Re Strategic Energy Resources Limited [2011] VSC 645 (16 December 2011)

2 SER is a publicly listed company which is in the business of exploration, mining and processing natural resources. It has three directly held 100% subsidiaries - Tarcoola Gold Pty Ltd ("Tarcoola"), Strategic Nickel Pty Ltd and Eagle Oil and Gas Pty Ltd. SER, through Tarcoola and Tarcoola's wholly owned subsidiary, Strategic Energy Graphite Pty Ltd ("SEG"), controls various graphite mining assets in the Uley area of South Australia, including a graphite mine, a processing facility and the business of mining and processing the graphite from this area ("Graphite Mining Business"). Through its other subsidiaries, and in its own right, SER also controls various other gas and oil resource exploration assets ("Exploration Business"). On 22 July 2011, the SER Board announced the signing of a Merger Implementation Deed ("MID") with MEGA Graphite Inc. ("MEGA"). Under the MID, SER and MEGA agreed that, subject to certain conditions:

• a scheme of arrangement would be proposed by SER partly to demerge Tarcoola and SEG ("the Demerger Scheme"); and

• Tarcoola would propose a further scheme of arrangement under which all of its shares would be acquired by MEGA and the shareholders of Tarcoola would receive shares in MEGA in exchange ("the Transfer Scheme").

3 The purpose of the Demerger Scheme is to separate the Graphite Mining Business from the Exploration Business. In the view of the Board of SER, this structural separation will benefit the two businesses. It is also the Board's view that a partial demerger will assist in the realisation of Tarcoola's value, regardless of whether the Transfer Scheme is implemented. The Board considers that it is in the best interests of SER's shareholders for the Demerger Scheme to proceed, irrespective of whether the Transfer Scheme proceeds.

4 SER has applied for an order under s 411(1) of the Act for the convening of a meeting of its shareholders for the purpose of voting on the proposed partial demerger. If the Demerger Scheme is approved, SER will hold only 20% of the shares in Tarcoola, in lieu of its present 100% shareholding, and the remaining 80% of the shares in Tarcoola will be held by the SER shareholders directly.

5 The proposed mechanism to effect the partial demerger will involve first, Tarcoola increasing its current shares on issue via a share split so that approximately 30 million additional shares are issued to SER. Secondly, Tarcoola will then issue a further 348 million shares approximately to SER shareholders so that SER shareholders will receive one Tarcoola share for every SER share at the demerger date. Tarcoola's obligation to issue shares to SER shareholders is supported by a Deed Poll under which Tarcoola covenants in favour of the SER shareholders that it will observe and perform its obligations under the Demerger Scheme. Tarcoola will retain its 100% holding in SEG. While the manner in which the shareholding will be held post demerger will differ from the shareholding pre-demerger, there will be no change in the ultimate ownership of, or underlying economic interest in, SER.

6 The role of the Court on an application for the convening of a scheme meeting essentially is:

(a) to consider whether the scheme booklet that will be provided to the shareholders sufficiently discloses the detail and effect of the scheme to enable shareholders to make an informed decision on how to vote;

(b) to consider procedural matters about the calling and conduct of the meeting;

(c) to ascertain whether the Australian Securities and Investments Commission ("ASIC") has had reasonable opportunity to examine the proposed scheme; and

(d) to consider whether there may be matters that may make it unlikely that the scheme would be capable of a grant of approval by the Court if, in due course, its approval is sought and so make it futile to put the scheme to the shareholders for their vote.[1]

7 It is not the function of the Court on an application for an order convening a meeting to consider the business or commercial efficacy of the proposed scheme, as that is a matter for the shareholders. Nor is it the Court's role to express a view on whether the proposed scheme should be approved, if the requisite majority of votes is obtained. An order of the Court that the meeting be convened is not an indication that the Court has a view as to the merits of the scheme or as to how shareholders should vote. [2] As the application is made ex parte SER has "the responsibility of bringing to the Court's attention all matters that could be considered relevant" to the exercise of power by the Court.[3]

8 I am satisfied that the order under s 411(1) of the Act for the convening of a meeting should be made.

9 The question of class should be considered by the Court at the time of the application for convening a meeting of shareholders.[4]

10 SER only has one class of shareholders that hold ordinary shares carrying the same rights and entitlements, but, relevantly, amongst those shareholders, there is expected to be a certain number of ineligible foreign shareholders who will receive the net proceeds of the sale of the shares to which those shareholders would otherwise be entitled, rather than an in specie distribution of the shares themselves. As at 6 December 2011, the total number of ineligible foreign holders was 56, representing approximately 1.54% of SER's shareholders. The question is whether those ineligible foreign shareholders should be treated as a separate class.

11 The test for identifying a class for the purposes of a scheme of arrangement is one of community of interest, not one of identical treatment.[5] Differential treatment does not automatically mean that there is no community of interest. As Barrett J observed in Re Hills Motorway[6] the focus is not on the fact of differentiation but on its effects. His Honour continued:

The extent and nature of differentiation must be measured in terms of the effect on the ability to consult together in a common interest or, in other words, the ability to come together in a single meeting and to debate the question of what is good or bad for the constituency as a whole and where the common good lies. Only if the differentiation destroys that ability does the class distinction come to prevail.[7]

Here the rights attaching to the shares remain the same with the difference being that the ineligible foreign shareholders, although entitled to SER shares, will receive the proceeds of sale of those shares on their behalf instead of the shares in specie. In my view there is no need to treat them as a separate class for the purposes of the proposed demerger.

12 There are currently a number of option holders over unissued SER shares. The Demerger Scheme is conditional on all options being exercised or cancelled prior to the vote on the demerger scheme at the first scheme meeting. In that event there will be no remaining options over unissued SER shares and hence there is no need to consider whether the option holders may constitute a separate class for the purposes of voting. The Court was informed that the meeting would not proceed if all options were not exercised or cancelled prior to the scheme meeting and if that becomes the case SER would come back to Court for directions.

13 The demerger will require SER to declare a dividend equal to 80% of the value of Tarcoola. This will be paid by Tarcoola in the form of an in specie share distribution to SER shareholders (although in the case of the ineligible foreign shareholders the in specie distribution will be to a nominee). SER has obtained advice from the appointed auditor of SER, BDO Audit (NSW-VIC) ("BDO"), that the in specie dividend will comply with s 245T of the Act if SER amends its current accounting policy of carrying its investment in Tarcoola at cost to measure the investment at fair market value in accordance with AASB 127 paragraph 38 to ensure that there are sufficient net assets available to enable payment of this dividend, and that SER can opt to change the accounting treatment that way. SER has put evidence before the Court that it will change its accounting policy to recognise its investment in Tarcoola at fair value, if the demerger scheme is approved.

14 The Court's attention was drawn to the inclusion of certain provisions in the MID. These types of provisions have been judicially considered in several cases. None of those provisions are exceptional or, in my view, provide a reason for the Court to refrain from making an order for the convening of the meeting of SER shareholders. The particular provisions are:

15 SER has agreed to certain restrictions on its ability to solicit or accept alternative proposals for SER, Tarcoola and SEG for a certain period. The concern of the Court about an exclusivity provision of this kind is whether the provision may operate against the interests of the shareholders. Santow J in Re Arthur Yates and Co Limited[8] stated that an exclusivity provision should be for no more than a reasonable period that is capable of precise ascertainment, that it must be subject to an overriding obligation not to breach director's fiduciary duties, and that it should be given adequate prominence in the materials sent to members.[9] The consistent approach of Courts in later cases has been to require a fiduciary carve out only in relation to "no talk" provisions.[10] These requirements are made out on the material before the Court - I note that the exclusivity period is for approximately seven months, which is within the period of restriction that the Courts have accepted and is reasonable,[11] and that there is a specific carve out in the no talk provision for fiduciary and statutory duties. I am also satisfied the exclusivity provisions are given adequate prominence in the Demerger Scheme booklet.[12]

16 Under certain conditions SER is potentially required to repay MEGA amounts actually paid by MEGA to SER specifically to obtain its agreement to the exclusivity provisions. The relevant issue is whether the liability to make that repayment would be likely to coerce the shareholders into agreeing to the demerger or to deter other companies from making a competing offer.[13] I am satisfied on the basis of the material before me that this potential liability is not likely to coerce SER shareholders into agreeing to the proposed demerger. I am also satisfied that this potential liability has been sufficiently disclosed in the scheme booklet.

17 I note that the directors of SER have unanimously recommended that the SER shareholders vote in favour of the demerger in the absence of a superior proposal. An independent expert's report has been obtained by DMR Corporate Pty Ltd in which the view of the expert is expressed that the demerger is both fair and reasonable. The Demerger Scheme is considered fair because the economic interests of the SER shareholders prior to and post demerger will remain the same and because there will be no change in the ultimate ownership of, or the economic interest in, SER. The Demerger Scheme is considered reasonable because it should result in the unlocking of potential value of the Uley Graphite project.

18 I am also satisfied that the explanatory booklet, on the face of it, contains the information required by the shareholders in order to make an informed decision on how to vote. Finally, I am satisfied that ASIC was given proper notice of the application and has had reasonable opportunity to examine the proposed scheme. ASIC provided a letter to the Court indicating that it did not intend to appear to make any submissions on whether the Court should make orders approving a convening of the meeting.

19 In light of these matters I am satisfied that the meeting should be convened.

[1] Re Orica Limited [2010] VSC 231, [7] (footnotes omitted).

[3] Re Permanent Trustee Co Ltd [2002] NSWSC 1177; (2002) 43 ACSR 601, 603 [7] (Barrett J); as cited in Re Gas 2 Grid Limited [2010] FCA 10 (Unreported, 20 January 2010, Stone J), [6].

[4] Re Orica Limited [2010] VSC 231, [12].

[5] Re Orica Limited [2010] VSC 231; Re Hills Motorway [2002] NSWSC 897; (2002) 43 ACSR 101; Re Wattle Limited [2010] FCA 854.

[6] [2002] NSWSC 897; (2002) 43 ACSR 101.

[8] [2001] NSWSC 40; (2001) 36 ACSR 758.

[10] Re APN News and Media Limited [2007] FCA 770; (2007) 62 ACSR 400; Re Coles Group Limited (2007) 25 ACLC 1380; Re Hostworks Group Limited [2008] FCA 64; (2008) 26 ACLC 137; Re Macquarie Private Capital A Limited [2008] NSWSC 323; (2008) 26 ACLC 366.

[11] Re Dyno Noble Limited [2008] VSC 154 (9 months); Re Hostworks Group Limited [2008] FCA 64; (2008) 26 ACLC 137 (6 months); Re Sino Gold Mining Limited [2009] FCA 1277; (2009) 74 ACSR 647 (7 months).

[13] Re APN News and Media Limited [2007] FCA 770; (2007) 62 ACSR 400; Re Coles Group Limited [2007] VSC 389; Re Healthscope Limited [2010] VSC 367.