Frustrating Action and Asset Lock-Ups in Australia in Challenging Economic Conditions: The Takeover Panel's Perilya Decision
CBH Resources Limited ("CBH") announced an off-market scrip takeover bid for Perilya Limited ("Perilya" or the "Company") on 2 October 2008 (the "Bid"). The Bid was subject to a number of conditions, which included that Perilya would not issue or agree to issue any new equity, and would not dispose or agree to dispose of any companies or assets in its group for an aggregate material amount ("Bid Conditions").
Perilya's Triggering Actions
On 9 December 2008, Perilya announced that it had entered into a transaction with a Chinese investor, Shenzhen Zhongjin Lingnan Nonfemet Co Ltd ("Shenzhen") under which Shenzhen would, subject to the approval of Perilya's shareholders in general meeting and various other conditions, invest in Perilya through subscribing for a AU$45 million share placement ("Placement"). The Placement would result in Shenzhen owning a 50.1 percent stake in Perilya. Shenzhen paid a AU$10 million refundable deposit to Perilya in connection with the Placement ("Deposit"). Payment of the Deposit was conditional upon Perilya also entering into a call option with Shenzhen under which Shenzhen could, if the Placement did not proceed and the Deposit was not repaid, choose to acquire for an agreed price all the shares in a Perilya subsidiary which housed Perilya's Mount Oxide exploration asset ("Option"). The Placement terms required shareholder approval but the Option terms did not.
Shortly thereafter, Perilya released its Target Statement in response to the Bid, in which it noted that the Company was in a "strong financial position", and the directors unanimously recommended that the Company's shareholders reject the Bid.
Shareholder Approval Sought
On 5 January 2009, Perilya issued its Notice of Extraordinary General Meeting ("Notice of Meeting") in respect of the Shenzhen transactions. The resolutions put to the meeting sought shareholder approval for both the Placement and (notwithstanding its terms) the Option. Perilya acknowledged in the Notice of Meeting that the Placement and the Option may have breached one or more of the Bid Conditions. Perilya also said in the Notice of Meeting that if the Shenzhen transaction was not implemented, it would need to raise comparable equity funding by the end of March 2009 or sell one or more of its assets. Given the economic environment, Perilya also said that any comparable equity raising would be at a significant discount to the current market price of its shares, and any asset sales would be at distressed values or values that differed from those in the Company's financial statements.
Shortly thereafter, the CBH entity which made the Bid ("Bidder") sought a declaration of unacceptable circumstances from the Takeovers Panel ("Panel"). The Bidder's arguments included that Perilya's entry into the Option, without it being subject to shareholder approval, was a "frustrating action", and that the Placement combined with the Call Option was an anti-competitive and coercive lock-up device. The Bidder submitted, amongst other things, that the effect of these arrangements was that the acquisition of control of Perilya contravened the legislative principles underlying Australia's takeover regime, which require that control transactions take place in an efficient, competitive and informed market, and all shareholders have a reasonable and equal opportunity to participate in the benefits available under a takeover offer.
The Panel's Policy on Frustrating Action and Asset Lock-Ups
The requirement that Australian control transactions of listed entities take place in an efficient, competitive and informed market, and that shareholders have a reasonable and equal opportunity to participate in any benefits, is the basis for the Panel's policy on conduct engaged in by a target board that triggers conditions in takeover offers which, in turn, are likely to defeat the offer (referred to in Australia as "frustrating action"). Although engaging in such conduct may be consistent with the duties of target board directors, the Panel considers that in certain circumstances, target board action which triggers defeating conditions may, due to its effect, nonetheless constitute unacceptable circumstances. In its 2003 Guidance Note on frustrating action, the Panel noted two examples of target company actions which might give rise to unacceptable circumstances: significant issues of new shares and the acquisition or disposal of major assets. However, the Panel acknowledges in its Guidance Note that there are also some actions that might be undertaken by a target board which would not constitute unacceptable circumstances. These include where the triggering action was part of the target's ordinary course of business; the triggering action was entered into or announced before a takeover bid was made known to the target (provided these arrangements were not otherwise found to create unacceptable circumstances); or there is a commercial or legal imperative for the target to take the action—other than as a result of voluntary action taken by the directors—after they become aware of a takeover offer, such as avoiding a materially adverse financial effect. The Panel also notes that, on the basis that control and ownership decisions are properly the preserve of shareholders, in some scenarios target directors may mitigate the risk that a triggering action will constitute unacceptable circumstances if prior shareholder approval is sought, or the triggering action is made conditional on obtaining shareholder approval.
The Panel has also previously issued a Guidance Note which discusses, among other things, asset lock-ups. The Panel's view is that if an asset lock-up involves an agreement to sell an asset which is the target's "crown jewel", such an arrangement can be anti-competitive and coercive because it makes the target less attractive to potential competing acquirers and to investors. Even where asset lock-ups are not anti-competitive, the Panel's view is that they run the risk of giving rise to unacceptable circumstances if, for example, there is no reasonable commercial basis for the arrangement, or they are not negotiated at arm's length or for a fair price. The risk of such arrangements giving rise to unacceptable circumstances increases in line with the size or strategic value of the asset which is the subject of the lock-up, and can also potentially constitute "frustrating action" if entered into after the target is on notice of a takeover bid.
The Panel's Decision in Perilya
In Perilya, the Panel declined to conduct proceedings in response to the Bidder's application as it was not satisfied that that there was a reasonable prospect of a declaration of unacceptable circumstances or the making of the orders sought by the Bidder. In declining to conduct proceedings, the Panel discussed the Placement, Deposit and Option, and whether in the circumstances the decision of Perilya's board to enter into these arrangements constituted frustrating action that might give rise to unacceptable circumstances. The Panel emphasised the following aspects of the circumstances that Perilya found itself in:
- The weakened financial position that the Company was in at the time it entered into the Placement and the Option;
- The current considerable volatility of credit and share markets, commodity prices and exchange rates, and the risks this added to transactions; and
- The fact that Perilya's board appeared to be making decisions to ensure that the Company could continue as a going concern, and that the directors were seeking to meet their obligations regarding insolvent trading in the period up to the shareholders' meeting.
In the circumstances, the Panel thought that the Deposit and the Option were not designed to frustrate the Bid. Although the Panel recognised that the payment of a deposit in respect of a share subscription was unusual, it was not satisfied that the Deposit had any potential material coercive effect on Perilya shareholders because it was capable of repayment (it is, however, interesting to note that the Panel did not provide any indication of how it came to the conclusion that the Deposit was capable of repayment by Perilya without the Option being exercised). The Panel also thought that the Deposit and the Option did not constitute an unacceptable asset lock-up because the assets which the Option was over were not the "crown jewels" of Perilya; if the Option were exercised, the sale of the asset would be at a market price (supported by an independent expert's opinion which was included in the Notice of Meeting); and if the Shenzhen proposal proceeded, the asset would not be sold.
The Panel noted in broad terms that in accordance with their Guidance Note on frustrating action, in circumstances where a target board had made a reasonable decision to avoid a potential material financial effect on the Company, that decision would be accepted as being commercially imperative and would not amount to a frustrating action which gives rise to unacceptable circumstances.
Given current economic conditions, arrangements analogous to those in Perilya may become more commonplace as liquidity and solvency concerns drive some companies to enter into urgent transactions with investors that ensure their short- to medium-term survival in a context where opportunistic takeover bids—because of the Company's same weakened financial position —may also be likely. Where solvency is an issue, the terms of such arrangements may also increasingly involve investors seeking commercial comfort or security on their investment through acquiring or taking an option over realisable physical assets, thereby giving rise to potential frustrating action and asset-lock up issues for directors, and the risk of the Panel overriding board decisions due to unacceptable circumstances arising. The Panel's decision to not conduct proceedings in Perilya shows that it is prepared to take these factors into account in analysing whether the decisions by a target board to engage in conduct which defeats bid conditions constitutes frustrating action or not. Having said this, the decision in Perilya was made against a background where the Panel accepted evidence that the Company's financial position was somewhat precarious and had changed since its initial response to the Bid, and where a number of the criteria in respect of the Panel's published policies on frustrating action and asset lock-ups looked like they had a good prospect of being satisfied (for example, the fact that the asset lock-up was not over the "crown jewels" of the Company). The Panel's decision also reinforces how the individual facts and circumstances that face a target company at a particular time will be a key factor in determining whether triggering actions have frustrated a bid or not. For that reason alone, the decision should be approached with some caution by boards that are facing similar challenges. In particular, an important fact in Perilya was that the terms of the resolution put to the Company's shareholders to approve the Placement also sought approval of the Option. Given the unique set of circumstances surrounding the Company's position in Perilya, it would be imprudent to form the view that the Panel is taking a more relaxed approach to asset lock-ups, which have the potential to frustrate current or prospective takeover bids.
There is scope for further developments in Australia on frustrating actions and asset lock-ups that have the potential to give rise to unacceptable circumstances. One tactic, for instance, which remains relatively untested in Australia relates to "poison pills" which are put in place outside a takeover context but are triggered by future changes in control. These could include, for example, pre-emptive rights or options over principal assets of a target company which are triggered by a subsequent takeover offer for the target. By analogy with the Panel's policy on frustrating action, disclosure and approval of any such arrangements by shareholders would appear to go some way to mitigating the risk of such arrangements giving rise to unacceptable circumstances, but this remains a relatively untested area before both the Panel and Australian courts in the context of the duties of target company directors.
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Matthew G. Latham
Weyinmi E. Popo
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 The Takeovers Panel is the Australian statutory body established to determine whether control transactions have given rise to unacceptable circumstances. The Panel has wide powers to make remedial orders if unacceptable circumstances are found to have arisen.
 The Bidder also raised in its submission to the Panel various issues relating to disclosures made by Perilya in its Notice of Meeting. These issues are not considered in this Commentary.
 Sections 602(a) and (c) of the Corporations Act require respectively that control acquisitions in respect of certain entities, including listed companies, take place in an efficient, competitive and informed market, and that as far as practicable, shareholders have a reasonable and equal opportunity to participate in any benefits that accrue to holders through an acquisition proposal which would lead to a person acquiring a substantial interest.
 Guidance Note 12: Frustrating Action ("GN 12").
 Para. 27, GN 12.
 Paras. 28-33, GN 12.
 Guidance Note 7: Lock-Up Devices, paras. 41-46.
  ATP 1.
 When it receives an application, the Panel's first decision is whether or not to conduct proceedings. One of the factors that it takes into account in deciding to conduct proceedings is whether the accusations would give rise to unacceptable circumstances if proven—Guidance Note 8: Matter Procedures, para. 45.
 Perilya submitted evidence to the Panel which showed that at the principal board meeting at which the company considered the Shenzhen proposal, it considered various alternate transactions to the Shenzhen proposal which would allow an amount equivalent to the Deposit to be raised.
 Under Australian law, in certain circumstances directors can be personally liable if they allow a company to continue trading while insolvent.
 A useful comparison to how the Panel viewed the circumstances in Perilya compared to other frustrating action matters it has considered, where targets have argued that their actions were driven by a genuine commercial imperative, is the recent decision in MacarthurCook Ltd  ATP 20. In that application, the target argued, among other things, that a strategic alliance and related placement to a strategic investor which was not referred to shareholders for approval (but was entered into after receipt of a takeover offer) did not constitute frustrating action because it enabled urgent funding to be put in place for the company. The Panel rejected this argument and found that the placement was not required to ensure the company's funding arrangements, and accordingly, the strategic alliance and placement constituted frustrating action that gave rise to unacceptable circumstances.
 On this point, the Panel notes in its reasons (at para. 29) that Perilya's situation was such "that the same outcome may not be applicable in other situations".
 The Panel noted in GN 12 (para. 35) that it might issue a guidance note on such arrangements in the future if it became necessary. In AMP Shopping Centre Trust 01  ATP 21 and 02  ATP 24, the Panel found that pre-emptive rights over a trust's assets that were triggered on a change of control gave rise to unacceptable circumstances, partly because they had not been previously disclosed and were not consented to by the trust's unitholders.