In any proposed scheme of arrangement to accomplish a friendly takeover, the target directors' public voting recommendations to shareholders are of central importance. Potentially complicating these recommendations is that one or more target directors are often eligible to receive some form of personal benefit if the scheme proceeds (in addition to the benefit they are entitled to receive under the scheme if they are also shareholders).

A line of recent, inconsistent cases suggests that disclosure alone of an additional contingent benefit may not be enough to allow a director to make a voting recommendation in schemes. In fact, there are now two diametrically opposing views in the Federal Court of Australia alone There is now significant uncertainty surrounding the ability of directors who stand to receive a contingent personal benefit to make voting recommendations in schemes and, if they do, the level of balancing disclosure required.

An aligned public message in schemes of arrangement

Friendly takeovers of ASX listed companies are now increasingly structured as a scheme of arrangement between the notional 'target' and its shareholders. The acquirer and the target board are usually aligned in wanting to send a strong public message to shareholders that the proposed scheme has the unanimous support of the target board.

In the context of takeover schemes, one or more directors of the target are often eligible to receive personal benefits if the scheme is approved and implemented (in addition to the benefit they are entitled to receive under the scheme if they are also shareholders). These additional personal benefits might include a cash bonus if the scheme is implemented, as well as several others.

“Should the fact that one or more (executive) directors stand to receive personal benefits if the scheme proceeds disqualify them from making a public recommendation to shareholders as to how they should vote?”

Until recently, the answer was a reasonably clear 'No'. However, as a result of a line of recent, conflicting cases, the position is no longer as clear-cut. In fact, there are now two diametrically opposing views in the Federal Court of Australia alone

What are the practical risks?

There is now considerable uncertainty relating to whether or not an interested director in a scheme should make a voting recommendation at all and, if they elect to do so, the level of balancing disclosure required regarding the contingent personal benefit that the director stands to receive. The consequences of getting this wrong are significant. For example:

• a Court may decline to make orders at the first Court hearing, on the basis that an interested director has already joined with the other directors in making a public recommendation at the time the scheme was first publicly announced and that director has then repeated that recommendation in the draft scheme booklet, in respect of which meeting orders are sought at the first Court hearing;
• if a director decides to make a recommendation but the balancing disclosure in the scheme booklet of that directors' contingent interest is regarded by the Court as inadequate, the Court may refuse to make orders at the first hearing, unless the balancing disclosure is amended to the Court's satisfaction – which may require an adjournment of the first hearing;
• ASIC may decline to give its usual preliminary no objection letter before the first Court hearing, refuse to register the scheme booklet after the first hearing or refuse to provide its final no-objection letter before the second Court hearing. If ASIC refuses to register the scheme booklet, the booklet cannot be released and the scheme would at that point be stopped firmly in its tracks.
• If shareholders approve the scheme, the Court may at the second hearing approximately one week later receive a formal objection from ASIC, an activist shareholder who voted against the scheme or from any other interested party, asserting that the Court should not approve the scheme because the relevant director should never have made a recommendation in the first place or, alternatively, the disclosure surrounding that director's contingent personal benefit was incomplete and/or insufficiently prominent.

Practical Guidance on how to manage the risks

At the earliest possible stage of a scheme transaction, each target director should consider with the benefit of professional advice whether any additional personal benefit they stand to receive if the scheme is successful is of such a magnitude that it should properly preclude that director from making a voting recommendation. This should be addressed during the negotiation of the scheme implementation agreement and before it is signed.

The target's board, without the relevant director present, should specifically consider whether or not it is appropriate for that director to make a recommendation on the Scheme despite the nature and quantum of the benefits which he or she will receive if the Scheme proceeds. As a guiding principle, the Board should consider the role that the director has played in the target's development, whether target shareholders "would be legitimately expecting that director to express [his or her] views as to [the merits of] the scheme and would be surprised and disconcerted if [he or she] did not do so."

As a general principle to guide the decision on this threshold issue, the value of the additional personal benefit must be kept within sensible limits and not be overly generous.

If the additional personal benefits arise under pre-existing executive employment contracts that were entered into well before the recent decisions referred to in this article, those arrangements should be revisited to reassess whether the nature and value of the benefits satisfy the above principle of being commercially reasonable.

A specific clause should be drafted into the scheme implementation agreement that modifies the usual 'unanimous' director recommendation obligation by expressly preserving the flexibility of a target company's director to not make a recommendation (or to not continue to maintain a recommendation) if he or she determines at any point that their interest in the scheme is so materially different from other shareholders.

Prominent disclosure must be given of the contingent additional personal benefit, as this will allow shareholders to assess what weight should be given to the relevant director's recommendation. It is suggested that prominent disclosure is best achieved as follows:

• In the Chairman's letter of the scheme booklet, as this is a key early part of the booklet that most shareholders are likely to read. This approach was taken in the recent Nippon Paper/Dulux scheme booklet where the Chairman's letter referenced that the CEO of Dulux and another executive director (who was also the CFO) would, if the scheme is implemented, become entitled to early vesting of unvested performance rights and forgiveness of 30% of the original amount of the associated loans. This disclosure should be made in the body of the Chairman's letter itself, not in a footnote to the letter.
• In the 'Frequently asked questions' section of the scheme booklet, the summary of the scheme section and in the core section on advantages and disadvantages of the scheme.
• In the additional information section.

If, as is usually the case, an offer information line is included for inbound shareholder queries and/or an outbound shareholder canvassing campaign is undertaken, the script used for such telephone discussions should, whenever referring to the directors' voting recommendation, expressly note the personal additional benefit that the relevant director(s) stands to receive if the scheme proceeds.

More generally, any form of shareholder canvassing or communication that is undertaken during the one month scheme notice period must be carefully constructed so that contingent director benefits are appropriately disclosed. Any failure to do so carries the risk that the Court may conclude at the second approval hearing that the integrity of the shareholder vote in favour of the scheme has been compromised by adjacent shareholder canvassing or other communications that did not align with the level of disclosure in the scheme booklet.