Watermark Global Leaders Fund Limited v Equity Trustees Limited, in the matter of Watermark Global Leaders Fund Limited

Introduction 1 The plaintiff, Watermark Global Leaders Fund Limited (WGF) seeks an order pursuant to s 411(1) of the Corporations Act 2001 (Cth) (the Act) that it convene a meeting of its members for the purpose of considering and, if thought fit, agreeing (with or without modification) to a scheme of arrangement (the WGF scheme or the scheme). 2 Unless otherwise indicated, capitalised terms and expressions used in these reasons are defined in the Scheme Booklet, which will stand as the explanatory statement under s 412(1) of the Act in respect of the WGF scheme.

Background 3 WGF is a public company limited by shares. Since December 2016, it has been admitted to the official list of ASX Limited (ASX) and its shares have been quoted for trading on the stock market operated by ASX. WGF employs an equity market neutral investment strategy with the objective of delivering risk adjustment returns, with little or no net exposure to the share market. It seeks to profit from the mispricing of listed securities, by investing in securities believed to be undervalued and selling securities considered to be overvalued. By retaining a fully-hedged exposure, its returns are expected to be uncorrelated with the underlying share market. 4 Watermark Funds Management Pty Limited (Watermark) is a specialist long/short investment manager, offering various listed and unlisted hedge fund products to institutional and retail investors. It is the investment manager of WGF. Its duties include the management of WGF's Portfolio. 5 The defendant, Equity Trustees Limited (Equity Trustees) is the responsible entity of a management investment scheme, the Watermark Absolute Return Fund (the Fund). 6 On 4 February 2019, WGF, Equity Trustees and Watermark entered into a Scheme Implementation Deed providing for the basis on which the WGF scheme will be proposed and implemented, and providing for roles and obligations of WGF, Equity Trustees and Watermark in relation thereto. 7 The WGF scheme has been proposed to address three issues. 8 First, the WGF Portfolio has a sub-optimal value of approximately $74 million and has failed to achieve its goal of growing to a market capitalisation in excess of $100 million. As a result, WGF Shares are thinly traded and relatively illiquid. 9 Secondly, the sub-optimal value of the WGF Portfolio means that the costs of running WGF as a listed investment company are relatively high compared to the value of the portfolio. 10 Thirdly, the persistent discount to NTA at which WGF Shares have traded in the last 18 months has been between 5% and 20%. 11 The directors believe that the WGF Scheme provides a solution to each of these problems. The directors are of the opinion that an unlisted unit trust is a preferable vehicle through which to offer investors exposure to Watermark's hedged investment strategy, as well as providing benefits in the form of improved liquidity and lower operating costs. 12 There is a parallel proceeding in which a substantially similar scheme of arrangement is proposed (Watermark Market Neutral Fund Limited v Equity Trustees Limited as responsible entity for Watermark Absolute Return Fund NSD 230/2019) (the WMK scheme). The two schemes have a common transaction structure which includes: the transfer of assets by the company to the Fund; the reduction of the company's capital to zero and the cancellation of its shares, followed immediately by the issue of one share to Watermark; and the issue (as the Scheme Consideration) of Units in the Fund to those members of the company who will be the Scheme Shareholders. 13 If the WGF scheme and the WMK scheme are implemented, the Net Asset Value (NAV) of the Fund will reflect the combined assets of the two companies. However, the WGF scheme is not conditional on implementation of the WMK scheme (and vice versa). The independent directors of WGF do not consider that the implementation of the WMK scheme affects their recommendation regarding the WGF scheme.

The evidence 14 The following affidavits were read in support of the present application: Michael Beaumont, first affidavit sworn 19 February 2019; Michael Beaumont, second affidavit sworn 4 March 2019; Philip Howard, affirmed 28 February 2019; David McCourt, affirmed 28 February 2019; Tim Bolger, first affidavit affirmed 1 March 2019; Tim Bolger, second affidavit affirmed 4 March 2019; John Abernethy, affirmed 4 March 2019; and Michael Jools, affirmed 5 March 2019.

The WGF Scheme 15 The parties to the WGF scheme will be WGF and those of its members who will be Scheme Shareholders (members holding WGF Shares at the Scheme Record Date). On the Implementation Date, without the need for any further act by any Scheme Shareholder: (a) the Scheme Consideration (comprising Units in the Fund) will be issued by Equity Trustees as the responsible entity; (b) WGF will reduce its share capital by the Capital Reduction Amount in accordance with the Capital Reduction Resolution (which provides for WGF's share capital to be reduced to zero on the Implementation Date and for the WGF Shares to be cancelled); (c) WGF will apply the Dividend Entitlement and Capital Reduction Entitlement of each Scheme Shareholder by procuring Equity Trustees to issue Units in the Fund to Eligible Shareholders in accordance with section 4.1 of the Scheme Implementation Deed (see clause 4.4 of the WGF scheme); (d) the WGF Assets will be transferred to the Fund; and (e) subject to the completion of steps (a) to (d), WGF will then immediately issue one fully paid ordinary share to Watermark as the Manager of the Fund. 16 It is apparent that between steps (b) and (e) there will be an instant when WGF has no share capital. Viewed in isolation, this seems anomalous. However, as Harman J observed in Re Anglo American Insurance Co Ltd [1991] BCLC 564 at 565 this is but a scintilla temporis. I accept that this fleeting and impermanent circumstance must be viewed in the context of the overall transaction and that, for all practical purposes, WGF should be taken as having retained a share capital. 17 Only Scheme Shareholders who are Eligible Shareholders will be entitled to be issued Units in the Fund. The Units to which Ineligible Foreign Shareholders would have been entitled will be issued to a Nominee. The scheme provides a Withdrawal Facility which requires the Nominee to withdraw units held for the benefit of each Ineligible Foreign Shareholder. The Nominee will then account to each Ineligible Foreign Shareholder for the proceeds of the withdrawal and any income attributable to the Units issued to the Nominee in respect of that Ineligible Foreign Shareholder. 18 Under the scheme, each Scheme Shareholder who receives Units agrees to become a Unitholder in the Fund and agrees and acknowledges that the issue of Units in the Fund constitutes satisfaction of all that person's entitlements in and to that person's Capital Reduction Entitlement. 19 Performance risk is managed under clause 4.3 of the scheme, which provides that implementation of all the steps referred to in (a) to (d) above will be carried out simultaneously and that no step will be deemed to have been completed until all steps have been carried out. Further, Equity Trustees has entered into a deed poll in favour of each person registered as a holder of one or more Units in the Fund, in which it has covenanted to comply with its obligations under the Scheme Implementation Deed and do all acts and things reasonably necessary or desirable on its part to give full effect to the WGF scheme, including issuing the Scheme Consideration and undertaking all other actions attributed to it under the scheme. 20 Although not part of the WGF scheme, the evidence before me is that WGF will retain a Retention Amount to satisfy the Transaction Costs and other liabilities with respect to the operation of WGF which remain outstanding or arise after the Implementation Date. I have been informed that, after the scheme is fully implemented, WGF will have no assets or operations. Watermark intends to immediately de-list WGF and convert it to a proprietary company, which will then be liquidated or deregistered.

The position of WGF's independent directors 21 WGF's independent directors have recommended that the members vote in favour of the scheme in the absence of a superior proposal. In the absence of a superior proposal, and subject to the independent expert (see below) continuing to conclude that the scheme is in the best interests of WGF's members, the independent directors intend to vote all their WGF Shares in favour of the scheme resolution.

The opinion of the independent expert 22 BDO Corporate Finance (East Coast) Pty Ltd (BDO) has been engaged by WGF's directors to prepare an independent expert's report setting out an opinion as to whether the WGF scheme is fair and reasonable, and in the best interests of members, in the absence of a superior proposal. 23 BDO has expressed the opinion that the scheme is fair and reasonable, and in the best interests of members. Mr McCourt is a director of BDO and supervised the team that assisted in preparing the report. Mr McCourt has verified the opinions expressed in the report.

The capital reduction 24 The Capital Reduction Resolution is to be proposed under s 256C(1) of the Act at a separate meeting following the conclusion of the scheme meeting. If passed, the Capital Reduction Resolution will be subject to and conditional on the scheme becoming Effective. 25 As proposed, the WGF scheme is a members' scheme and must be considered as such. However, the position of creditors is important. WGF's directors do not consider that the proposed capital reduction will materially prejudice WGF's ability to pay its creditors. It is intended that, at the Calculation Date, WGF will have no actual liabilities other than those that are to be paid out of the Retention Amount. The directors have stated that, as at the date of the Scheme Booklet, they are not aware of any actual liability of WGF that will not be satisfied prior to the Calculation Date or, following the Implementation Date, out of the Retention Amount. 26 At a second court hearing, I would expect to see evidence of WGF's financial position as at the Calculation Date and confirmation that its future liabilities will be met by the Retention Amount.

Chairperson of scheme meeting 27 Mr Howard is the Chairman and an independent director of WGF. He has consented to act as chairperson of the scheme meeting. Mr Abernethy is an independent non-executive director of WGF. He has consented to act as chairperson of the scheme meeting if for any reason Mr Howard is either unable or unwilling to act in that capacity. Mr Howard and Mr Abernethy have made affidavits which have been filed in compliance with r 3.2 of the Federal Court (Corporations) Rules 2000.

Verification of the scheme booklet 28 There is evidence before me as to the verification of the statements made, and the information provided, in the Scheme Booklet. On 4 March 2019, the directors of WGF unanimously approved the Scheme Booklet.

ASIC's position 29 The Australian Securities and Investments Commission (ASIC) has provided its "usual letter" in which it has confirmed that it has had 14 days' notice of the hearing of this application and that it has had a reasonable opportunity to examine the terms of the scheme and the draft explanatory statement, and to make submissions to the Court: see s 411(2).

Conclusion and disposition 30 I am satisfied that WGF is a Pt 5.1 body and that the WGF scheme, as proposed, is a "compromise or arrangement" within the meaning of s 411(1) of the Act. I am satisfied that, if approved by the required statutory majorities at a scheme meeting, the scheme is likely to be approved by the Court on an unopposed application for approval under s 411(6). I am satisfied that the procedural requirements preliminary to making an order under s 411(1) have been satisfied. 31 Orders as presently sought will be made. I certify that the preceding thirty-one (31) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Yates.