Konekt Limited, in the matter of Konekt Limited [2019] FCA 1811

Introduction 1 These are the reasons for the Court making orders under ss 411(1) and 1319 of the Corporations Act 2001 (Cth) in relation to convening a meeting (scheme meeting) of members of Konekt Limited to consider whether to approve a scheme of arrangement between Konekt and the holders of its fully paid ordinary shares (Konekt Shares) and approving the despatch of a scheme booklet and related documents.

Background 2 Konekt is a publicly listed company. It is admitted to the official list of ASX Limited (ASX). Konekt says that it is one of the largest integrated employment placement, workplace injury management and workplace health solutions providers in Australia. Konekt's focus is on helping organisations, individuals and government to maximise workforce participation and productivity, and minimise the impact of workplace injury. It has over 700 staff, including more than 200 allied health professionals, with over 107 offices and 30 outreach sites through two business divisions, Konekt Employment and Konekt Workcare Group. 3 The purpose of the scheme is to effect a takeover of Konekt by Advanced Personnel Management International Pty Ltd (ACN 606 330 910) (APM). On 8 October 2019, Konekt and APM entered into a Scheme Implementation Deed (SID). 4 The scheme booklet describes APM as a leading international human services organisation with a global team of over 5,000 people operating from 700 locations in 10 countries, including Australia. In 2017, through affiliated entities, private equity investment fund manager, Quadrant Private Equity Pty Ltd acquired a majority interest in APM. 5 If the scheme is approved by shareholders and the Court, Konekt shareholders will receive a Total Cash Consideration of $0.49 for each Konekt Share. The total amount of cash required to fund this consideration is $52,467,933, having regard to the dilution of Konekt's issued capital by acceleration of the Konekt Performance Rights and cancellation of Konekt Options referred to below. 6 It is envisaged that Konekt will pay a Special Dividend and APM will pay the Total Cash Consideration an aggregate amount of $0.49 per Konekt Share as follows: (1) The Scheme Consideration is $0.44 per Konekt Share. It will be paid to each person who is a Konekt shareholder on the Scheme Record Date (expected to be 16 December 2019); and (2) The Special Dividend is a fully franked special dividend of $0.05 per Konekt Share. It is expected to be paid on 20 December 2019 (Implementation Date) to each person who is a Konekt shareholder on the register on the Special Dividend Record Date which is expected to be 11 December 2019. The Special Dividend was declared by the board of directors of Konekt on 25 October 2019 and its payment is subject to the scheme becoming Effective. 7 Under clause 7.6 of the SID, APM (or one of its group members) will be required to lend Konekt the amount required to fund payment of the Special Dividend (Dividend Loan).

Share capital and 8 Konekt currently has on issue: (1) 105,786,835 Konekt Shares; (2) 2,878,885 performance rights (Konekt Performance Rights) granted or issued under Konekt's long term incentive plan adopted in May 2014 (Konekt Incentive Plan); and (3) 960,000 options (Konekt Options).

Konekt Performance Rights 9 Konekt's Board intends that, before the scheme is implemented, it will exercise its discretion under the Konekt Incentive Plan to determine that 1,039,804 Konekt Performance Rights will become exercisable and are exercised in accordance with their terms. Each tranche of Konekt Performance Rights in respect of which the Board's discretion is exercised in this way will be based on the proportion of the vesting period of the relevant tranche of Konekt Performance Rights that has elapsed at the time they become exercisable. Once exercised, those Konekt Performance Rights will result in the issue of Konekt Shares to their holders on a one-for-one basis. Konekt's Board will use its discretion to cause the balance of Konekt Performance Rights to lapse in accordance with their terms. 10 As a result, the number of Konekt Shares on issue will increase from 105,786,835 to 106,826,639, which is the number of Konekt Shares that will be on issue when the scheme becomes Effective. There will then be no Konekt Performance Rights on issue.

Konekt Options 11 Konekt and APM have entered into legally binding agreements with each holder of Konekt Options such that, subject only to: (1) The Scheme becoming Effective; and (2) To the extent required, Konekt obtaining a waiver from the ASX under Listing Rule 6.23.2 to enable the Konekt Options to be cancelled for consideration without shareholder approval, the Konekt Options will be cancelled for a cash sum equivalent to the difference between the exercise price of those Konekt Options and the Total Cash Consideration (the Konekt Options Offer). The ASX has issued the required waiver.

Retention arrangements 12 Konekt has also put in place specific retention arrangements with certain senior executives. They are summarised at section 8.5 of the scheme booklet which is set out fully below.

Benefits received by the Managing director/Chief Executive Officer 13 Section 8.5 of the scheme booklet contains the following disclosure which includes disclosure of interests in the outcome of the scheme held by the Managing Director and CEO, Damian Banks. It is as follows: 8.5 Agreements or arrangements with Konekt Directors connected with or conditional on the Scheme Damian Banks, Konekt's Managing Director and Chief Executive Officer holds: (a) 280,000 Konekt Options; and (b) 408,414 Konekt Performance Rights. Damian's Konekt Performance Rights and Konekt Options will be treated in the manner set out in section 3.7 of this Scheme Booklet. This will result in 168,546 of Damian Banks' Konekt Performance Rights being exercised and will result in the issue of 168,546 Konekt Shares to Mr Banks. As described in section 3.7, the resultant Konekt Shares will participate in the Scheme alongside existing Konekt Shares. Mr Banks has entered into an option cancellation deed in relation to his Konekt Options pursuant to which his Konekt Options will be cancelled for aggregate consideration equal to $35,840. Consistent with the treatment of short term incentive payments as described in section 4.7 of this Scheme Booklet, the Konekt Board intends to exercise its discretion to pay to Damian Banks an amount of $93,000, representing a pro rata proportion of the FY20 short term incentive payment Damian would have been eligible to receive (subject to satisfaction of applicable performance criteria). In addition, Konekt has put in place specific retention arrangements with certain senior executives (each, a Senior Executive), including Damian Banks (as Chief Executive Officer of Konekt). The only Konekt Director that is entitled to receive a retention payment is Damian Banks. The Konekt Board considered it appropriate and in the interests of Konekt to put in place the retention arrangements: (a) to protect Konekt against the risk that it loses some of its Senior Executives given the uncertainty and disruption arising from the Scheme by incentivising them to remain with Konekt until, and for three months after, the Scheme is implemented; and (b) in recognition of the significant role of each Senior Executive both in respect of the process relating to the Scheme and in ensuring the continuity of the business regardless of the outcome of the Scheme. Under these retention arrangements the Senior Executives will be entitled to receive the retention payments to the extent that they have not given notice of their resignation pursuant to the terms of their employment agreement with the Konekt Group on or prior to the date that is three months after the Implementation Date. The retention payments will be made on the earlier of the date: (a) which is three months after the Implementation Date; or (b) on which the Konekt Group has given the relevant Senior Executive notice of termination of their employment. The maximum aggregate amount of the retention payments that may be payable to all Senior Executives is $400,000. The amount of Damian Banks' retention payment is $125,000. Save as noted above, there is no agreement or arrangement made between any Konekt Director and any other person, including an APM Group Member, in connection with or conditional upon the outcome of the Scheme.

Independent Expert 14 The proposed scheme booklet contains, at Attachment E, an independent expert's report prepared by representatives of Lonergan Edwards & Associates Limited (Lonergan Edwards). Lonergan Edwards assessed the value of Konekt Shares on a 100% control basis as being within a range of $0.39 to $0.43 per share. This valuation was arrived at on the basis that Konekt's enterprise value was to be determined by capitalising future maintainable earnings approach (using EBITDA) employing a multiple which reflects the risk inherent in those earnings. 15 Lonergan Edwards found that the Total Cash Consideration represents a premium of: (1) 69% to the closing price of $0.39 per Konekt Share on ASX on 4 October 2019, being the last trading day before Konekt entered a trading halt and announced the proposed scheme; (2) 89% to the 1 month VWAP of $0.26 per Konekt Share; (3) 100% to the 3 month VWAP of $0.25 per Konekt Share; and (4) 162% to the 6 month VWAP of $0.20 per Konekt Share. 16 Lonergan Edwards' opinion is that the scheme is fair and reasonable and in the best interests of Konekt shareholders in the absence of a superior proposal emerging.

Directors' recommendation 17 The directors of Konekt unanimously recommend that shareholders vote in favour of the scheme, in the absence of a superior proposal and provided that the independent expert continues to consider the scheme to be fair and reasonable and in the best interest of Konekt shareholders. 18 Mr Banks has joined in that recommendation. Dependent on whether shareholders approve the scheme, Mr Banks will enjoy the right to benefit from some of the Konekt Performance Rights earlier than he otherwise would, he will get the value of his Konekt Options upon their cancellation and he will receive a short term incentive payment earlier than he otherwise would. This manner of addressing these issues is in accordance with common practice and they do not appear to be excessive. The same might be said of the retention payments. They are fully disclosed in section 8.5 of the scheme booklet and attention is drawn to that disclosure wherever the directors' recommendation is referred to in the body of the scheme booklet (such as in the Chairman's Letter at page 9 and in "Frequently Asked Questions" at pages 18 and 25). The Court accepts Konekt's submission that there is appropriate disclosure of the nature of Mr Bank's interests in the scheme booklet. 19 Having regard to the current debate concerning recommendations by directors which was adverted to in submissions, there is also no issue about the fact that Mr Banks elected to make a recommendation. As noted in Ruralco Holdings Ltd, in the matter of Ruralco Holdings Limited [2019] FCA 878 at [28], the Court accepts that it is for a director who has interests contingent on the outcome of a scheme to decide whether to make a recommendation, and if he or she decides not to, to state why. That is what is provided for in reg 8301(a)(iii) of Sch 8 of the Corporations Regulations 2001 (Cth). 20 The appropriateness of a director's decision to make a recommendation is always fact sensitive: Re Mod Resources Ltd; ex parte Mod Resources Ltd [2019] WASC 326 at [86] per Vaughan J. While it is clear that reg 8301(a)(iii) reflects the general desirability that directors provide guidance to shareholders by making a recommendation, the regulation also expressly envisages that it will not always be appropriate for a director to do so. 21 In this case, although Mr Banks' capacity to take advantage of performance rights, options and short term incentives is being accelerated, this is the realisation of rights that exist and payment is by reference to the scheme consideration. He is also receiving a retention payment which is not dependent on the outcome of the scheme and such payments may properly be thought to be in the interest of both the target and acquiring company, recognising that change of control events can affect senior executives' decisions to stay or leave a company. 22 As a matter of general principle, it is necessary for directors to be alive to the issue of whether it is appropriate to make a recommendation where there is a conflict of duty and interest or a conflict of interests, since directors' recommendations are influential in shareholders' decisions on how to vote. The capacity to make an unbiased recommendation might not be realistic in some cases. It is also necessary for the board as a whole to ensure that the nature and degree of any conflict is adequately disclosed in all communications which contain such a recommendation, including, where appropriate, by explicit and prominent disclosure (such as in the Chairman's Letter) as to the amount of benefit contingent on the scheme. I respectfully agree with comments made by O'Bryan J that the impact of those decisions and the nature of the disclosure are matters that fall within the supervisory jurisdiction of the Court on applications under s 411 of the Corporations Act: see Wellcom Group Limited, in the matter of Wellcom Group Limited [2019] FCA 1655 at [59]-[60].

Dividend loan 23 At the hearing, senior counsel for Konekt drew to the Court's attention the terms of the disclosure in section 8.11 of the scheme booklet in relation to the possibility that s 260A of the Corporations Act may apply to the Dividend Loan, since the payment of a dividend before the acquisition of shares may constitute financial assistance of a kind prohibited by s 260A. The Court accepted senior counsel's submission that this issue would not prevent the Court approving despatch of the scheme booklet and any issues which arise fall to be considered at the second court hearing and in light of APM's obligations under the SID. The Court notes that section 8.11 contains the following paragraph: The Directors of Konekt have determined to call on the Dividend Loan after assessing the financial position of Konekt and the expected impact on creditors. Based on the information currently available, and given that the payment of the fully franked Special Dividend is contingent on the Scheme becoming Effective, the Directors of Konekt believe that calling on the Dividend Loan to pay the fully franked Special Dividend was and is in the best interest of Konekt and Konekt Shareholders and did not and will not materially prejudice Konekt's ability to pay its creditors.

Submissions and evidence 24 Konekt filed an outline of submissions which discusses: (1) The principles applied by the Courts in determining whether to make the orders sought at the first court hearing; they are conventionally expressed and the Court accepts them. (2) Implementation of the scheme. The submissions note: (a) The scheme is subject to conditions precedent set out in section 3.1 of the scheme booklet. In the course of the hearing, senior counsel advised that a waiver had been obtained from compliance with Listing Rule 6.32.2 in relation to the cancellation of the Konekt Options without first obtaining shareholder approval. (b) Terms of the scheme of arrangement which ameliorate performance risk, including the requirement for APM to deposit cleared funds into a trust account operated by Konekt on the day before the Implementation Date. (c) APM has executed a deed poll in conventional terms. (4) The provisions of the SID dealing with exclusivity and provision for a "break fee" (Konekt Reimbursement Fee) in an amount of $528,000 and the circumstances of the negotiation of those provisions. The amount of $528,000 is roughly equal to 1% of the equity value of the Konekt securities on issue (including performance rights and options) at the time the SID was announced and therefore consistent with the Takeover Panel's Guidance Note 7. (5) The deemed warranty and its disclosure. 25 The evidence filed in these proceedings includes: (1) The affidavit of Colleen Anne Platford, a partner at Gilbert + Tobin, the law firm acting for Konekt, sworn on 16 October 2019 and exhibit CAP-1 in support of the originating process. CAP-1 includes a search of the register maintained by the Australian Securities and Investments Commission (ASIC) in relation to Konekt. CAP-1 also contains a copy of the SID. (2) The affidavit of Rachel Lindy Bassil, a partner of Gilbert + Tobin, affirmed on 29 October 2019 and exhibit RLB-1. It is evidence that Gilbert + Tobin provided a draft of the scheme booklet to ASIC on 11 October 2019 and of the written communications with ASIC. (3) Exhibit 2, which is a letter from ASIC to the directors of Konekt dated 30 October 2019 indicating that ASIC had been provided with the draft scheme booklet on 11 October 2019 and revised versions and that it did not propose to appear to make submissions or intervene to oppose the scheme at the first court hearing. (4) The affidavit of Damian Eric Banks, managing director and chief executive officer of Konekt, sworn on 29 October 2019 and exhibit DEB-1. It provides evidence of Konekt's capital structure and constitution; the interests of directors in Konekt Shares; the intentions of the Board with respect to Konekt Performance Rights, short term incentives, retention arrangements and the treatment of Konekt Options; the directors' recommendation; the process for despatch of the scheme booklet; the negotiation of exclusivity arrangements and the Konekt Reimbursement Fee; and the conditions to which the scheme is subject. It also provides evidence concerning the due diligence process undertaken by Konekt to verify factual information in the scheme booklet. (5) The affidavit of Michael Lachlan Flood, General Counsel of APM, affirmed on 28 October 2019 and exhibits MLF-1 to MLF-4. The affidavit deposes to the drafting and verification process in relation to information in the scheme booklet concerning APM; APM's entry into the SID on 8 October 2019 and negotiations concerning exclusivity provisions and the Konekt Reimbursement Fee; and APM's execution of a deed poll in favour of persons who hold Konekt Shares on 24 October 2019. (6) The affidavit of Phillip Martin Holt, a director of Lonergan Edwards & Associates Ltd, sworn on 29 October 2019 and exhibit PMH-1, which contains the draft independent expert's report. (7) The affidavit of Douglas Ronald Flynn, Chairman of Konekt, sworn on 29 October 2019 indicating that Mr Flynn consents to act as chairman of the scheme meeting and deposing that he has no interest or obligation that may give rise to a conflict of interest or duty if he were to act in that role except as disclosed in the scheme booklet. (8) The affidavit of Philip Small, a director of Konekt, sworn on 25 October 2019 consenting to act as chairman of the scheme meeting if Mr Flynn is unwilling or unable to do so and deposing that he has no interest or obligation that may give rise to a conflict of interest or duty if he were to act as chairman of the scheme meeting except as disclosed in the scheme booklet.

Conclusion 26 On the basis of the evidence set out above and having regard to those principles, the Court was satisfied that this is an appropriate case for the exercise of the discretion to make orders under ss 411(1) and 1319 and that: (1) Konekt is a Part 5.1 body within the meaning of the Corporations Act. (2) The proposed scheme is an arrangement within the meaning of s 411 of the Corporations Act. (3) The scheme booklet marked as exhibit 1 provides appropriate disclosure. (4) The scheme is bona fide and properly proposed. (5) ASIC has had at least 14 days' notice of the proposed hearing date and has had a reasonable opportunity to examine the terms of the scheme and the scheme booklet and to make submissions. It did not appear to oppose the orders being made or to intervene in the proceedings. (6) The various procedural requirements of the Corporations Act and the Federal Court (Corporations) Rules 2000 (Cth) have been met. (7) Subject to any issues which may arise out of the Dividend Loan which will be addressed at the second court hearing as discussed above and the satisfaction of conditions precedent (including FIRB approval), there is no apparent reason why orders approving the scheme would not be made if requisite majorities are obtained at the scheme meeting. I certify that the preceding twenty-six (26) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Farrell.