ASIC's Latest Corporate Finance Update: Practice Points for Schemes of Arrangement
The Situation: The Australian Securities and Investments Commission ("ASIC") recently released its update on corporate finance regulatory activities for the second quarter of 2022. From an M&A perspective, schemes of arrangement are in focus, with ASIC providing useful practical guidance and reminders on various technical points which can arise in implementing a scheme.
The Result: ASIC singled out the following points arising from its observation of schemes in the last quarter: providing target shareholders with certainty in relation to the value of the earn-out consideration before the scheme vote; maintaining independence of an expert in the event of a change of opinion; ensuring target companies take steps to dispatch scheme documents to members in the manner requested; and the appropriate procedures to be followed for scheme-related briefing materials outside of the scheme booklet.
Looking Ahead: ASIC's observations provide useful reminders and guidance in relation to particular issues which often emerge in the implementation of a scheme of arrangement. Taking note of ASIC's guidance could assist scheme proponents have a smoother path through the scheme process.
Practice Points for Schemes of Arrangement
Uncertainty in earn-out consideration. ASIC raised concerns where target shareholders were being asked to vote on a scheme—which involved earn-out consideration—where there was considerable uncertainty about the amount of consideration which would be paid. Although the transaction involved a relatively rare set of facts, ASIC's perspective is worth noting for those thinking of bridging the value gap in a scheme transaction through incorporating an earn-out.
ASIC's concerns arose in a recent scheme undertaken by an unlisted public company, where the consideration comprised an initial cash payment, dividends and earn-out consideration, and where the total consideration to be paid under the scheme would not be known until 2026. The arrangement was further complicated as the earn-out was contingent on certain disqualifying conditions which effectively resembled restraints of trade that would ordinarily be negotiated between a company and its employees.
Persuaded by the discrete factual scenario where the unlisted scheme company's share register comprised almost entirely of current and former employees and officers, and coupled with the independent expert opining that the initial cash payment was fair, reasonable and in the best interests of shareholders, ASIC chose not to pursue the matter further other than to draw its "general concerns" about the uncertainty of the scheme consideration to the Court's attention within its usual "indication of intent" letter prior to the first Court hearing.
In publicly, widely held companies with a substantial retail shareholder base—which is much more typically the case with schemes—scheme proponents should take note that ASIC is continuing to monitor the use of and disclosure around earn-outs.
Maintaining expert independence in the event of a change of opinion. The importance of maintaining expert independence has long been a fundamental principle—and remains an issue on ASIC's radar in the context of change of control transactions. The issue came to the fore in a recent example reported by ASIC, where the expert changed their opinion in their draft report from 'fair and reasonable' to 'not fair and not reasonable' because of movements in a commodity price. Relevantly, the change occurred before the first Court hearing and therefore before the target's shareholders had seen the independent expert's report.
As is often the case, the scheme was subject to a condition precedent that the independent expert continues to conclude that the scheme was in the best interests of shareholders. In order to press ahead with the scheme, the change in the expert's opinion prompted the bidder and target to recut their deal, with the bidder increasing the consideration so that it fell within the bottom end of the range of the expert's draft valuation—with the target having provided the expert's revised draft valuation range to the bidder.
The handling of the draft independent expert's reports before the first Court hearing is a delicate matter. Once ASIC was comfortable that the disclosure in both the scheme booklet and the expert's report was adequate with regard to the circumstances and the resulting change in opinion and increase in consideration, ASIC did not raise any issues with the content of the report or the expert's independence. The expert also confirmed that they were aware of ASIC's RG11 and also that the expert had determined, of their own accord, that there had been a change in material circumstances requiring revisions to their draft report.
Member dispatch elections for scheme booklet. Ensuring that target shareholders receive the scheme booklet in order to make an informed voting decision is always a focus in the scheme process. In this context, ASIC reminds scheme proponents that the dispatch election provisions under sections 110C to 110K of the Corporations Act 2001 (Cth) are applicable to the dispatch of documents (i.e., whether physical or electronic) for member meetings to vote on schemes of arrangement.
Reasonable steps must be taken to send documents in a manner that matches with each member's election, including accommodating any ad hoc request from a member to receive a copy of a particular document within a reasonable time either before any dispatch deadline, or after they have been sent.
Investor 'road show' briefing materials provided to target shareholders. Effective shareholder engagement is a key objective in the lead up to a scheme meeting, with the aim of maximising voter turnout and a positive vote. In that regard, shareholder engagement has long been encouraged, provided that any briefing materials and other communications provided to the shareholders before the vote be consistent with the Court-approved scheme booklet. A prudent approach to this issue in the past has seen scheme proponents return to Court to seek approval for any supplementary disclosures, after providing them to ASIC, which are proposed to be given to target shareholders.
In a recent demerger scheme of arrangement, the scheme proponent was on the front foot and obtained approval at the first Court hearing to give its members a briefing presentation.
ASIC now seems to be more comfortable with briefing materials being provided to target shareholders. ASIC reiterates, though, that if scheme proponents wish to engage with target shareholders before the scheme meeting (and in addition to the provision of the scheme booklet), they should:
- Advise the Court of any proposed briefing presentation and information sessions at the first Court hearing;
- Not interfere with the Court-approved 'message' before the scheme meeting; and
- Keep records of any information presented by way of briefing presentation or other communications, and make those records available to ASIC and to the Court.
Four Key Takeaways
- Providing as much certainty as possible is vital where earn-out consideration is offered under a scheme of arrangement. As value gaps look to be emerging on the horizon, targets and bidders should critically consider their proposed disclosure of any earn-out utilised in a scheme, as ASIC is likely to be focussing on this issue.
- Any change in an independent expert's opinion which results in a change in the proposed scheme consideration will likely raise the attention of ASIC. Ensuring that the scheme materials being provided to target shareholders adequately explain the position, and having an expert who robustly guards their independence, is paramount.
- Companies should take care to dispatch scheme meeting materials in accordance with their members' elections under the Corporations Act.
- Pre-scheme shareholder engagement is a critical element of the scheme process. Ensuring the Court remains informed of any briefing materials being provided to members outside of the scheme booklet, and not interfering with the Court-approved 'message' before the scheme meeting, remain fundamental principles.
Jones Day publications should not be construed as legal advice on any specific facts or circumstances. The contents are intended for general information purposes only and may not be quoted or referred to in any other publication or proceeding without the prior written consent of the Firm, to be given or withheld at our discretion. To request reprint permission for any of our publications, please use our “Contact Us” form, which can be found on our website at www.jonesday.com. The mailing of this publication is not intended to create, and receipt of it does not constitute, an attorney-client relationship. The views set forth herein are the personal views of the authors and do not necessarily reflect those of the Firm.