Exclusivity provisions
20 The Implementation Agreement contains exclusivity provisions including "no shop", "no talk", "no due diligence", "provision of information" and "notification and matching right" provisions which endure during the exclusivity period.
21 In relation to these provisions I note that:
a. the exclusivity period will last until the earlier of termination of the Implementation Agreement, implementation of the Scheme and 31 December 2014;
b. the "no talk" and "no due diligence" obligations are subject to a fiduciary carve out which enables the directors to entertain a competing proposal if the directors in good faith consider that it is likely to result in a superior proposal, subject to their obtaining written legal advice; and
c. the notification and matching rights provision requires TRO to give Heron five business days' notice of material terms of the competing proposal and the opportunity to match a superior proposal which is likely to result in the decision of the directors to qualify or withdraw their recommendation.
22 There is provision for a mutual break fee of $250,000 (plus applicable GST). It is payable by Heron if TRO terminates the Implementation Agreement for a material breach by Heron.
23 The fee is payable by TRO if any TRO director withdraws, qualifies or changes his recommendation or support of the Scheme other than because the independent expert has opined that the Scheme is not in the best interests of shareholders (as long as the reason is not the existence of a competing proposal). It is also payable if TRO announces a superior proposal, or if Heron terminates the Implementation Agreement for breach by TRO, upon the happening of a material adverse change in relation to TRO or the occurrence of a Target Regulated Event. The range of events which comprise a Target Regulated Event goes beyond the events described in s 652C of the Corporations Act. These are not unusual conditions for the payment of a break fee, although it is notable that the Implementation Agreement is highly prescriptive of the directors' freedom of action in managing the affairs of TRO during the exclusivity period.
24 Unusually, the break fee is payable by TRO if a competing proposal is announced before 31 December 2014 (or such later date as TRO and Heron may agree) and by 8 March 2015 (the anniversary of the execution of the Implementation Agreement) a third party has acquired 20% or more of TRO's total voting power and the competing proposal is or becomes unconditional.
25 Mr Wayne Taylor, the managing director and chief executive officer of TRO, affirmed an affidavit on 29 May 2014 and Mr Ian Buchhorn, the managing director and chief executive officer of Heron swore an affidavit of 30 May 2014. Each deposed that the exclusivity provisions were negotiated. Mr Taylor deposed that he considers the break fee is not excessive, that it is a genuine pre-estimate of costs and that the Board considered that the benefits of the Scheme outweighed the risk of having to pay the break fee. He pointed out that Heron must also pay a break fee. He said that between May 2013 and February 2014 TRO undertook considerable efforts to identify investors who would be prepared to finance the advancement of the Woodlawn Underground Project; the Scheme proposal is the outcome of those efforts. Mr Buchhorn notes that the break fee is not payable by either party if the Scheme is not approved by shareholders or if the independent expert opines that the Scheme is not in the best interests of TRO shareholders. Notably Mr Buchhorn does not say that Heron would not otherwise have entered into the Scheme proposal.
26 There are three issues concerning the exclusivity provisions and the break fee applicable to TRO.
27 The first is that the break fee exceeds 1% of the equity value of TRO implied by the Scheme Consideration. It therefore exceeds the Takeovers Panel's guideline set out in Guidance Note 7: Lock-up Devices. The break fee is approximately 1.6% of TRO's equity value implied by the Scheme Consideration. Counsel for TRO, in my view correctly, submits that this may be justified having regard to the actual costs incurred by each of the parties due to the complexity of the Scheme proposal and TRO's relatively low equity value.
28 The second element of concern is that the exclusivity period exceeds nine months and it is effectively 12 months in relation to control transactions (see [24] above). That is a much longer period than actually required to effect the Scheme proposal, given that the Scheme Meeting is proposed for 28 July 2014, even recognising the complexities introduced by the condition that the key SML 20 mining lease connected with the Woodlawn Project be transferred to TRO by 30 June 2014 and the need to secure TSX quotation of Heron shares.
29 Further, the Implementation Agreement contains provisions more akin to a private sale agreement; for instance, although Heron would not have a right to terminate the Implementation Agreement because the TRO shareholders did not approve the Scheme, Heron would have a right to terminate the Implementation Deed and receive payment of the break fee if, among other things, at any time before 31 December 2014, TRO:
incurs any capital expenditure exceeding $200,000 in aggregate;
incurs $100,000 worth of financial indebtedness outside the ordinary course of its business;
acquires or disposes of any entity, business or asset (other than trade inventories or consumables) exceeding $500,000 in aggregate;
provides financial accommodation to a third party; or
shareholders pass a special resolution.
30 This gives Heron a considerable measure of control of TRO's actions and although it may be justified up to the point at which shareholders vote on a Scheme proposal and it is implemented, it is difficult to see the justification for this measure of control for a long period after that time. It is not unusual for exclusivity periods to operate for a slightly longer time than the typical scheme timetable envisages for convening a scheme meeting and implementation of an approved scheme. This can be justified as necessary to accommodate possible slippages in the timetable. However, the existence of provisions of the kind in this Implementation Agreement would normally suggest that the exclusivity period should be short.
31 The third issue is that although TRO submitted that there was no break fee associated with the Convertible Notes that is the commercial effect of the Implementation Agreement. If TRO shareholders do not approve the Scheme, in order to be free of the exclusivity provisions and the prescriptions on its activities referred to as "Target Regulated Events" TRO must pay the break fee in order to terminate the Implementation Agreement. If this occurs before the Convertible Notes mature on 31 December 2014, Heron can require repayment of the Convertible Notes. I infer that the end date in the Implementation Agreement is so long because the extent of the Target Regulated Events protects Heron's position as a lender as well as giving Heron control of significant aspects of how TRO may conduct its business.
32 Counsel drew the Court's attention to the judgment of Jacobson J in Re Professional Investment Holdings Ltd [2010] FCA 1193 at [12]-[22] (Re Professional Investment Holdings). Justice Jacobson was called upon to consider whether an early repayment fee payable by a company for the redemption of convertible notes would amount to a break fee if schemes proposed in relation to the company were not approved by shareholders and in circumstances where the noteholder would, if the notes were not redeemed, have the right to be issued shares equal to 12% of the company. His concern was whether a condition such as that might be an obstacle to shareholders wishing to vote against the scheme exercising their vote freely. At the second court hearing, Jacobson J noted that even if the fee were to be treated as a break fee it would amount to between 0.94% and 1.11% of the enterprise value of the company: see Re Professional Investment Holdings Ltd (No 2) [2010] FCA 1336 at [21]-[27].
33 The application which I am now considering is different from Re Professional Investment Holdings Ltd because the obligation to pay the break fee is characterised by the parties in the Implementation Agreement as a break fee. There may be an issue, if the Scheme is not approved and the break fee becomes payable (for some other reason since there is no "naked no vote" trigger for payment of the break fee), as to whether the true nature of the break fee is a penalty connected with the early repayment obligation on the Convertible Notes. That is not an issue I need to resolve.
34 Counsel drew attention to the comments of Santow J in Re Arthur Yates & Co Ltd (2001) 36 ACSR 758 at [9]:
The present clause does not involve any break fee though to a degree there are overlapping issues. It is important that an exclusivity clause satisfy the following concerns:
(a) it should be for no more than a reasonable period capable of precise ascertainment, hence the need to ensure that any exclusivity period is properly defined;
(b) while an exclusivity clause may differentiate between actively soliciting an alternative merger proposal or simply dealing with an unsolicited one, in either case it is important that such an exclusivity clause be framed so that it is subject to the overriding obligation not to breach the directors' fiduciary duties or be otherwise unlawful; and
(c) there should be adequate prominence given to that constraint in the explanatory memorandum sent to shareholders.
35 These statements of principle have been adopted by Justices of this Court and of many of the Supreme Courts of the States.
36 I do not consider that the length of the exclusivity period (and in particular its effective extension to March 2015) is appropriate. Although the exclusivity period is precisely ascertainable it is more extensive than may be required to effect the Scheme within a reasonable timeframe and carries control implications for an extensive period after TRO shareholders vote on the Scheme if they do not approve it. Actions taken to implement the exclusivity provisions and any requirement to pay a break fee at a time after the Scheme is not approved (should that occur) may well fall for adverse consideration by the Takeovers Panel. Were an application to be made to the Takeovers Panel before the second court hearing, it may be relevant to the Court's consideration of the application to approve the Scheme under s 411(4)(b).
37 However, I do not consider that the exclusivity or break fee provisions should be an obstacle to my making orders under s 411(1) in this case because:
(1) TRO sought sources of financial accommodation necessary to develop its tenements over a long period from May 2013 and I have no reason to doubt Mr Taylor's evidence of the difficulty in obtaining investor interest;
(2) The qualification in the auditor's review report on the half yearly financial statements indicates TRO's need for capital in order to continue as a going concern;
(3) There is commercial sense (and in light of (2), possibly some urgency) in the merger of a company which apparently has viable tenements which require funding but which has no ready access to funds and another company also in the mining industry which has available funds and no debt. In that circumstance, shareholders should not be deprived of the opportunity of considering the proposal and obtaining ongoing benefit as shareholders in the merged entity;
(4) The directors of TRO consider the risk of TRO being required to pay the break fee is outweighed by the opportunity offered by the proposal;
(5) The break fee is not payable merely by reason that the shareholders vote against the Scheme and this fact is prominently disclosed early in the Scheme Booklet;
(6) The break fee exceeds the $190,000 of costs which Mr Buchhorn said that Heron has incurred to date but it is not an unlikely assessment of what Heron's total costs will ultimately amount to even though it exceeds 1% of the implied equity value of TRO. I note that TRO has spent in excess of $300,000;
(7) Heron must also pay a break fee of the same size if the Implementation Deed is terminated for Heron's breach, albeit that TRO has already incurred more costs as the Scheme company; and
(8) If the shareholders do vote against the Scheme, it may be open to TRO shareholders or directors to seek relief from the Takeovers Panel if Heron seeks to rely on the exclusivity provisions and require payment of the break fee.