Re SMS Management & Technology Ltd [2017] VSC 257 (5 May 2017)

1 I made orders on the application by SMS Management & Technology Limited (SMS) for the convening of a meeting of members to consider and, if thought fit, approve a scheme arrangement between SMS and its shareholders for the reasons that follow.

2 I note by way of introduction, that there are generally two methods provided in the Corporations Act 2001 (Cth) (Corporations Act) for one company to take over another company. One is by a takeover offer and the other is under a scheme arrangement.

3 A scheme of arrangement involves the target company agreeing with its members to the takeover bid. Naturally, such a takeover is not hostile but done with the agreement of the target company's board, as in the application before me. SMS, a company listed on the Australian Stock Exchange, has agreed with DWS Limited (DWS), to propose to its members, a takeover bid by DWS, a company also listed on the stock exchange.

4 The agreement between SMS and DWS has been formalised in a scheme implementation agreement. In this case, the scheme involves the required majority of members of SMS to agree to their shares being transferred to DWS in exchange for $1 and 0.39 DWS shares for each share held by a SMS shareholder.

5 The proposed scheme, however, is subject to some refinements and adjustments that the Court will need to address, along with the other duties the Court has in considering the application. The proposal and approval of this scheme, like all other takeovers that follow this route, involves the following steps:

(1) The agreement between the bidder and the target to propose the scheme.

(2) The preparation of the scheme documents, submission of the scheme documents to ASIC for approval, preparation of the first court application, and the making of the formal scheme implementation agreement between the bidder and the target.

(3) The first hearing by the Court to hear the application to approve the calling of the meeting members to consider and if thought fit, approve the scheme.

(4) The meeting of the members to consider and if though fit, approve the scheme.

(5) The certification by an Associate Judge of this Court of the outcome of the meeting of members.

(6) The second Court hearing to consider the application for approval of the scheme, if the members have supported it.

(7) If the Court approves the scheme, the execution of the scheme involving the payment of the moneys and transferring the shares.

6 The target company must give a full and complete information to its members of the proposed scheme and the possible advantages and disadvantages of the scheme. This is done in the explanatory statement, which is included in the scheme booklet. It is customary for the target company to also obtain the opinion of an independent expert on whether in the expert's opinion the scheme is fair and reasonable. The independent expert in this case is KPMG Corporate Finance.

7 ASIC plays an important role in the scheme approval process; the scheme booklet is required by law to contain a great deal of information, and it must be provided to ASIC for examination of the terms of the scheme and the explanatory statement. The Court is greatly assisted by the role that ASIC performs in considering the scheme material.

8 The preparation of a scheme arrangement involves a high degree of care and skill and a large volume of papers produced. This requires the involvement of competent and experienced solicitors. It is customary, and of a great deal of assistance to the Court, for the application to the Court be made by experienced and competent counsel.

9 The Court relies greatly on counsel bringing to the attention of the Court matters in the scheme that should be addressed by the Court or otherwise known by the Court. This has been done in this case by Mr Ahern of counsel.

10 As mentioned above, the proposed scheme is subject to refinements.

11 First, ineligible foreign shareholders, which do not include shareholders resident in Australia and its external territories, New Zealand, United Kingdom, although entitled to vote on the scheme, will not receive shares in DWS in cash but will receive a cash compensation only.

12 Primarily this approach is taken to avoid the target company having to comply with the regulatory requirements of other jurisdictions that may apply where the consideration includes the issuing of shares to non-resident members by the bidding company. I am satisfied that the proposal to cash out the foreign shareholders shares is reasonable in the circumstances. In this case, the proposal involves the shares being sold by an agent and the moneys distributed to the non-resident shareholders.

13 Secondly, the target company has issued to certain of its employees, performance rights that entitle those employees to acquire shares in SMS at advantageous terms. Under the terms of the performance rights, SMS may cancel those rights in the event of a takeover such as the scheme proposed in this case. This raises the question of whether the members of SMS who have performance rights should be entitled to vote as a separate class.

14 The written submissions of Mr Ahern for the target company, comprehensively canvassed the authorities on this issue. Those authorities establish that generally speaking, if a member has other commercial considerations for supporting or not supporting the scheme, that do not arise from the characterisations of the security that the member holds, then that factor will not normally require that the member vote in a different class to the other members who do not have those commercial considerations.

15 Specifically in this case, the members with performance rights are faced with the commercial prospect of losing their performance rights if the scheme goes ahead. The relevant test of a class is determined by whether the interests of persons in question are so different as to make it impossible for them to consult together with other shareholders.

16 In this case, members may have a range of reasons to support or to not support the scheme, including the loss of performance rights. In my opinion, however, those circumstances do not make it impossible for them to consult together. They are all discussing the sale of their shares of the same type.

17 Another feature of the scheme that requires attention is that the chief executive officer and managing director, Mr Rostolis of SMS, is to receive $600,000 as a cash incentive, if the scheme is implemented. Under his current employment contract with SMS, if he ceases to be the most senior executive in the SMS group of companies, or ceases to be chief executive officer of SMS, or there is a substantial diminution in his responsibilities, Mr Rostolis is entitled to resign with immediate effect and receive $583,000 representing 6 months' salary in lieu of notice plus 6 months' base salary.

18 It is the intention of the bidder, if it is successful, that Mr Danny Wallis, the current chief executive of DWS, will become the chief executive officer and managing director of the merged group, thereby substantially diminishing the position of Mr Rostolis, if not removing him as CEO of SMS.

19 At the meeting of members, Mr Rostolis' votes are to be tagged. If the scheme is supported by the required majority, the Court will take into account, at the hearing to consider whether or not to approve the scheme, whether or not Mr Rostolis' vote was critical to the outcome of the meeting.

20 Other incentive payments are to be made to six employees of SMS, totalling $873,000. The consideration for these payment is expressed as being their personal efforts to have the scheme implemented. Mr Ahern informed me that that consideration was intended to comprehend the retention of the services of those six employees during the period from when the scheme was announced in February 2017, until the scheme is approved, if it is, sometime after July.

21 Their votes should also be tagged and brought to the Court's attention at the second hearing, if the members support the scheme.

22 A further issue which was raised by ASIC in communications with the target, is the proposed recommendation by the managing director of SMS, Mr Rostolis, that the members approve this scheme.

23 The issue that is raised is whether this is appropriate in the circumstances where Mr Rostolis is to be compensated with the payment of $600,000 if the scheme is implemented, to provide a recommendation. Mr Ahern submitted that the Corporations Act and the Regulations made under it, requires that the directors state their opinion as to whether or not the scheme is recommended to be approved by the members. Mr Ahern referred me to schedule 8 reg 8301(a)(i) of the Corporations Regulations which so provides.

24 Regulation 8301(a) of the Corporations Regulations states:

Part 3 - Prescribed information relating to proposed compromise or arrangement with members or a class of members

8301 The statement must set out:

(a) unless the company the subject of the Scheme is in the course of being wound up or is under official management, in relation to each director of the company:

(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.

25 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.

26 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.

27 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.

28 The scheme provides that the directors might resolve to pay a fully franked special dividend up to 10.2 cents per share.

29 The scheme provides that if such special dividend is declared and the scheme becomes effective, the cash component of the scheme consideration will be reduced by the value of the special dividend. This payment raises the issue whether SMS may be providing financial assistance to DWS to assist DWS to purchase the target company.

30 DWS does not own any shares in SMS. The chief executive officer and the chief financial officer of DWS do hold shares in SMS, constituting .08 per cent of the shares on issue in SMS. Thus there is no material issue of providing financial assistance to DWS.

31 The other aspect of the dividend is that the receipt of the dividend will lead to the cash consideration being reduced. To my mind, that raises issues as to whether a dividend, even though franked, may, in the hands of the shareholder, be of lesser or greater benefit than the receipt of the capital cash component.

32 For example, a shareholder who acquired their shares at a value equal to or above the takeover offer and therefore stood to make no capital gain, may prefer to receive cash consideration rather than a franked dividend.

33 Mr Ahern informed me that my example was correct, therefore I required some further explanation or clarification about the matter being inserted in the chairman's letter. The letter initially said:

If declared, the Special Dividend is expected to be paid to SMS Shareholders on or shortly before the Implementation Date. Those SMS Shareholders who are able to realise the full benefit of franking credits attached to the Special Divided (if declared) will realise additional value of up to a maximum of 4.4 cents per SMS Share (based on a Special Dividend of 10.2 cents per SMS Share). Whether you will be able to realise the full benefit of the franking credits attached to the Special Dividend will depend on your individual tax circumstances.

34 I formed the view that that did not convey the full picture as in some cases, the shareholder who received the franking dividend and might be financially disadvantaged, as opposed to receiving the cash payment. That observation now is to be subject to a footnote which says:

In assessing the value to them of any Special Dividend, SMS shareholders should seek professional taxation advice as to whether or not the receipt of any Special Dividend and any entitlement to a tax offset in respect to the franking credits attached to any Special Dividend is beneficial to them in their own individual circumstances. Refer to Section 12 ("Tax Considerations") for further information.

35 Mr Ahern has brought to my attention a declaration required of SMS shareholders that, speaking generally, they do not have an 'indirect property interest' in SMS that might be subject to a withholding tax in respect of land rich companies where they are non-resident shareholders.

36 As it was, I was not satisfied with the explanation given to shareholders as to why they were being asked to make the declaration in circumstances where the company had formed the view that they did not fall within the category shareholders caught by the legislation. To that end, the chairman's letter has been amended to provide as follows:

Section 7.12 of the Scheme Booklet identifies certain warranties that are deemed to be given by Scheme Shareholders. In relation to the tax withholding declaration, SMS has been advised that although any SMS Shares held by a foreign resident for tax purposes do not constitute indirect Australian real property interests, it is nevertheless advisable for tax purpose for SMS Shareholders to make such a declaration.

37 It might be said that this explanation does not comprehensively address the point, but at least the shareholders are being told that, for tax purposes, they are being required to make such a declaration, and I am satisfied that in the circumstances that is sufficient.

38 Initially, SMS proposed that it would not supply hard copies of the scheme booklet to any member who had previously informed the company that it was prepared to receive communications from the company by email rather than hard copy.

39 I was informed, in giving these reasons, that ASIC expressed its view that hard copies of the scheme booklet should be made available to scheme members who request the same, despite the fact that they have previously authorised and requested that communications be made to them by email.

40 SMS has agreed that it should provide hard copies of the scheme booklet, and the order made by the Court provides that the plaintiff send to each SMS shareholder an email, on or before 15 May 2017, substantially in the form exhibited to the affidavit of Rick Rostolis sworn 2 May 2017, save for the words: '[i]f you wish to receive a hard copy of the Scheme Booklet, please contact the SMS Shareholder Information Line, [and the number is given] and a copy will be sent to you free of charge'; are to be inserted after a computer link and the words: 'which contains links to an electronic copy of a document substantially in the form of the scheme booklet and the online meeting website'.

If any such SMS shall request from the plaintiff in writing that a hard copy of the Scheme Booklet be provided to that SMS Shareholder, then the plaintiff shall send by ordinary prepaid post a hard copy of the Scheme Booklet to the relevant SMS Shareholder free of charge as soon as practicable.

42 In my view, it is appropriate, in this case, that shareholders may seek a hard copy of the scheme booklet and explanatory statement which is some 200 pages long, on such an important matter as a takeover, in addition to an attachment to an email. It is unnecessary for me to rule that in all future schemes that need be done.

43 The authorities establish there are several factors that the Court must take into account in deciding whether or not to approve the calling of a meeting of members to consider the scheme. The factors are inherent in the following findings. I am satisfied that:

(1) The proposed scheme fits within the statutory concept of an arrangement or compromise with the meaning of s 411 of the Corporations Act.

(2) There will be available to members all the main facts relevant to the exercise of the members' judgment.

(3) ASIC has had a reasonable opportunity to examine the proposal, the terms of the scheme and make submissions as required under s 411(2) of the Corporations Act.

(4) The scheme, as proposed, is so conceived or presented, so far as I can see, why it should not, in due course, receive the Court's approval, if the necessary majority of members votes is achieved.

(5) The scheme is such that could reasonably be supposed by sensible business people to be for the benefit of the class concerned.

44 As indicated, I understand those to be the prerequisites to me exercising my discretion whether or not to allow the meeting to be convened to consider the scheme.

45 Finally, I confirm that I have otherwise read the written submissions of Mr Ahern for which the Court expresses its appreciation and, subject to the observations I have made, I accept in substance the submissions Mr Ahern has made.

46 For these reasons, I made orders that the plaintiff convene the meetings of shareholders to consider that the scheme and other incidental orders.