Ian David Brown in His Own Capacity and as Duly Authorised Representative of Michael Noel Aarons in His Capacity as trustee for the Aarons Superannuation Fund and in His Capacity as trustee for I.M.S Pacific Trust,... - [2020] WASC 393

JURISDICTION : SUPREME COURT OF WESTERN AUSTRALIA
IN CHAMBERS

CITATION:   IAN DAVID BROWN IN HIS OWN CAPACITY AND AS DULY AUTHORISED REPRESENTATIVE OF MICHAEL NOEL AARONS IN HIS CAPACITY as trustee for THE AARONS SUPERANNUATION FUND AND IN HIS CAPACITY AS TRUSTEE FOR I.M.S. PACIFIC TRUST, ANTARCTICA PACIFIC PTY LTD, DONGKE ZHANG (AS TRUSTEE FOR THE ZHANGS FAMILY TRUST) AND PETER JOHN WILLIAMS -v- RECCE PHARMACEUTICALS LTD [2020] WASC 393
CORAM:   MASTER SANDERSON
HEARD:   14 SEPTEMBER 2020
DELIVERED          :   2 NOVEMBER 2020
PUBLISHED           :   2 NOVEMBER 2020
FILE NO/S:   COR 98 of 2020
BETWEEN:   IAN DAVID BROWN IN HIS OWN CAPACITY AND AS DULY AUTHORISED REPRESENTATIVE OF MICHAEL NOEL AARONS IN HIS CAPACITY as trustee for THE AARONS SUPERANNUATION FUND AND IN HIS CAPACITY AS TRUSTEE FOR I.M.S. PACIFIC TRUST, ANTARCTICA PACIFIC PTY LTD, DONGKE ZHANG (AS TRUSTEE FOR THE ZHANGS FAMILY TRUST) AND PETER JOHN WILLIAMS
Plaintiff
AND
RECCE PHARMACEUTICALS LTD
Defendant

Catchwords:

Corporation law - 'Performance shares' - Whether shares should be issued

Legislation:

Corporations Act 2001 (Cth)

Result:

Plaintiff's application granted

Category: A

Representation:

Counsel:

Plaintiff	:	SK Shepherd
Defendant	:	G Sirtes SC

Solicitors:

Plaintiff	:	Forbes Kirby
Defendant	:	Automic Legal Pty Ltd

Case(s) referred to in decision(s):

Nil

MASTER SANDERSON:

By amended originating process filed 7 September 2020 the plaintiff sought relevantly the following orders:
1.1Setting aside the purported variation, alternatively cancellation, of the Performance Shares by the Company; and
1.2Requiring the Company to convert the C Class and Class D Performance Shares to ordinary shares in the Company; and
2.An order that the Company pay the Plaintiffs' costs of and incidental to this application (including any costs reasonably incurred by the represented Registered Shareholders).
There is no dispute between the parties as to the relevant facts. These are set out in detail in the plaintiff's written submissions. Paragraphs 2 to 25 of these submissions read as follows. In the submissions reference is made to various affidavits filed by the parties. I have omitted these references:
The Company
2.The Company was registered in Western Australia as a proprietary company on 11 April 2007.
3.From about June 2015, the Company took steps to list on the Australian Securities Exchange (ASX).
4.On 5 June 2015, to effect the ASX listing, the Company gave notice to shareholders of an extraordinary general meeting to be held on 30 June 2015.
5.The notice of meeting indicated that the Company sought shareholder approval for the adoption of a new constitution (the Constitution).
The performance shares
6.The notice of meeting further indicated that the Company sought shareholder approval for the issue of 'performance shares' to shareholders in the company, including the Registered Shareholders, prior to an initial public offering (IPO).
7.The terms and conditions on which it was proposed that the Company issue performance shares - subject to any changes required by the ASX – were set out in a schedule to the notice.
7.1.The schedule provided for the conversion of one performance share into one share:
7.1.1. For Class C: when the Company was granted FDA's phase 1 approval (or European equivalent - European Medicines Agency (EMEA)) (Class C Milestone).
7.1.2. For Class D: when the Company was granted FDA's phase 2 approval (or European equivalent - European Medicines Agency (EMEA)) (Class D Milestone).
7.1.3. Each of the Class C and Class D Milestones were required to have occurred within 10 years of the issue of the shares.
8.On 24 June 2015, Steinepreis Paganin, acting for the Company applied by letter for in-principle advice that the ASX would approve, inter-alia, the issue of performance shares by the Company.
9.On 30 June 2015, the extraordinary meeting of shareholders in the Company was convened. The minutes of the meeting record that:
9.1.the Chairman advised the shareholders that the ASX were still reviewing the proposed resolutions in relation to the Performance Shares and that it was possible that the Company might be required to amend the resolutions in relation to:
9.1.1. the shareholders eligible to receive the performance shares; and
9.1.2. the 'time horizon' of 10 years for the Company to meet the performance criteria.
9.2.a resolution that, for the purposes of Section 246B, Corporations Act and clause 2.6, Constitution, the Company was authorised to issue Performance Shares on the terms and conditions set out in the Explanatory Statement; and
9.3.the shareholders agreed to proceed with the relevant resolutions subject to the possibility that variations to the terms of the resolutions might be requested by the ASX.
The ASX Confirmation Letter
10.On 17 July 2015, Sandra Wutete, a senior manager at the ASX informed Steinepreis Paganin by email that the ASX preferred the proposed performance shares to have:
10.1. an expiry date of no longer than 5 years from the date of issue; and
10.2. alternative milestones for the Class C and D performance shares.
11.On 27 July 2015, Steinepreis Paganin informed the ASX by email that the Company proposed that the performance criteria for the conversion of the performance shares was now proposed to be:
11.1. for Class C: the volume weighted average price of Shares as traded on ASX over 20 consecutive trading days on which the Shares are traded is not less than $0.60; and
11.2. For Class D: the volume weighted average price of Shares as traded on ASX over a 20 consecutive trading days on which the Shares are traded is not less than $1.20, in each case within 5 years from the date of issue of the Performance Shares.
12.On 17 August 2015, following the communications between the ASX and Steinepeis Paganin, the ASX wrote to the Company, indicating the terms and conditions upon which ASX 'would be likely' to approve the issue of the proposed performance shares (ASX Confirmation Letter).
13.On 18 August 2015, Steinepreis Paganin wrote to the Company (Peter Williams) by email informing it of the ASX position on the proposed performance shares and that, although not expressly stated in the ASX letter, the ASX would only permit the performance shares to be issued to directors and key management personnel of Recce and not general seed capital shareholders.
Conditions of ASX in principal approval
14.Consequently, the ASX in-principle approval of the issue of the proposed performance shares was conditional upon, inter alia:
14.1. performance shares being issued only to directors or key management personnel of the Company; and
14.2. the milestones attached to Class C and Class D Performance Shares being amended, including to a term of 5 years.
The Registered Shareholders
15.On 20 August 2015, the Company directors executed a circular resolution varying the resolutions passed at the extraordinary general meeting held on 30 June 2015 (Issuing Resolution), to accord with the ASX’s in principle agreement.
16.The effect of the Issuing Resolution was to issue Class C and Class D performance shares to:
16.1.Michael Noel Aarons (as trustee for The Aarons Superannuation Fund);
16.2.Michael Noel Aarons (as trustee for I.M.S. Pacific Trust);
16.3.Antarctica Pacific Pty Ltd;
16.4.Ian David Brown;
16.5.Dongke Zhang (as trustee for The Zhangs Family Trust); and
16.6.Peter John Williams,
(collectively the Registered Shareholders).
17.At 20 August 2015, the non-corporate Registered Shareholders held positions at the Company.
17.1. Ian Brown was a non-executive director appointed on 23 June 2015.
17.2. Dongke Zhang was a non-executive director appointed on 23 June 2015.
17.3. Michael Aarons was employed by the Company as Laboratory Manager from 1 July 2015.
17.4. Peter Williams was employed by the Company as Chief Financial Officer from 19 May 2015 and appointed Company Secretary on 3 June 2015.
Resignations of the non-corporate Registered Shareholders
18.The ASIC Company records disclose that:
18.1.Ian David Brown resigned from the Company as a non‑executive director with effect from 8 April 2016;
18.2.Dongke Zhang resigned from the Company as a non-executive director with effect from 8 April 2016.
18.3.Michael Noel Aarons resigned his position on or about 15 August 2016.
18.4.Peter Williams’ engagement by the Company was terminated on 27 November 2017.
Disclosure of the performance shares issued to the Registered Shareholders
19.Between September 2015 and 2020 the Company disclosed the issue of performance shares (including those issued to the Registered Shareholders) in:
19.1.a Company shareholder update referring to the variation of the terms of issue of the performance shares circulated to shareholders of the Company on 1 September 2015.
19.2.the Company’s annual reports for: 19.2.1. Financial year ending 2016;
19.2.2. Financial year ending 2017;
19.2.3. Financial year ending 2018;
19.2.4. Financial year ending 2019.
19.3.the Company’s appendix 3B reports for the years 2016 to 2019.
Refusal to convert the performance shares
20.It is not in dispute that:
20.1.the milestones for the conversion of the class C and Class D performance shares have been met within 5 years from the issue of the performance shares;
20.2.the Company has refused to issue shares converting the performance shares held by the Registered Shareholders.
No cancellation or variation
21.It is not entirely clear from the correspondence whether the Company’s refusal is a purported cancellation of the relevant performance shares or a purported variation of the conditions for conversion of the performance shares.
22.In either event, the Constitution sets out the procedure for varying or cancelling rights attached to shares in a class of shares.
23.Rights attaching to the Class C and Class D shares may be varied or cancelled only in accordance with the procedure in the Constitution. The procedure may be changed only if the procedure itself is complied with.
24.Clause 2.4 Constitution relevantly provides:
24.1.the rights attached to any class of shares in the Company may be varied
24.1.1.with the consent in writing of the holders of three quarters of the issued Shares of the class; or
24.1.2.if authorised by a special resolution passed at a separate meeting of the holders of the Shares of the class.
24.2.Any variation of rights under clause 2.4 is subject to Part 2F.2 of Chapter 2F, Corporations Act.
25.It is not suggested by the Company that the procedure set out in the constitution or in Part 2F.2 of Chapter 2F, Corporations Act has been complied with by the Company to cancel or vary the performance shares.
In the defendant's written submission they set out the matters in dispute between the parties. Relevantly the submissions read as follows:
5.The Company has not converted the plaintiffs’ shares into ordinary shares because the plaintiffs did not contribute to the achievement of the performance milestones owing to their departure from the Company a number of years ago.
6.The Company submits that the terms and conditions which governed the Performance Shares, properly construed, do not entitle the plaintiffs to require the Company to convert the performance shares into ordinary shares. Alternatively, the terms of the shares contain an implied term that performance be provided by the plaintiffs up to or around the point in time when the milestone has been reached.
7.These are the two questions for the Court to determine. Absent such a construction, or the implication of such an implied term, the plaintiffs are entitled to receive ordinary shares only because the Company achieved the performance milestones even though they themselves did not contribute to the attainment of those milestones.
The defendant advanced two arguments. First, it was said - applying orthodox principles of construction to the meaning of 'performance share' - what was required was 'performance' to have been provided by the plaintiff up to or around the point in time when the milestone has been reached. The defendant said, without performance by the plaintiff, the rights they held were not properly construed as performance shares, giving the plaintiff no right of conversion. Second, it was said that if such meaning does not arise from an interpretation of the expressed provision it should be implied.
With respect, neither of these two arguments can be made out. As the defendant noted in their written submissions, the parcel of rights that are 'performance shares' were expressly subject to (a) the company's constitution; (b) the Corporations Act 2001 (Cth); (c) the ASX listing rules; and (d) the approval of the ASX. In the event of inconsistency between the listing rules and the constitution, the listing rules take precedence. Under listing rule 6.1, the terms that apply to each class of equity securities must, in the ASX's opinion, be appropriate and equitable. That includes having an appropriate nexus between the performance milestone in question and the conduct being rewarded.
On 28 April 2014, the ASX released ASX Listing Rules Guidance Note 19. The purpose of Guidance Note 19 was to assist listed entities to structure the terms of performance shares to comply with the listing rules. Under the sub‑heading 'What are "Performance Shares"' there appears the following:
The term 'Performance Share' is a generic term referring to a share that has limited rights unless and until a nominated performance milestone is achieved, but that converts into a given number of ordinary shares with all the usual rights attached if and when the milestone is achieved. The number of ordinary shares into which the Performance Share converts may be fixed in number (often it is one for one) or it may be determined by reference to a particular formula.
Nothing in that section or elsewhere in the Guidance Note refers to actual performance by the individuals to whom the shares are issued. What triggers the issue of the shares is an achievement of a milestone. Clearly the term 'performance' refers to the shares. It does not, as the defendant submitted, refer to the performance of the holders of the shares. In this case, as the milestone has been achieved, the plaintiff is entitled to the issue of the shares.
There is no warrant for implying any term in the contract such as would require the holders of the performance shares to have contributed in some way to achieving the trigger event. Apart from anything else, to find a term could be implied runs counter to the 'full and complete disclosure' principle, which the ASX regards as fundamental. But more than that, the conditions for implying a term simply do not exist. By way of example - how could the term be defined. If, for instance, a person to whom performance shares were issued was instrumental in the upward trajectory of the company and its share price but was forced to resign from the company through ill health before the milestone was achieved, would he or she be denied the chance to convert the performance share? The difficulties of implying a term are manifest and obvious. No term can be implied into this contract.
The plaintiff has made good its argument. There is no basis for refusing the order they seek. Subject to hearing from counsel, I will make orders in terms of the amended originating process. The defendant should pay the costs of this application, including the reserved costs.
Before leaving this matter I should say something about the concept of 'performance shares' embodied in Guidance Note 19. First, the term 'performance shares' is a misnomer. The term 'share' is not defined in the Corporations Act but it is a concept which is well understood by investors, including retail investors. In pt 6 of the Guidance Note, under the heading 'Base Requirements for all Performance Shares' there appears the following:
The essence of a performance share is that it has limited rights unless and until the applicable performance milestone is achieved and limited value if that milestone ultimately is not achieved. ASX therefore expects that a performance share generally will not:
·be transferrable (and, consequently, not be quoted on ASX or any other exchange);
·confer any right to vote, except as otherwise required by law;
·confer any entitlement to a dividend, whether fixed or at the discretion of the directors;
·confer any right to a return of capital, whether in a winding up, upon a reduction of capital or otherwise;
·confer any right to participate in the surplus profit or assets of the entity upon a winding up; or
·confer any right to participate in new issues of securities such as bonus issues or entitlement issues.
Unless and until the applicable performance milestone is achieved and the performance share converts into ordinary shares. Otherwise, ASX is unlikely to consider that a performance share meets the requirements of Listing Rules 6.1 and 12.5 or Listing Rule 1.1 condition 1.
It is acceptable for performance shares to have a 'change of control' provision allowing the holder to convert it into ordinary shares if there is a change in control of the entity that issued the performance shares, notwithstanding that the applicable performance milestone has not been achieved, but only if there is a term that limits the total number of ordinary shares that the performance shares in aggregate convert into to no more than 10% of the issued ordinary capital of the entity as to the date of conversion. If they were able to be converted ahead of the relevant performance milestone being satisfied into a higher percentage of the ordinary share capital, then the performance shares may act as a deterrent to a future change of control transaction and ASX does not regard that as appropriate.
It is also acceptable for performance shares to have 'anti-dilution' provisions that adjust the number of ordinary shares into which the performance shares convert if the entity splits or consolidates its ordinary shares or undertakes a bonus issue, entitlement issue or other capital reconstruction.
Really what is being issued is a bare right. It has none of the hallmarks normally associated with a 'share'. It would be appropriate to refer to 'performance right'; it is misleading to refer to 'performance share'.
The second point relates to an internal inconsistency in Guidance Note 19. Under the subheading 'Reasons for Issuing Performance Shares' there appears the following:
Performance shares are sometimes issued to a vendor seeling an asset to a listed entity as a form of contingent deferred consideration, often where the value of the asset being sold is unclear or may vary materially, depending on whether the relevant performance milestone is achieved. For example, a listed entity buying a mining tenement that has been the subject of a preliminary drilling program with promising results but that requires an in‑full drilling program and other work to confirm the size and quality of the resource, may wish to protect itself in case the tenement does not live up to its initial promise. To do this, it may agree to include as part of the consideration for the purchase an issue of performance shares to the vendor with a performance milestone attached that an indicated or measured resource of a given size and quality is confirmed. From the perspective of the entity and its investors, this will help to avoid overpaying for the tenement if it does not live up to its initial promise. For the perspective of the vendor, this will help to ensure that it is appropriately compensated if the tenement does live up to its initial promise.
Performance shares are sometimes issued to directors, senior managers or contractors as a means of incentivising them to achieve a particular performance milestone. They can be especially useful for cash‑strapped start‑up ventures that may have no other practical means of remunerating key individuals for the substantial efforts that may be required to get the venture up and running profitably.
Performance shares are also sometimes issued as part of an employee incentive scheme, although for tax and other reasons it is more common for employee incentive schemes to utilise performance rights rather than performance shares.
Examples of performance milestones that have been attached to performance shares include:
·an entity achieving a particular financial target (eg a nominated level of EBITDA, profit, EPS or some other financial measure);
·an entity obtaining an environmental or other governmental approval needed to commence operations;
·a biotech entity achieving a step in the regulatory approval process for the licensing of a new drug; and
·a mining producing entity achieving a nominated level of production at a particular mining facility.
ASX understands that appropriately framed performance shares can benefit listed entities and their security holders and is willing to allow them, provide they comply with the Listing Rules.

Against that, under pt 8 with the heading 'Appropriate and Equitable Performance Milestones' there appears the following:
To meet the requirements of Listing Rules 6.1 and 12.5 or Listing Rule 1.1 condition 1, the performance milestone attached to a performance share must be appropriate and equitable. ASX considers that this requires the following:
(1)there must be an appropriate link between the performance milestone and the transaction or purpose of which the performance share is to be issued;
(2)the performance milestone must be clearly articulated by reference to objective criteria so that investors and analysts can readily understand, and have reasonable certainty as to, the circumstances in which the performance milestone will be taken to have been met;
(3)the number of ordinary shares into which the performance shares will convert if the relevant milestone is achieved must be fixed or calculated by reference to a formula that delivers a fixed outcome so that investors and analysts can readily understand, and have reasonable certainty as to, the impact on the entity's capital structure if the milestone is achieved; and
(4)the performance share must have an expiry date by which the relevant milestone is to be achieved and, if the milestone is not achieved by that date, either the performance share must be cancelled or bought back for no or nominal consideration only or else the total number of performance shares on issue must convert into a nominal amount of ordinary shares only.
Examples of performance milestones that ASX has considered inappropriate under requirement (1) above, and therefore not allowed, include:
·a performance share proposed to be issued to a vendor by an entity where the performance milestone was tied to the market price of the ordinary shares of the entity issuing the performance share rather than to the performance of particular assets vended in'
·a performance share proposed to be issued to a vendor by an entity where the performance milestone was tied to the financial performance of the entity as a whole rather than to the performance of particular assets vended in;
·a performance share proposed to be issued to a director where the milestone to be achieved was that the director simply hold office until a nominated date; and
·a performance share proposed to be issued to a director which converted into ordinary shares if the director was removed from office before a nominated date.
An example of conversion terms that ASX has considered inappropriate for failing to meet requirement (3) above was a performance share where the number of ordinary shares into which it converted was calculated by reference to the market price of the ordinary shares at the time of conversion, without any floor on the market price for these purposes.
In relation to requirement (4) above, ASX does not usually permit performance shares with an expiry date longer than 5 years from the date of issue.
ASX has no objection, in an appropriate case, to having a performance milestone related to the market price of an entity's securities. Care, however, needs to be taken in framing the milestone so that it is appropriate and equitable, noting that:
·security prices can be affected by macroeconomic factors, market sentiment and other matters unrelated to the performance of the entity;
·security prices can fluctuate significantly over a short period and achieving a nominated hurdle briefly before the price falls back below that hurdle may not be a fair measure of sustainable performance; and
·security prices may be susceptible to manipulation, especially in the case of thinly traded securities or if measured at a single point in time (for example, at the close of trading on a particular day).
For these reasons, ASX recommends that a security price hurdle attached to a performance share should be based on volume weighted average market price over a reasonable period (for example, over 20 consecutive trading days on which the entity's securities have actually traded).
It is clear in this case there was no link between the performance milestone (the achievement of a certain share price) and the purpose for which the performance share was issued (presumably an incentive to those who received the share to advance the interests of the company and increase the share price). That fact has undoubtedly led to this application. It would be inappropriate for me to elaborate further. But this case does illustrate the need for the ASX to further consider their guidance in relation to performance shares.

I certify that the preceding paragraph(s) comprise the reasons for decision of the Supreme Court of Western Australia.
CB
Associate to Master Sanderson
2 NOVEMBER 2020