applications of this type is, rather, to ensure that the nature and extent of the relevant benefit(s) that the director(s) stand to receive if the scheme is approved is/are properly disclosed. As his Honour said at [87]-[89]:
I was prepared to make orders convening the scheme meeting, and approve the scheme booklet for distribution, despite the fact that Messrs Arnesen and Smits joined in the directors' recommendation to shareholders to vote in favour of the scheme proposal. I did so as:
• The additional and different interest held by the executive directors was not out of the ordinary and within the scope of what might be considered commercially not unreasonable, ie one year's salary.
• The additional and different interest held by the executive directors arose under pre-existing contracts executed well before the SID.
• The additional and different interest held by the executive directors was linked to the possibility that their employment might be terminated immediately after the scheme becomes effective: the executive directors are not entitled to notice of termination or payment in lieu of notice if terminated within six months after the change in control. Accordingly, there is a not unreasonable commercial rationale for the bonus payment.
Most importantly, however, the scheme booklet made fulsome and prominent disclosure of Messrs Arnesen's and Smits' additional and different interests …
116 As counsel for Kidman submitted, in this case the sworn evidence discloses the following:
(a) The proposed incentive payment to Mr Donohue equates to one year's fixed annual remuneration.
(b) The Kidman Board, in the absence of Mr Donohue, specifically considered whether Mr Donohue should make a recommendation to shareholders in relation to the Scheme and the factors the Board took into account included the following:
(i) Mr Donohue was the founder of Kidman, the managing director and a significant shareholder. He had been intimately involved in the consummation of the joint venture with SQMA and the development of the Mt Holland Lithium Project and that in those circumstances Kidman Shareholders would be legitimately expecting Mr Donohue to express his view as to the Scheme and would be surprised and disconcerted if he did not do so.
(ii) If the Scheme became effective, Mr Donohue would receive benefits different from other shareholders (being the vesting of performance rights and the incentive payment).
(iii) The benefits to be received by Mr Donohue were not out of the ordinary and in the circumstances commercially reasonable.
(iv) The total consideration to be received by Mr Donohue in the context of the Scheme Consideration is not excessive nor is it unwarranted given the additional work and attention required by Mr Donohue throughout the Scheme process, where there is no certainty of continued employment and in a situation where the retention of Mr Donohue's services was seen to be in the best interests of Kidman and its shareholders.
(v) The grant of performance rights had been approved by the Kidman Shareholders at a general meeting held at a time well before the Scheme Implementation Deed was entered into.
(vi) The incentive payment would be disclosed in the Scheme Booklet in some detail, as a consequence allowing a shareholder to understand that there is an issue of what weight should be given to his recommendation.
(c) The Kidman Board resolved (in the absence of Mr Donohue) that given the importance of the Scheme and Mr Donohue's role in the company, Mr Donohue can, and should, if he wished to, make a recommendation on the Scheme notwithstanding the nature and quantum of the benefits which will be derived by Mr Donohue if the Scheme becomes effective.
(d) The Scheme Booklet makes fulsome and prominent disclosure of both the proposed incentive payment to Mr Donohue and the proposed treatment of his performance rights, including in the body of the Chairman's letter at the front of the Scheme Booklet.
(e) The Chairman's letter also refers to the reasons why the Kidman Board (in the absence of Mr Donohue) considers that Mr Donohue can and should (if he wishes to do so) make a recommendation on the Scheme and the reasons why Mr Donohue considers it appropriate to make a recommendation.
117 I am accordingly satisfied that there has been adequate disclosure of the proposed incentive payment to Mr Donohue and the proposed treatment of his performance rights and that there is a reasonable commercial basis for both the proposed payment and the treatment of those performance rights.