Re Cytopia Ltd [2009] VSC 560 (8 December 2009)

2 Cytopia is an Australian Securities Exchange listed bio-technological company, focussed on the research and development of new drugs to treat cancer and other diseases. Cytopia has negotiated an agreement with YM Biosciences Inc. ("YM"), a public Canadian company, for YM to acquire all the issued shares in Cytopia. The share swap is to be implemented by way of a scheme of arrangement between Cytopia and its shareholders ("the scheme"). If the scheme is implemented, Cytopia shareholders will received 1 YM share for every 11.737 Cytopia fully-paid shares. This ratio may be adjusted up or down in accordance with the formula set out in the Implementation Agreement and Scheme Booklet in the event that the volume weighted average price for shares in YM, in the 20 trading days before the scheme becomes effective, falls within certain specified ranges.

3 The approach that the Court should adopt when considering this application is to review the scheme and the Scheme Booklet to ascertain whether the scheme complies with the requirements under the Act and to consider whether there is any presently discernible reason as to why the proposed scheme of arrangement should not be put to the meeting of the members to vote on. Ordinarily, the Court will not order the convening of a meeting "unless the scheme 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".[1] Thus, as Finkelstein J observed in Re Opes Prime Stockbroking Ltd:[2]

[I]t is necessary for a court to be alive to any difficulties that may arise if in due course it may be asked to approve the scheme.[3]

The authorities make it clear that the Court's role at this stage is not to express a view on whether the proposed scheme should be approved.[4] It is also clear that it is not the Court's role to usurp the shareholders' decision, by attempting to intrude its own commercial judgment.[5] The Court is to be concerned with whether there is adequate disclosure to the shareholders in the Scheme Booklet (or explanatory memorandum), whether the legal requirements otherwise have been complied with and whether the scheme, on its face, is one that is sufficiently "fair and reasonable" to be capable of being put to shareholders for their approval or rejection.[6]

5 Cytopia commissioned an expert's report from Lonergan Edwards & Associates Limited ("LEA") on whether, in the expert's opinion, the scheme is fair and reasonable and in the best interests of Cytopia shareholders. LEA assessed the scheme based on the Australian Security and Investments Commission ("ASIC") Regulatory Guide 111 and formed the view that the scheme "is not fair but is reasonable to, and in the best interests of, Cytopia shareholders in the absence of a superior proposal".[7] ASIC Regulatory Guide 111 outlines ASIC's views on how experts should analyse a proposed transaction. Under Regulatory Guide 111 the scheme is "fair" if the value of the offer price or scheme consideration is equal to, or greater than, the full underlying value of the shares in the target company prior to implementing the scheme. The scheme is "reasonable" if it is "fair" or if there are sufficient reasons for shareholders to accept the offer in the absence of any higher bid before the close of the offer. In the report LEA concluded that:

(a) the value of a Cytopia share is within the range of A$0.13 to A$0.176;

(b) the value of the scheme consideration is within the range of A$0.113 (C$0.11) to A$0.131 (C$0.128).

On the basis of these valuations and the analysis set out in the report, LEA concluded that the scheme is not "fair", as the value of the scheme consideration is less than the full underlying value of the Cytopia shares. However, LEA was of the view that the scheme is "reasonable" to Cytopia shareholders and "in [their] best interests" for six reasons:

(a) Cytopia has estimated that its cash reserves at 30 June 2009 would only support operations until early 2010;

(b) In Financial Year 08 and Financial Year 09 Cytopia's cash flow before financing activities was negative $7.9 million and $7.1 million respectively. Management and general administration expenses totalled approximately $3.3 million and $3.6 million respectively in these years;

(c) In the absence of the scheme or a similar proposal Cytopia will therefore need to raise significant equity capital in order to remain a going concern;

(d) Following the global financial crisis, the availability of equity capital for small bio-technology companies with drug programs at early stages of development is extremely limited;

(e) Any equity capital raising by Cytopia, if successful, would need to occur at a substantial discount to Cytopia and is likely to be significantly dilutionary to Cytopia's shareholders. There is also a high risk that such a capital raising would not be successful;

(f) Cytopia has sought potential partners for the continued development of its drug programs and/or expressions of interest for the sale of the programs or the company but no acceptable partnering offers or superior proposals to the merger with YM have been received.

6 In Zenyth Therapeutics Ltd v Smith[8] Dodds-Streeton J stated that courts should adopt a cautious approach to the approval of any scheme which the independent expert considers "not fair", particularly when it may involve an offer at an undervalue.[9] Her Honour stated:

In my opinion, a scheme involving an offer of an undervalue, which is not fair, should generally not be considered reasonable unless it is accompanied by some positive compensatory feature. The fact that the security holders are unable to exact fair, or better, consideration through any avenue alternative to the scheme would not necessarily render an unfair scheme reasonable in the relevant sense.[10]

Thus, where an independent expert reports that the scheme "is not fair", there is a "serious question for investigation"[11] by the Court. The investigation at this stage should consider whether shareholders will be "acting on sufficient information" [12] in order to make an informed decision as to whether or not to accept a particular price or consideration for their shares.

7 It was submitted that the Cytopia shareholders are presented here with a careful analysis by LEA of the share swap and its advantages and disadvantages. The shareholders also have the recommendation of the directors whose unanimous view is that the scheme is in the best interests of the Cytopia shareholders and who have expressed their intention to vote any shares held by them or for which they have undirected proxies in favour of the scheme.[13] There is also extensive discussion of the advantages and disadvantages and risks of the merger in the Scheme Booklet.[14]

8 In the circumstances, I accept the submission that the Court can be satisfied that the scheme, if considered and adopted by the members, is one that the Court would be likely to approve if the shareholders vote in its favour.

9 I am also satisfied that there has been adequate disclosure of the independent expert's opinion in the Scheme Booklet.[15]

10 This aspect is directed to the mechanisms that will ensure that the share swap occurs, once the scheme has become effective. The scheme involves YM acquiring all of the Cytopia shares on issue in exchange for the issue of new YM shares to scheme shareholders. The performance risk is dealt with by cl.4.2 and 5.1 of the share scheme which provide for YM to provide, or procure the provision of, the scheme consideration to each scheme shareholder on the Cytopia shares held by scheme shareholders being transferred to YM and by cl.3 of a deed poll under which YM covenants in favour of the Cytopia shareholders that it will, on the implementation date, undertake the steps that it is required to take under the share scheme.[16] The deed poll also provides in cl.1.3 that the covenant may be enforced by any scheme shareholder.

11 In the circumstances I do not think that the Cytopia shareholders will be unduly exposed to risk.

12 Paragraph 11 of the Implementation Agreement contains certain provisions in relation to a reciprocal break fee of $500,000, which may be paid by either Cytopia or YM depending on the circumstances (which are set out in s.8.6(c) of the Scheme Booklet). The circumstances in which the break fee were agreed upon are set out in cl.11.1 of the Implementation Agreement. The evidence shows that:

(a) the break fee was the result of ordinary commercial negotiation between Cytopia and YM;[17]

(b) the directors of Cytopia believed, and it was the fact, that it was in the interests of Cytopia shareholders that the directors agreed to the inclusion of cl.11 in the Implementation Agreement;[18] and

(c) the break fee of $500,000 represents 4.57% of the equity value of Cytopia at the date upon which the proposed acquisition was announced.[19]

13 In the Takeovers Panel's Guidance Note 7: Lock-up Devices, the Takeovers Panel states that:

It is good practice for anyone who agrees to pay a break fee to negotiate a fixed or capped figure, whether dollar or percentage based. In this regard, the Panel will use a guideline that a fee should not exceed 1% of the equity value of the target. For this purpose, the equity value is the aggregate of the value of all classes of equity securities issued by the target, where relevant having regard to the value of the consideration under the bid, as at the date the bid is announced.

...

... if the amount of the break fee is more than the 1% guideline, in order to find that the break fee is not unacceptable the Panel must be satisfied that the arrangement is neither anti-competitive nor coercive.[20]

14 The break fee in the Implementation Agreement exceeds the 1% equity value guideline in relation to Cytopia. It does not follow necessarily that this should be an obstacle to the making of an order under s.411(1) of the Act for the convening of a meeting. In Re SFE Corporation Ltd (No. 1); Re SFE Corporation Ltd (No. 2)[21] Gyles J stated that he would only be inclined to refrain from ordering a meeting if the amount of the break fee was such that it could influence voting at the meeting or if there were some other unusual circumstances.[22] In Re APN News & Media Ltd[23] Lindgren J said that the relevant questions, which he thought were related, were whether the fee was likely to coerce shareholders into agreeing to the scheme or to deter companies from mounting a competing offer.[24]

15 I accept the submission that the provisions for the break fee, although the fee exceeds 1% of the equity value of Cytopia, do not warrant the Court refraining from making the order for the convening of a meeting. Cytopia and YM have recorded, and the evidence verifies in general terms, that $500,000 is a genuine pre-estimate of the internal and external costs that would be incurred. This is reflected in cl.11.1 of the Implementation Agreement which provides for the "background" to the payment of costs. Clause 11.1(a) provides that Cytopia and YM believe that the scheme will provide significant benefits to Cytopia, YM and their respective shareholders and acknowledge that if the transaction is not implemented, both parties will have incurred significant costs and other losses. In those circumstances, Cytopia and YM believed it was appropriate to agree to the break fee "without which the parties would not have entered into this agreement" and "in order to secure the participation of the other party in the Schemes". Clause 11.1(c) contains an acknowledgment that the fees payable to the other are "appropriate to compensate the other party for their reasonable external and internal costs and opportunity costs in connection with the Schemes".

16 Importantly, the break fee is not payable if the shareholders do not vote in favour of the scheme. In the circumstances the provision of the break fee is unlikely to be a matter which could influence voting at the scheme meeting.[25]

17 The break fee is payable only in the circumstances contained in cl.11.3 and 11.4 of the Implementation Agreement. One circumstance which will trigger the payment of the break fee is if a competing transaction is made before the scheme meeting is held and the transaction is completed before 5 July 2010. The Takeovers Panel states at paragraph 7.25 of guidance note 7 that a provision of this kind is unlikely to have a coercive effect on shareholders "as the success of the competing proposal has commercially supplanted the proposal which had been supported by the break fee agreement".

18 Accordingly, I am satisfied that I should not refrain from ordering the meeting because of the break fee. I am also satisfied that the break fee provisions are adequately disclosed in the Scheme Booklet.[26]

19 Clause 10 of the Implementation Agreement contains reciprocal "No-talk and no shop" provisions in respect of Cytopia and YM during the "No Shop Period" which is defined as:

[T]he period from and including the date of this agreement and to the earlier of:

1. the termination of this agreement in accordance with its terms; and
2. the End Date.

The End Date is 28 February 2010 or such other date as Cytopia and YM may agree in writing.[27]

20 The "no-talk and no shop" issue is concerned with the anti-competitive effect of such clauses. In Re Arthur Yates & Co Ltd,[28] Santow J said that an exclusivity period should meet the following criteria:

(a) it should be for no more than a reasonable period capable of precise ascertainment;

(b) it must be framed so that it is subject to an overriding obligation not to breach the directors' fiduciary duties or be otherwise unlawful; and

(c) there should be adequate prominence given to the exclusivity clause in the explanatory memorandum sent to the shareholders.

(a) the exclusivity period of little under five months is within the range accepted in other cases;[29]

(b) there is a carve out in relation to directors' fiduciary duties contained in cl.10.2 of the Implementation Agreement; and

(c) the exclusivity period is disclosed in the explanatory memorandum to go to shareholders in s.8.6(d) of the Scheme Booklet.

The Scheme provides that each Scheme shareholder is deemed to have warranted to YM and Cytopia, that:

(a) all their Scheme Shares (including any rights attaching to those shares) which are transferred under this Scheme will, at the date of transfer, be fully paid and free from all mortgages, charges, liens, encumbrances and interests of third parties of any kind, whether legal or otherwise, and restrictions on transfer of any kind; and

(b) they have full power and capacity to transfer their Scheme Shares together with any rights attaching to such shares.

23 The view consistently taken by courts in recent times is that the purpose and effect of such a clause simply is to ensure that a scheme participant whose shares are subject to an encumbrance is not unfairly advantaged and that the deemed warranty clause is unobjectionable.[30] I note that the deemed warranty clause is disclosed in s.8.2 of the Scheme Booklet and I accept the submission that it is no obstacle to the Court ordering the convening of a meeting.

24 The next issue is whether I am satisfied that there is sufficient disclosure of the information that should be put to the shareholders to enable them to exercise their judgment whether to support the proposed scheme. In my view, the explanatory memorandum does sufficiently address the effect of the proposed scheme, including the effect of the arrangement on the directors' interests.[31] I note for completeness that I have not been asked to approve the explanatory memorandum.

25 I was also provided with a schedule by counsel for Cytopia in which the requirements of Part 3 of Schedule 8 of the Regulations are set out and cross-referenced to the relevant parts of the Scheme Booklet and accompanying materials. On the material before me it appears that the obligations in s.411 and s.412 of the Act have been met.

26 There was one further matter that I should mention. YM is a Canadian company. Accordingly, its accounts are prepared in accordance with Canadian accounting statements. In part 11.3 of the Scheme Booklet, the shareholders are told that it may be that there are differences between accounts which are prepared in accordance with the Canadian accounting statements and accounting standards by which Australian companies must prepare their accounts. YM is currently undertaking a comparison of the standards as it applies to the accounts of the merged entity in order to identify whether any material differences exist between the two accounting policies as they relate to the presentation of financial information of the merged entity. If, in the opinion of YM, any material differences are identified which may be material for Cytopia shareholders, this information will be provided to them at least 10 days before the date of the scheme meeting.

27 I am satisfied with the disclosure to the shareholders in the Scheme Booklet and the steps taken, and to be taken, to ensure that shareholders are fully and properly informed.

28 In light of these matters, I am satisfied that the matters to which my attention has been drawn do not give rise to anything that should cause the Court to refrain from making an order for the convening of a meeting of the members. Accordingly orders will be made for convening the scheme meeting in the form of the orders handed up at the hearing.

Since publishing my reasons it has been brought to my attention by the solicitors for the plaintiffs and ASIC that page 100 of the scheme booklet attached to the orders made on 8 December 2009 incorrectly stated "[i]f, in the opinion of YM, any material differences are identified which may be material for Cytopia shareholders, this information will be provided to them at least 10 days before the date of the scheme meeting", which is the statement I have referred to at paragraph 26 of my judgment, and that the relevant wording in the scheme booklet should have been "[i]f, in the opinion of YM, any material differences are identified, this information will be provided to them at least 10 days before the date of the scheme meeting". The amended wording has deleted the words "which may be material for Cytopia shareholders". I have been informed by the solicitors for the plaintiff that the scheme booklet has been amended to include the correct wording. I have given consideration to whether the amended wording would have any impact on the view that I expressed in paragraph 26 and I have concluded that it does not impact on the view I expressed in that paragraph.

[1] FT Eastment & Sons Pty Ltd v Metal Roof Decking Supplies Pty Ltd (1977) 3 ACLR 69, 72 (Street CJ); Australian Securities Commission v Marlborough Gold Mines Ltd [1993] HCA 15; (1993) 177 CLR 485, 504 (Mason CJ, Brennan, Dawson, Toohey, Gaudron JJ); Re Opes Prime Stockbroking Ltd (recs and mgrs appointed) (in liq) [2009] FCA 813; (2009) 258 ALR 362, 386 [102] (Finkelstein J).

[2] [2009] FCA 813; (2009) 258 ALR 362.

[4] Re Sonodyne International Ltd (1994) 15 ACSR 494, 497 (Hayne J).

[5] Re GIO Australia Holdings Ltd (1999) 37 ACSR 483, 286 (Santow J).

[6] Re GIO Australia Holdings Ltd [1999] NSWSC 1276; (1999) 33 ACSR 283, 286 (Santow J).

[7] Paragraph 9 of LEA Report dated 4 December 2009.

[8] [2006] VSC 436; (2006) 60 ACSR 548.

[11] Re Rancoo Ltd (1995) 17 ACSR 206, 207 (Hayne J).

[12] Re ACM Gold Ltd; Re MT Leyson Gold Mines Ltd (1992) 34 FCR 530, 534 (O'Loughlin J).

[13] Section 6.2 of the Scheme Booklet.

[14] See pp 25-54 of the Scheme Booklet.

[15] See s 4.4 and 6.5 of the Scheme Booklet.

[16] Cf Re WebCentral Group Ltd [2006] FCA 937 (Unreported, Lindgren J, 24 July 2006).

[17] Paragraph 67 of the affidavit of Ashley Neil Arnott sworn 20 November 2009.

[18] Paragraph 68 of the affidavit of Ashley Neil Arnott sworn 20 November 2009.

[19] Paragraph 15 of the third affidavit of Ashley Neil Arnott sworn 26 November 2009.

[21] [2006] FCA 670; (2006) 59 ACSR 82.

[23] [2007] FCA 770; (2007) 62 ACSR 400.

[25] Re People Telecom Ltd [2009] FCA 180 (Unreported, Jacobson J, 25 February 2009).

[26] Paragraph 8.6(c) of the Scheme Booklet.

[27] See the Implementation Agreement cl.10 and definitions of "No Shop Period" and "End Date".

[28] [2001] NSWSC 40; (2001) 36 ACSR 758, 760 [9].

[29] Eg Re Dyno Noble Ltd [2008] VSC 154 (Unreported, Robson J, 16 May 2008) (9 months); Re Hostworks Group Ltd [2008] FCA 64; (2008) 26 ACLC 137 (6 months); Re Sino Gold Ltd [2009] FCA 1277 (Unreported, Lindgren J, 6 November 2009) (7 months).

[30] Re Hostworks Group Ltd [2008] FCA 64; (2008) 26 ACLC 137; Re Macquarie Private Capital A Ltd [2008] NSWSC 323; (2008) 26 ACLC 366; Re Dyno Nobel Ltd [2008] VSC 154 (Unreported, Robson J, 16 May 2008); Re Coles Group Ltd (2007) 25 ACLC 1380; Re Adelaide Bank Ltd [2007] FCA 1582 (Unreported, Lander J, 5 October 2007); Orion Telecommunications Ltd [2007] FCA 1389 (Unreported, Gyles J, 4 September 2007). Cf Mincom Ltd v EAM Software Finance Pty Ltd [2007] QSC 37; (2007) 61 ACSR 266.

[31] See s.411(3) of the Act.