Watermark Market Neutral Fund Limited v Equity Trustees Limited, in the matter of Watermark Market Neutral Fund Limited

Introduction 1 The plaintiff, Watermark Market Neutral Fund Limited (WMK) 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 WMK 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 WMK scheme.

Background 3 WMK is a public company limited by shares. Since July 2013, 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. WMK was established to take advantage of opportunities to invest in listed securities in a market neutral structure, where net market exposure is limited to less than 10% of WMK's capital. WMK's objective has been to increase the value of its portfolio over the long-term via capital growth and income, while minimising exposure to volatility. 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 WMK. Its duties include the management of WMK's Portfolio. 5 The defendant, Equity Trustees Limited (Equity Trustees) is the responsible entity of a managed investment scheme, the Watermark Absolute Return Fund (the Fund). 6 On 4 February 2019, WMK, Equity Trustees and Watermark entered into a Scheme Implementation Deed providing for the basis on which the WMK scheme will be proposed and implemented, and providing for their respective roles and obligations in that regard. 7 The WMK scheme has been proposed to address three issues. 8 First, the WMK Portfolio has a sub-optimal value of approximately $70 million and has failed to achieve its goal of growing to a market capitalisation in excess of $100 million. As a result, WMK Shares are thinly traded and relatively illiquid. 9 Secondly, the sub-optimal value of the WMK Portfolio means that the costs of running WMK as a listed investment company are relatively high compared to the value of the portfolio. 10 Thirdly, the persistent discount to NTA at which WMK Shares have traded in the last 18 months has been up to 17%. 11 The directors believe that the WMK 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 Global Leaders Fund Limited v Equity Trustees Limited as responsible entity for Watermark Absolute Return Fund NSD 229/2019) (the WGF 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 WMK scheme and the WGF scheme are implemented, the Net Asset Value (NAV) of the Fund will reflect the combined assets of the two companies. However, the WMK scheme is not conditional on implementation of the WGF scheme (and vice versa). The independent directors of WMK do not consider that the implementation of the WGF scheme affects their recommendation regarding the WMK 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; David McCourt, affirmed 28 February 2019; Matthew Kidman, affirmed 1 March 2019; Tim Bolger, affirmed 1 March 2019; John Abernethy, first affidavit affirmed4 March 2019; John Abernethy, second affidavit affirmed 4 March 2019; Michael Jools, affirmed 5 March 2019.

The WMK Scheme 15 The parties to the WMK scheme will be WMK and those of its members who will be Scheme Shareholders (members holding WMK 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) WMK will reduce its share capital by the Capital Reduction Amount in accordance with the Capital Reduction Resolution (which provides for WMK's share capital to be reduced to zero on the Implementation Date and for the WMK Shares to be cancelled); (c) WMK 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 WMK scheme); (d) the WMK Assets will be transferred to the Fund; and (e) subject to the completion of steps (a) to (d), WMK 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 WMK 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, WMK 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 WMK scheme, including issuing the Scheme Consideration and undertaking all other actions attributed to it under the scheme. 20 Although not part of the WMK scheme, the evidence before me is that WMK will retain a Retention Amount to satisfy the Transaction Costs and other liabilities with respect to the operation of WMK which remain outstanding or arise after the Implementation Date. I have been informed that, after the scheme is fully implemented, WMK will have no assets or operations. Watermark intends to immediately de-list WMK and convert it to a proprietary company, which will then be liquidated or deregistered.

The position of WMK's independent directors 21 WMK'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 WMK's members, the independent directors intend to vote all their WMK 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 WMK's directors to prepare an independent expert's report setting out an opinion as to whether the WMK 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 WMK scheme is a members' scheme and must be considered as such. However, the position of creditors is important. WMK's directors do not consider that the proposed capital reduction will materially prejudice WMK's ability to pay its creditors. It is intended that, at the Calculation Date, WMK 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 WMK 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 WMK'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 Kidman is the independent chairman and a director of WMK. He has consented to act as chairperson of the scheme meeting. Mr Abernethy is an independent non-executive director of WMK. He has consented to act as chairperson of the scheme meeting if for any reason Mr Kidman is either unable or unwilling to act in that capacity. Mr Kidman 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 WMK 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 WMK is a Pt 5.1 body and that the WMK 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.