Summary

• There has long been concern that the Court may decline to approve a scheme of arrangement at the second Court hearing where material events occur subsequent to the shareholder vote on the scheme
• Given that concern, scheme companies have been careful to preserve the status quo up to and following the shareholder vote, which may materially impact their ability to grow their business such as through acquisitions or disposals.
• The Court's judgement in the Skyland scheme gives guidance as to what issues the Court will consider in deciding to approve a scheme where a major M&A transaction is announced by the scheme company after the shareholder vote

Why are events subsequent to the shareholder vote on a scheme an issue?

When the Court is asked to exercise its discretion to approve a scheme of arrangement at the second Court hearing, the Court may decline to do so for various reasons, even where shareholders have voted overwhelmingly to approve the scheme and even if ASIC has produced its customary 'final no objection letter'.

The Court's discretion to approve a scheme is a broad one. This is because the discretion is based on the Court's supervisory jurisdiction over schemes of arrangement and the Court's resulting obligation to consider the 'fairness' of the scheme. Whilst shareholder approval of the scheme is, of itself, a key indicia of fairness, the scheme company still bears the onus of convincing the Court that the scheme is fair.

Relevantly, inadequate disclosure has been seen by the Court as a ground on which the Court may decline to approve a scheme. In Re NRMA Ltd (2000) 34 ACSR 261, Santow J suggested that there was a clear link between unfairness and inadequate disclosure, and that where there was inadequate disclosure the Court is justified in intervening to not approve the scheme.

This link between fairness and disclosure is important in the context of subsequent events – that is, if a material event occurs after shareholders vote to approve a scheme, can it be said that those shareholders voted on a fully informed basis?

In considering whether to approve a scheme, the Court has on occasion considered the impact of material changes in circumstances between the date of the scheme meeting at which shareholders vote to approve the scheme and the second Court hearing. The position adopted by the Court based on a string of cases dealing with that issue was described by Santow J in Re James Hardie Industries Limited [2001] NSWSC 888 – namely that nothing should occur after the shareholder vote that, had it been known to shareholders at the time of the vote, might have caused them to vote differently.

Hence, where a scheme company involves itself in a material M&A transaction after shareholders vote to approve the scheme, there is a real question to be considered by the Court as to whether to approve the scheme. This is because the scheme booklet, which would have been sent to shareholders several weeks before that M&A transaction eventuated, is unlikely to have included any detailed disclosure of that M&A transaction or its impact on the scheme company.

What has been the past practice?

In order to avoid the risk that an event subsequent to a shareholder vote may cause the Court to decline to approve the scheme, scheme companies have traditionally tried to ensure that no such events take place. To do so, scheme companies must necessarily restrict the way in which they operate their business.

That restricted operation may continue for some time, as the scheme company will not only want to ensure that there are no changes in circumstances between the date of the scheme meeting and the second Court hearing (which gap can be a short as a few days), but also will want to ensure that no such changes occur after the disclosure materials are sent to shareholders ahead of the vote.

Whilst such restrictions are typically accepted as part of the price of undertaking the scheme, they may be a high price for some companies to pay. For example, where a scheme company has a business strategy that is underpinned by regular M&A activity, a hiatus in such activity for some months may materially impact its business going forward.

The alternative open to scheme companies wishing to undertake an M&A transaction after disclosure materials are sent to shareholders would be to send supplementary disclosure to shareholders explaining the M&A transaction and its impact on the scheme company. However, that would necessitate obtaining the necessary orders from the Court and potentially delaying the shareholder vote by postponing or adjourning the scheme meeting, which means it has not been an option that many scheme companies have been willing to take.

Faced with those options, there have no doubt been occasions where companies have considered potential schemes of arrangement, for example to effect a corporate action such as a re-domiciliation, but have declined to undertake them because of the chilling effect they would have on the company's ability to undertake other business changing initiatives.

Given this, it is interesting to understand the circumstances in which the Court may allow such activity to continue and not cause the scheme to fail.

What are the ramifications of the Court's approach in the Skyland scheme?

Skyland is a junior oil and gas exploration company listed on ASX. A key facet of its business strategy is to undertake M&A transactions to acquire assets within the ambit of its operations.

Skyland had proposed a scheme of arrangement under which it would be re-domiciled to the Cayman Islands. The scheme affected Skyland's corporate structure, but not its business – it would continue to be ASX listed after the scheme was implemented and its business would operate in the same way.
Given Skyland's M&A focus, it was not reasonably practicable for it to simply pause on its M&A strategy for some months while the re-domiciliation scheme was approved. As a result, after shareholders had voted to approve the scheme and in the week prior to the second Court hearing, Skyland entered into an agreement with a private Russian company for the purchase of an oil and gas producing asset located in Eastern Siberia.

The impact on Skyland of the acquisition of that asset was considered material, and given it occurred after the shareholder vote, the disclosure materials that were sent to Skyland shareholders regarding the scheme did not disclose the possibility of that specific transaction occurring, or its impact on Skyland.
Despite this, the Court was prepared to approve the scheme. In doing so, the Court opened the possibility for scheme companies that they may, in certain circumstances, continue to undertake M&A transactions or other corporate actions without causing their proposed scheme to fail.

The Court based its decision on six factors, the main ones being centred on the fact that there was adequate disclosure to Skyland shareholders that Skyland is in the business of acquiring and operating assets in oil and gas markets, and that precisely the type of M&A transaction undertaken was a real possibility. The Court noted that such disclosures were included in the scheme booklet, as well as in past ASX announcements made by Skyland. Thus a Skyland shareholder would be expected to understand that M&A transactions involving Skyland may occur, even during the period of the re-domiciliation scheme.

Interestingly, the Court did not consider it necessary that Skyland shareholders be provided disclosures detailing the key terms of the transaction announced by Skyland or its impact on Skyland (such as through pro forma financial statements showing Skyland business post completion of the transaction).

Whilst the Court in the Skyland scheme did not indicate that a scheme company could undertake major transactions without any risk that the Court may decline to approve the scheme, the Skyland decision is an interesting data point that we expect will inform approaches to disclosure in scheme booklets where M&A transactions during the scheme period are a real possibility.