Sovereign Life Assurance Company v Dodd

IN THE MATTER OF PR FINANCE GROUP LIMITED ACN 109 299 390 PR FINANCE GROUP LIMITED ACN 109 299 390

JUDGE: FARRELL J DATE: 27 MAY 2013 PLACE: SYDNEY

REASONS FOR JUDGMENT 1 The plaintiff company, PR Finance Group Limited ACN 109 299 390 (PRF) sought orders under s 411(1) of the Corporations Act 2001 (Cth) (the Act) to convene a meeting of its members (Scheme Meeting) to consider a scheme of arrangement between PRF and its members (Scheme). I made those orders on 13 May 2013 following a hearing on that date, and these are my reasons for doing so. 2 PRF is an unlisted public company registered in Queensland on 28 May 2004. Its principal activity is the provision of consumer finance through its subsidiaries. As at 10 May 2013, it had 118 members and there is only one class of shares on issue. 3 Keybridge Capital Limited (Keybridge) is a company registered in New South Wales on 25 June 1999. Its shares are listed for quotation on markets operated by the Australian Securities Exchange Limited (ASX). It is a financial services company that has, as investor or lender, been involved in transactions backed by real estate or financial assets or cash flow. Its major asset classes are: aviation, lending, property, private equity and infrastructure. 4 For convenience, words which are defined in the booklet which is Exhibit 1 in these proceedings (Scheme Booklet) have the same meaning in these reasons. In general, those terms are used in the way they are commonly used in "acquisition" schemes of arrangement, unless otherwise indicated.

Background 5 PRF and its subsidiaries (PRF Group) experienced rapid growth in 2005 to 2008, and had a peak debt of $78 million. A proposed listing in 2007 did not proceed. In 2008, in the course of the global financial crisis, the Commonwealth Bank of Australia Limited (CBA), PRF Group's primary lender, required PRF to reduce its debt by entering into a debt reduction arrangement, with a cap of $40 million (Senior Debt Facility). There followed a substantial debt reduction campaign in 2009 and 2010. Keybridge (and others) had also lent money to PRF under a syndicated loan facility agreement dated 29 June 2007 (Keybridge Facility or Mezzanine Debt Facility). Keybridge also required its facility to be repaid, and there was some limited debt reduction in 2011 and 2012. PRF Group's cost of funds also increased. 6 PRF directors engaged Deloitte Corporate Finance Pty Limited (Deloitte) to explore funding options, including the possible sale of assets and equity capital raisings. Deloitte sought interest broadly, approaching 98 parties internationally. PRF received expressions of interest from 13 parties but ultimately there were only 2 offers, and only 1 progressed past the term sheet stage. PRF signed a non-binding heads of agreement with Marubeni Corporation, a Japanese entity (Marubeni), to sell its motor vehicle leasing and finance business on 4 September 2012, but that transaction did not proceed, and a proposed meeting of PRF shareholders in February 2013 to approve the sale to Marubeni was cancelled. 7 At the end of February 2013, CBA notified PRF that it was in breach of its loan to value ratios, which put PRF in breach of the Senior Debt Facility and the Keybridge Facility. On instructions from CBA, PRF failed to make its monthly interest payment under the Keybridge Facility on 1 March 2013. There were some short term extensions of the Keybridge Facility but Keybridge indicated that it would not further extend the termination date of the Keybridge Facility past 7 April 2013. 8 Against this background, Keybridge approached PRF with a proposal to acquire 100% of PRF under a scheme of arrangement. On 30 March 2013 PRF and Keybridge agreed final terms and entered into a scheme implementation agreement (Scheme Implementation Agreement). On 2 April 2013, Keybridge made an announcement to the ASX of the proposed Scheme. It disclosed, in effect, that PRF's net exposure to Keybridge is $12.1 million. The Keybridge Facility will remain in place and be extended if the Scheme is approved. 9 PRF's aggregate debt is in the order of $52 million. If the Scheme does not proceed PRF has no certainty of ongoing funding from either of CBA or Keybridge. If the Scheme Implementation Agreement had not been entered into, the Keybridge Facility would have become due and PRF would have become technically insolvent. PRF's financial report for the 2012 year has not been filed yet with the Australian Securities & Investments Commission (ASIC), although PRF directors have said that it will be filed before the Scheme Meeting. The report has been prepared on a "going concern" basis, but PRF's directors have been advised that it is likely to receive a qualified audit report concerning PRF's ability to continue to operate as a going concern, as this is dependent on PRF's ability to satisfy conditions imposed by its financiers to extend facilitates. Those conditions relate to the successful sale of PRF's motor vehicle leasing and finance division. 10 At the time of the hearing, negotiations with Marubeni had been reopened, and a revised proposal was before Marubeni's investment committee. There is a further proposal from an unnamed party relating to some of the motor vehicle leasing and finance business. Neither of these proposals was capable of acceptance at the time of the hearing. I will refer to these as Alternative Offers.

Proposed Scheme 11 The Scheme is in the nature of an "acquisition scheme". Keybridge will acquire all of the shares issued by PRF with the result that PRF will become a wholly owned subsidiary of Keybridge. 12 The consideration (Scheme Consideration) for the transfer of PRF shares comprises cash and Keybridge shares. The calculation of the Scheme Consideration is less straightforward. It comprises three elements: 78.40 cents cash (Cash Consideration) for every 100 PRF shares. This would be an aggregate amount of $1.35 million. Keybridge shares (Scrip Consideration). The Scrip Consideration will be calculated by reference to the aggregate value, divided by the aggregate number, of Keybridge shares traded on ASX in the 30 days ending on the Effective Date of the Scheme (being the date the Scheme comes into effect under s 411(10) of the Act). If that value is 20 cents or less, the Scrip Consideration will be 1.452 Keybridge shares for every 100 PRF shares. If the value is greater than 20 cents, the Scrip Consideration will be the number of Keybridge shares that is equal to the amount of 29.04 cents per 100 PRF shares. Keybridge would become liable to issue the lesser of 2.5 million Keybridge shares and Keybridge shares with an initial market value of $500,000. The Scrip Consideration will be rounded up or down to the nearest whole Keybridge share. An uplift payment if, within 12 months after the Implementation Date, there is a Subsequent Control Transaction for an amount greater than $52 million plus the amount of interest which has accrued and remains unpaid under the Keybridge Facility (Subsequent Control Transaction Consideration). A Subsequent Control Transaction would involve PRF or Keybridge entering into an agreement to sell all or substantially all of the shares in PRF or its subsidiaries or their assets. The uplift amount is an aggregate of $1 million dollars in cash or Keybridge shares (at Keybridge's election), and if the consideration is Keybridge shares, they will be rounded up or down to the nearest whole Keybridge share. 13 On the Implementation Date, Keybridge will: (a) pay the Cash Consideration to PRF on trust for PRF shareholders; (b) pay Deloitte's fee of $150,000 to PRF on trust for Deloitte; and (c) issue the Scrip Consideration to PRF shareholders.

Compromise or arrangement 14 This is a common form of "arrangement" proposed under s 411 of the Act under which the PRF shareholders give benefits (the transfer of the PRF shares to Keybridge) and receive benefits (Scheme Consideration) through the proposed Scheme. The Scheme does not involve an associated cancellation of capital.

Disclosure to members 15 Consideration of the Scheme Booklet is a central task of the Court at the first hearing. The Court needs to be satisfied that the proposed Scheme is of such a nature and cast in such terms that if it receives the statutory majority at the meeting of members, the Court would be able to approve the scheme on an application which is unopposed at the second court hearing. Although, by convening the Scheme Meeting, the Court does not give its imprimatur to the proposed scheme; the question for the Court is whether a sensible business person might consider the arrangement proposed as beneficial. Whether to approve the scheme is ultimately a decision for the members. The Court must to be satisfied, so far as it reasonably can on an ex parte application made "in a summary way", that the information requirements set out in s 411(3) have been met. 16 Essentially, the question is whether shareholders have been provided sufficient information to make a decision whether to vote for or against the proposed Scheme. The Scheme Booklet follows a common format although, unusually, it contains in full the Scheme Implementation Agreement and the unexecuted Deed Poll, rather than a summary alone. It contains a statement of risks associated with implementation of the Scheme and the reasons why shareholders might vote for or against the Scheme as well as full detail of the conditions to which the Scheme is subject.

Directors' Interests 17 There are three directors. Mr Tong holds 1.9% of the issued PRF shares. 18 Mr Llewellyn (the Chairman) and Mr James each hold 31.8% of the issued PRF shares: see Section 5.6 of the Scheme Booklet. They are the founders of PRF. They are each owed over $1 million in contractual entitlements which have accrued but not yet been paid by PRF. The Scheme is subject to a precondition that they (and their independent contractor entities) enter into revised arrangements which cap their claims to $1 million each. The capped amount must be paid as to $625,000 each in instalments over 12 months after the Implementation Date (so long as that does not cause PRF to be insolvent and subject to CBA consent). Any part of that amount which is unpaid becomes unconditionally payable at the end of that period. Whether the further balance of $375,000 each is paid depends on whether and the extent to which a refund is received from the Australian Taxation Office in the year following the Implementation Date in respect of GST returns for the period ended 31 December 2012: see Section 11.1 of the Scheme Booklet. 19 All three directors must resign at the Implementation Date. Messrs Llewellyn and James will each continue to hold management positions in PRF as independent contractors (through their contracting entities) and it is a condition of the Scheme that (relevantly) their annual fee for the provision of management services is reduced from $710,000 to $400,000 each and their termination notice period is reduced from 24 months to 3 months.

Directors' Recommendation 20 The directors of PRF recommend that members vote in favour of the Scheme. They advise that they and their related entities will vote in favour of the Scheme, in the absence of a superior proposal. The interests of Messrs Llewellyn and James are referred to in the same part of the Scheme Booklet as the recommendation.

Independent Expert 21 Although not required by Schedule 8 of the Corporations Regulations 2001 (Cth), the Scheme Booklet includes an independent expert's report by BDO Corporate Finance (QLD) Limited (BDO). BDO concludes that the proposed Scheme is "not fair but reasonable" and, in the absence of any other information or a superior proposal, that it is in the best interests of PRF shareholders. Its reasons for this conclusion are: PRF is currently experiencing financial distress. It has breached covenants relating to its Senior Debt Facility and is in default of the Keybridge Facility; Keybridge will be in a position to place PRF into receivership in circumstances where the Scheme is not approved and no superior offer has been received; If PRF is placed into receivership and the receiver is not able to obtain a superior proposal to the offers obtained by the directors of PRF over the previous 12 months period, it is possible that PRF shareholders will realise a value for their investment which is significantly less than the consideration anticipated by the proposed Scheme, or may not receive any value at all; The termination date of the Keybridge Facility, in the absence of a superior proposal having been received by PRF, is the date the Scheme Implementation Agreement is terminated or 30 June 2013 if the Scheme Implementation Agreement is terminated due to a superior proposal being entered into; and PRF and its corporate adviser, Deloitte, have made significant attempts to either recapitalise or sell PRF by presenting the opportunity to a wide range of potential investors and purchasers. Despite these attempts, PRF's directors and their advisers hold the view that the proposed Scheme is the best proposal that has been received and which is capable of acceptance as of the date of the BDO report. 22 BDO attributes no value to the Subsequent Control Transaction Consideration because of the degree of uncertainty attached to whether any such consideration will ever be received, as it is dependent on the willingness of third parties to enter into transactions with PRF in the year after the Implementation Date. 23 BDO assesses the value of each PRF share to be in the range of $0.0248 to $0.0919, which is greater than its assessment of the value of the Scheme Consideration. In accordance with ASIC Regulatory Guide 111, BDO therefore assesses that the Scheme is not "fair". BDO comes to that conclusion without taking into account PRF's distressed circumstances, as required by Regulatory Guide 111. ASIC's Regulatory Guide asserts that it has been "long accepted" that there is a need to break down the term "fair and reasonable" into the elements of "fair" and "reasonable", rather than treating it as a compound phrase along the lines of "the best interests of shareholders". It is true that ASIC has long enforced that policy. 24 In the circumstances of this case, this methodology, including the need to value PRF shares disregarding its distressed state, tends to obscure the commonsense finding to which BDO ultimately comes. Compliance with the Regulatory Guide leads to over complexity in the expression of BDO's opinion and in the length of its report. This undermines its clarity and therefore is utility to PRF shareholders, but BDO's opinion appears to be well founded.

Classes 25 The Scheme is proposed on the basis of that all shareholders form a single class. This is so notwithstanding that Messrs Llewellyn and James together have relevant interests in 63.6% of the issued capital of PRF and they will continue as managers of PRF following implementation of the Scheme for which their controlled entities (as independent contractors) will receive annual fees. 26 Counsel for PRF submitted that these factors would not "make it impossible for [all PRF shareholders] to consult together with a view to their common interest" within the formulation of Bowen LJ in Sovereign Life Assurance Company v Dodd [1892] 2 QB 573 at 583. The arrangements proposed are less advantageous to Messrs Llewellyn and James on their face than the current arrangements, acknowledging that those current arrangements may be of marginal value in the existing financial circumstances of PRF. It is true that there is a better chance that PRF's obligations to Messrs Llewellyn and James (albeit as modified) will be performed. All shareholders are likely to be better off if the Scheme proceeds and CBA and Keybridge modify their arrangements with PRF. Further, even though the shares in which they have a combined relevant interests comprise a substantial proportion of the 75% of votes required to approve the Scheme, the 50% in number of shareholders test will allow other shareholders a significant voice: see s 411(4)(a)(ii) of the Act. 27 Counsel acknowledged that whether this view of the appropriate classes for consideration of the Scheme proves correct will be a matter for final determination at the second court hearing.

Conditions 28 The Scheme is subject to a number of common conditions as well as the following, each of which must be satisfied by the time of the second court hearing: (a) Conditions relating to whether PRF has entered into arrangements with a third party which would result in them acquiring a significant business of PRF, the acquisition of a relevant interest in PRF shares of 10% or greater, control of PRF, or relating to a scheme of arrangement or takeover for PRF (Exclusivity Arrangements); (b) CBA agreeing to extend its facility, consenting to the Scheme and consenting to the extension of the Kebridge Facility. This condition was amended at the first court hearing; the Scheme Implementation Agreement originally provided for the consent to the extension of the Keybridge Factiliy to be obtained by the first court hearing, and it had not been obtained; (c) The terms under which Deloitte is engaged being amended satisfactorily to Keybridge; (d) PRF directors agreeing with PRF to partially extinguish contractual entitlements as mentioned in [18] above and Messrs Llewellyn and Mr James agreeing to amend the terms under which they will provide management services as described in [19] above. The conditions are set out fully in the Scheme Implementation Agreement which is included in the Scheme Booklet and they are summarised at Sections 1.11 and 9.2 of the Scheme Booklet.

Alternative Offers 29 The existence of the Alternative Offers for the motor vehicle leasing and finance business is disclosed in a number of places in the Scheme Booklet. PRF will inform PRF shareholders of any developments concerning the Alternative Offers. If an offer is received by PRF which the directors determine to be a superior proposal, further information will be provided to PRF shareholders about the offer and its impact on the Scheme. 30 BDO prepared an addendum to its report which takes into account the Alternative Offers, and it is dated the same date as the report. BDO notes that the Alternative Offers are not legally binding, that they are currently not open for acceptance by PRF and they are conditional on a range of factors. BDO concludes that for so long as they do not remain open for acceptance by PRF, the existence of the Alternative Offers has no impact on its opinion. As PRF is financially distressed, BDO states that: "It is our view that certainty of completion, time to completion and certainty of terms are particularly important considerations at the current time."

Subsequent Control Transaction Consideration 31 Keybridge must pay the Subsequent Control Transaction Consideration within 120 days of the Subsequent Control Transaction to those who were PRF shareholders on the record date for determining entitlements under the Scheme. The Subsequent Control Transaction Consideration is calculated on the basis of 58.08 cents for every 100 PRF shares and payable in cash or Keybridge shares, at Keybridge's election. There is considerable uncertainty that any Subsequent Control Transaction Consideration will ever be paid, since it requires a third party to be willing to enter into such a transaction within the 12 months timeframe. This is disclosed prominently throughout the Scheme Booklet and BDO attributes no value to this aspect of the Scheme.

Keybridge's strategic direction 32 Keybridge itself appears to be at something of a crossroads. At Section 6.3 of the Scheme Booklet, Keybridge discloses: With the full retirement of Keybridge's corporate debt, Keybridge intends to consider the strategic direction of the company. The likely options range from a continuation of the gradual wind down process over an appropriate period to a reinvigoration of the company by a capital raising and recommencement of investment activities. The board of Keybridge will continue to keep Keybridge shareholders fully informed as this process develops.

Deemed Warranty 33 Counsel for PRF drew to the Court's attention the existence of the deemed warranty by PRF shareholders in relation to their shares disclosed at Section 3.8 of the Scheme Booklet and contained in clause 5.2 of the Scheme. This warranty is in a form consistent with the approach of the Court in Re APN News & Media Ltd (2007) 62 ACSR 400 at [59]-[62], followed by Barrett J in Macquarie Private Capital A Limited (2008) 26 ACLC 366 at [13]-[14].

Verification 34 Officers of PRF and Keybridge have each deposed to a verification process undertaken in relation to those parts of the Scheme Booklet for which those companies are respectively responsible.

Lock up devices 35 Notwithstanding the Exclusivity Arrangements, PRF was permitted to continue discussions with a number of specified parties before 10 May 2013. Since that date, PRF is restricted from dealing with third parties unless the directors determine that such a proposal may reasonably be expected to lead to a superior proposal and such action is required to satisfy its fiduciary and statutory duties. 36 In paragraphs [26] to [34] of his affidavit of 10 May 2013, Mr Llewellyn provides an explanation in relation to the deal protection measures included in the Scheme Implementation Agreement. Those measures include "no shop" and "no talk" provisions. 37 Mr Llewellyn deposes that: The deal protection measures are disclosed in Section 10.5 of the Scheme Booklet; There is no break fee payable by either of PRF or Keybridge; The measures were the subject of arms length negotiation with the assistance of legal advice to both parties; PRF had regard to Takeovers Panel Guidance Note 7 on Lock-up Devices; Keybridge required those provisions and Mr Llewellyn considers that they do not operate to the detriment of PRF shareholders; He considers them reasonable because they have a fiduciary and statutory carve out in clauses 10.8 and 31.8 of the Scheme Implementation Agreement if the PRF board determines, in good faith and after having taken legal and financial advice, that action or inaction is required to discharge those duties; and He confirms that he has spoken to the other directors and they share that view. 38 It is notable that the directors and Deloitte have made considerable efforts to find parties interested in some or all of the businesses of PRF without success (the Alternative Offers being not capable of acceptance), and PRF is now in financially distressed circumstances. There is also no break fee. 39 Accordingly, the "no shop", "no talk", "no due diligence" and "matching rights" features of the Scheme Implementation Agreement do not appear to be unduly anti-competitive in accordance with the Takeovers Panel Guidance Note 7 on Lock-up Devices, nor are they coercive of PRF shareholders in expressing their attitude to the proposal.

Foreign shareholders 40 There is a pro forma disclosure in the "Important Notices" section on page 6 of the Scheme Booklet which indicates that the Booklet and Scheme do not constitute offers in any place in which, or person to which, it would be unlawful to make those offers. At the hearing, Counsel confirmed to the Court that there are no foreign shareholders of PRF. Accordingly there are no provisions which create a sale facility for the sale of Keybridge shares which form part of the Scheme Consideration.

Performance Risk 41 The issue of performance risk has been dealt with in a standard way, except for the issue of Keybridge shareholder approval.

Keybridge shareholder approval under ASX Listing Rule 11.1.2 42 ASX notified Keybridge after it had entered into the Scheme Implementation Agreement that it requires Keybridge to seek the approval of its shareholders to the Scheme on the basis that the acquisition of PRF by Keybridge would result in a significant change in the nature or scale of its activities. Keybridge will convene a general meeting of shareholders to obtain the approval before the second court hearing. This is disclosed in Section 1.11 of the Scheme Booklet. The need to obtain this approval is not, in those words, a condition of the Scheme. 43 If Keybridge shareholder approval is not forthcoming before the second court hearing, then it will be a matter for the Court at that time to determine whether the Scheme is subject to any relevant condition which has not been fulfilled. If the failure to obtain Keybridge shareholder approval (for the purpose of satisfying the ASX Listing Rules) is not found to be a condition, but the Scheme has been approved by PRF shareholders, it will be necessary for the Court to determine whether to approve the Scheme in the interests of PRF shareholders (recognising PRF's perilous financial condition). This is an undesirable outcome, but in PRF's strained financial circumstances and recognising that PRF is an unlisted public company without a ready market for its shares, the Court accepted that this factor should not prevent it from making orders convening the Scheme Meeting.

No transfer before payment 44 Keybridge is required to pay the Cash Consideration and to issue the Scrip Consideration before PRF shares are transferred to Keybridge: see clause 2.2 of the Scheme.

Conditions 45 All conditions of the Scheme (including the conditions set out in the Scheme Implementation Agreement) must have been satisfied or waived by 8 am on the date of the second court hearing, other than that relating to the Court approval of the Scheme. Accordingly, the Scheme will be self executing if the Court makes the order unconditionally or on conditions imposed by the Court under s 411(6) which are acceptable to Keybridge.

Deed Poll and Scheme Implementation Agreement 46 Although it is a condition of the Scheme Implementation Agreement that Keybridge will, by the time of the first court hearing, execute a Deed Poll in favour of PRF shareholders in the usual form (whereby it undertakes for their benefit to pay the Scheme Consideration), this has not occurred. The Court will, at the second court hearing, expect evidence that the Deed Poll has been executed, as Keybridge is a "stranger" to the Scheme. 47 However, under clause 3.2 of the Scheme Implementation Agreement, which has been executed, Keybridge covenants in favour of PRF, in its own right and separately as trustee or nominee of each of the Scheme Participants to provide the Scheme Consideration in consideration of the transfer of PRF shares under the Scheme. This provision would seem to address the performance risk. 48 Under the Scheme Implementation Agreement, PRF is obliged to propound the Scheme and each of PRF and Keybridge have undertaken to do the things on their respective parts necessary to give effect to the Scheme.

Part 5.1 body 49 I am satisfied the PRF is a "Part 5.1" body. Rule 8.5 of PRF's constitution allows the directors to prohibit transfers at any time when PRF is not listed. However, the directors have indicated that they will approve the transfer of shares to Keybridge pursuant to the Scheme.

ASIC 50 ASIC has provided the "usual letter". I am therefore satisfied for the purposes of s 411(2) of the Act that ASIC received 14 days' notice of the hearing and that it has had adequate opportunity to consider the Scheme Booklet and make submissions to the Court.

Chairman of Scheme Meeting 51 Mr Tong or failing him Mr Llewellyn consented to act as Chairman of the Scheme Meeting and I am satisfied that in all of the circumstances they are appropriate. Given Mr Llewellyn's interests in PRF and the outcome of the Scheme referred to in these reasons, it is preferable that Mr Tong act as Chairman, even though Mr Llewellyn is the chairman of PRF. However, as there has been substantial disclosure of Mr Llewellyn's interests in the Scheme Booklet, and having regard to PRF's size and circumstances, I do not think Mr Llewellyn is ineligible to act as Chairman of the Scheme Meeting should Mr Tong be unable to do so. 52 PRF has requested that the Chairman of the Scheme Meeting have power to adjourn the meeting in his discretion. I agree that this is a convenient mechanism to prevent unnecessary applications to the Court.

Orders 53 Based on the material provided to the Court and the matters referred to in these reasons, there is no evidence at this stage to suggest that the Scheme is not bona fide or proposed for an improper purpose. The formal requirements of s 411 for the Court to order the convening of a meeting of members to consider the Scheme and to approve the Scheme Booklet for circulation to PRF shareholders appear to have been met. I certify that the preceding fifty-three (53) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Farrell.