Mallina Holdings Ltd v Biala Pty Ltd
[1996] FCA 1160
•24 December 1996
C A T C H W O R D S
CORPORATIONS - application to confirm proposed issue of shares at a discount - application opposed by three shareholders - relevant considerations - whether any need for issue of shares at a discount - commercial interests of the company - allegations that scheme existed to vest control of company in shareholder underwriter without need to make full bid or pay premium - proposed price of issue equal to current stock market price but below nett asset backing per share - whether proposed issue price too low - whether sufficient information provided to shareholders - whether incorrect information provided to shareholders - whether information required by shareholders authorising issue at a discount is co-extensive with or similar to information required by them before deciding to subscribe to proposed new issue - whether prejudice to present or future creditors or shareholders - application granted on conditions.
Corporations Law 1990 s.190
Re Esmeralda Exploration Ltd (1992) 10 ACLC 20
Re Jarass Pty Ltd (1988) 6 ACLC 767
Re Melacare Industries of Australia Pty Ltd (1994) 12 ACLC 60
Re "Air North-West" Pty Ltd (1988) 6 ACLC 1,143
Killen v. Marra Developments Ltd [1979] ACLD 608
Re Mallina Holdings Ltd (1990) 8 ACLC 281
Harlowe's Nominees Pty Ltd v. Woodside (Lakes Entrance) Oil Co NL (1968) 121 CLR 483
Kingston & Anor v. Keprose Pty Ltd (No. 2) (1988) 6 ACLC 111
Catto v. Ampol Ltd (1989) 7 ACLC 717
Devereaux Holdings Ptd Ltd v. Pelsart Resources NL (No. 2) (1985) 9 ACLR 956
MALLINA HOLDINGS LIMITED v. BIALA PTY LTD and
T.S. HOLDINGS PTY LTD
No. WAG 3041 of 1996
CARR J
PERTH
24 DECEMBER 1996
IN THE FEDERAL COURT )
OF AUSTRALIA )
WESTERN AUSTRALIA )
DISTRICT REGISTRY ) No. WAG 3041 of 1996
GENERAL DIVISION )
B E T W E E N : MALLINA HOLDINGS LIMITED
ACN 008 720 965
Applicant
and
BIALA PTY LTD and T.S.
HOLDINGS PTY LTD
Respondents
CORAM: CARR J.
PLACE: PERTH
DATE: 24 DECEMBER 1996
MINUTE OF ORDERS
THE COURT ORDERS THAT:
On or before 6 January 1997 the applicant bring in a minute of orders which is to include the following:
(a)The proposed issue of shares by Mallina Holdings Limited at a discount authorised by a resolution of a General Meeting of the Company held on 14 November 1996 is confirmed.
(b)The period within which the shares must be issued pursuant to s.190(2)(c) is extended to twelve (12) weeks from 24 December 1996.
(c)The applicant shall not issue any further shares for a period of five (5) years unless it provides full particulars, at the time of such issue, of any shares issued pursuant to the resolution referred to in paragraph (a) above.
(d)Existing shareholders are to be given two entitlements in the proposed issue. In the first entitlement all shareholders are to be given the opportunity to subscribe for one new discounted share for every one share already held. At the completion of the allotment of shares in the first entitlement, if there is any shortfall remaining from the shares in the issue, then all shareholders will have a second entitlement to subscribe for the balance of shares remaining, pro rata to their shareholding at that time.
A copy of this minute of orders and accompanying reasons for judgment is to be lodged with the Australian Securities Commission and Australian Stock Exchange Limited on or before 10 January 1997.
Any party or intervenor shall have leave to file and serve written submissions on the question of the costs of this application within 21 days of 24 December 1996. Any such party or intervenor may also file and serve written submissions in reply in respect of that matter within seven days of being served with the written submissions last served by any such other party or intervenor.
NOTE:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
IN THE FEDERAL COURT )
OF AUSTRALIA )
WESTERN AUSTRALIA )
DISTRICT REGISTRY ) No. WAG 3041 of 1996
GENERAL DIVISION )
B E T W E E N : MALLINA HOLDINGS LIMITED
ACN 008 720 965
Applicant
and
BIALA PTY LTD and T.S.
HOLDINGS PTY LTD
Respondents
CORAM: CARR J.
PLACE: PERTH
DATE: 24 DECEMBER 1996
REASONS FOR JUDGMENT
Introduction
This is an application by Mallina Holdings Ltd ("the Company") under s.190 of the Corporations Law for the confirmation of an issue of shares at a discount ("the Issue"). The application is opposed by three of its shareholders. Two of those shareholders, Biala Pty Ltd ("Biala") and T.S. Holdings Pty Ltd ("TS"), are respondents to this application. The third shareholder, TDS Investments Pty Ltd ("TDS") was given leave to intervene. Biala and TS together hold 4.8 million shares in the Company. Those shareholdings together represent about 11.61% of the issued capital. TDS holds, in its own right and as trustee of a superannuation fund, approximately 1.8 million shares in the Company. That shareholding represents approximately 4.29% of the issued capital.
Factual Background
The Company was incorporated as a public company in May 1969. It has been listed on the Australian Stock Exchange and its predecessor since about that time. Its home exchange is in Perth. The Company is engaged principally in the mining, processing and marketing of industrial minerals, in particular Attapulgite products. Attapulgite is an industrial absorbent and is also used as cat litter. The Company has other mineral interests. There is evidence which suggests that the Company owns the largest deposits of diatomaceous earth in Australia. The respondents dispute this and, in cross-examination of Mr D.H. Sutton, Managing Director of the Company, their counsel referred him to the "Great Fitzroy" deposit in Queensland. The evidence is inconclusive on the point and for the purposes of this application it is not necessary to resolve that issue. Diatomaceous earth is used in a wide range of industries as a filtering agent, an insulating material, a filler and an extender. The market is at present served exclusively by imports. The Company says that the principal purpose of the Issue is to raise funds to develop its diatomaceous earth mine and to build a production plant to process that product ("the DE project").
On 14 November 1996 the shareholders of the Company, at its annual general meeting, approved the Issue. In a prospectus for the Issue ("the Prospectus") which had been circulated to the shareholders in the Company prior to the meeting, there appeared the following statements:
"The purpose of the Issue is primarily to finance the development of the Company's Diatomaceous Earth project and also to assist in providing funds for working capital and other investments to be identified by the Board. The development of the Diatomaceous Earth deposits located
between Geraldton and Perth has been the subject of extensive feasibility and engineering studies previously reported to Shareholders and the Directors believe that the resources should be brought into production as soon as possible, more particularly to take advantage of perceived market opportunities in Australia. The total funding requirement for the project will exceed the amount raised by the rights issue and Directors are investigating additional sources of funding to provide for the balance of the project. Funds raised by this Issue will also assist in financing further new investments."
...
"Based on preliminary engineering and design studies, the total cost of a 12,000 to 15,000 tonne per annum production plant is estimated to cost (sic) approximately $14 million and the forecast time required for construction is between nine and twelve months. The Directors anticipate construction of the production plant will be commenced in the first six months of 1997."
The resolution was passed with 18,795,140 votes in favour and 7,635,906 votes against. That represents a majority of 71.1% of the votes cast at the meeting. The application to this Court for confirmation of the Issue had been filed, in anticipation of the resolution, on 28 October 1996 and was scheduled for hearing on 15 November 1996. On that date, Biala and TS filed a notice of intention to appear. When the matter came on for hearing, I made an order that Biala and TS be joined as respondents to the application, made further directions orders for the filing of affidavits, particulars of objections and outlines of argument, and adjourned the matter to a full hearing on 10 December 1996. On 27 November 1996 TDS filed notice of intention to appear at the hearing. At a directions hearing on 6 December 1996, I gave leave to TDS to intervene at the hearing upon certain terms. I gave Mr P.B. Rakich, a director of TDS, leave to represent that company in these proceedings. [Mr Rakich was the Managing Director of the applicant for many years. He ceased to be a director of the applicant in August 1995.] On 10 December 1996 the proposed underwriter to the Issue, Hudson Corporate Pty Ltd ("the Underwriter"), sought leave
to intervene. The respondents opposed that application as being premature. I granted leave because, apart from its interest as proposed underwriter, the Underwriter was the subject of serious allegations raised against it by the respondents and has a beneficial interest in approximately 19.8% of the issued share capital of the Company.
The Statutory Framework
Section 190 of the Corporations Law relevantly provides:
"POWER TO ISSUE SHARES AT A DISCOUNT
190(1)[No liability company] A no liability company may issue shares at a discount.
190(2)[Other classes of companies] Subject to this section, a company other than a no liability company may issue at a discount shares in a class of shares already issued if:
(a)the issue of the shares at a discount:
(i)is authorised by resolution passed in general meeting of the company; and
(ii)is confirmed by order of the Court;
(b)the resolution specifies the maximum rate of discount at which the shares are to be issued;
(c)the shares are issued within the period of one month after the day on which the issue is confirmed by order of the Court or within that period as extended by the Court; and
(d)the shares are first offered to every holder of shares in that class in proportion to the number of shares in that class already held.
190(3)[Court may confirm issue] The Court may, if having regard to all the circumstances of the case it thinks proper to do so, make an order confirming the issue on such terms and conditions as it thinks fit.
190(4)[Particulars in prospectus] If there is a prospectus relating to the issue of the shares, the company shall set out in the prospectus particulars of the discount allowed or of so much of that discount as has not been written off as at the day of the issue of the prospectus
190(5)[Notice of offer to shareholders] An offer made for the purposes of paragraph (2)(d) shall be made by notice specifying the number of shares to which the member is entitled, and specifying a period, being not less than 21 days from the date of the notice, within which the offer may be accepted.
190(6)[Offer not accepted] If an offer in respect of shares made in accordance with subsection (5) is not accepted within the period
specified by the notice, the shares may be issued on terms not more favourable than those offered to the shareholders."
The Case Law
In Re Esmeralda Exploration Ltd (1992) 10 ACLC 20 French J reviewed the statutory history of the legislative predecessors of s.190 of the Corporations Law and the relatively few decisions in relation to that section. His Honour set out a list of factors which he described as consistent with the concerns expressed in authorities both before and after the introduction of legislative provision for judicial approval of discount issues. That list was as follows:
1. The public interest in ensuring that prospective shareholders and creditors are not misled by a nominal capital figure that exceeds the true capital of the company. The significance of this factor may be mitigated by the contemporary recognition that issued capital may by reason of trading losses and the like not reflect the asset backing of the company.
2.The effect of the proposal upon the interests of actual or prospective shareholders and creditors.
3.The extent to which shareholders have been informed of the reasons for the issue prior to voting on it.
4. The extent to which creditors may find the proposal objectionable and the notice both formal and substantive that they have been given to enable them to object if they so wish.
5. The objectives of the proposed issue and the extent to which it serves the interests of the shareholders and creditors of the company.
French J said that he did not suggest that the above factors are exhaustive, but the list is most useful.
I shall not recite all of the relevant decisions but I shall refer to some of them. In Re Jarass Pty Ltd (1988) 6 ACLC 767 Young J (at p.769) said that the approach of the Court in a matter such as this should be similar to its approach to reduction of capital matters. His Honour said (in a passage which continues over to p.770):
"There is little guidance as to how the Court should exercise its power to confirm an issue of shares at a discount under sec. 118. Indeed, the only decided case that I have been able to find of even passing value is Re Edinburgh & Dundee Investment Co (1930) S.C. 601 which held that the Court must weigh the pros and cons of the proposal and not merely rubber stamp what the company had done. It seems to me that the approach of the Court under sec. 118 should be similar to its approach to reduction of capital matters. In the 20th century the doctrine of maintenance of capital has not the same sanctity as it had in the 19th, and if all persons who might be affected by the proposal have had the appropriate information put before them and have been given the chance to object, then the Court should be confident that it is proper in the spirit of the Code to confirm the resolution. At least this is the situation where there is nothing in the proposal which makes it appear other than one which is submitted bona fide and in the best commercial interests of the company." [Emphasis added]
In Re "Air North-West" Pty Ltd (1988) 6 ACLC 1143, McLelland J, in confirming an issue under s.118 of the Companies Code, relied upon the legitimate commercial justification shown for it and the fact that no-one was likely to be prejudiced except possibly for persons taking up shares otherwise than at a discount in future, believing that they were subscribing for shares on the same basis as existing shareholders. An appropriate condition was imposed requiring notice to be given of the discount issue to any person subscribing for shares in the ensuing five years. In Re Mallina Holdings Ltd (1990) 8 ACLC 281 ("Mallina I") (a case to which I will return), which involved an earlier issue at a discount by the applicant in this matter, Seaman J was satisfied that the proposal was submitted bona fide and in the best commercial interests of the Company. A great deal of time at the hearing of this application was taken up with what was alleged to be the paucity of information contained in the Company's 1996 annual report and the Prospectus, both of which documents were forwarded to its
shareholders when the meeting was convened at which the resolution of 14 November 1996 was passed. Notwithstanding the width of the language in s.190(3) ("... having regard to all the circumstances of the case ..."), I think it is important to remember that the focus of the inquiry should be on the matter of whether the shares may be issued at a discount. That is not to suggest that the level of information provided to the shareholders is not important. It is obviously a most important matter. The second main objection in Mallina I was (as in this case) that a sufficient statement of facts had not been put before the shareholders before they voted upon the resolution. Seaman J acknowledged the importance of the information provided to the shareholders, but drew a distinction between the information which is needed by the shareholders of a company before making a decision to vote on the Issue (i.e. to authorise the issue of the shares at a discount) and the information which they need before deciding whether or not to subscribe for the shares. I respectfully agree with the distinction drawn by his Honour in that case. In my view, there are strong parallels between Mallina I and the present matter.
In Mallina I the evidence which demonstrated that the proposal was bona fide and in the best commercial interests of the Company centred upon its urgent need for funds principally to repay a very substantial debt to the Company's bank, which was pressing for payment. There was a long history of disputation between Biala and TS which then held about 29.75% of the issued capital of the Company, on the one side, and other companies (controlled by a Mr Dallas Dempster) which at that time together held about 27.2% of the issued capital, on the other side. In Mallina I, Biala and TS based their first principal objection on an allegation that the issue was made for the ulterior
motive of placing control of the Company in the hands of the Dempster interests, and had no commercial reality. A similar allegation surfaced at the hearing in this matter i.e. to the effect that the Underwriter was party to a scheme to increase its shareholding above 20% without making a full bid for all of the outstanding shares in the Company not held by it, and paying a premium for control.
In Re Melacare Industries of Australia Pty Ltd (1994) 12 ACLC 60 at p.61, Young J after referring to the four abovementioned cases said:
"All of these cases say that, if the court can see that there are sound commercial reasons for issuing the shares at a discount and that the public is not misled by a nominal capital figure that exceeds the true capital of the company, then the court should make the order."
The Applicant's Case
Compliance with the formal requirements
As might be expected, in addition to the requirement of a resolution passed by the shareholders in general meeting authorising the Issue, there are certain formal regulatory requirements to be complied with before an order may be made under s.190 of the Corporations Law. These include fairly extensive advertising of the application. Neither the respondents nor the objecting intervenor raised any issue in relation to compliance with the formal requirements. I note that notice of this application has been given to the Australian Securities Commission and to the Australian Stock Exchange Ltd. Compliance with the formal requirements is, of course, most important. So far as the shareholders are concerned, they received individual notice of the meeting and the proposed application together with the Company's annual report
for the year ended 30 June 1996. One of the main purposes of due advertising of this application is to give notice to creditors about the proposed issue of shares at a discount. There is evidence before the Court that the application has been duly advertised in accordance with the regulatory requirements. No creditor has filed any notice of intention to appear, or shown any interest whatsoever in these proceedings. The only procedural problem arose out of the terms of Article 67(a) of the Company's Articles of Association. In the circumstances of this matter Article 67(a) required that, in addition to other notice requirements, the Company give notice of the general meeting by advertisement in one of the metropolitan daily newspapers published and circulating in Perth. That advertisement was required not less than 14 days prior to the General Meeting. The notice was in fact published on 14 November 1996. Article 67 provides that the accidental omission to give notice shall not invalidate the proceedings at any general meeting. The applicant applied for an order under s.1322(4) of the Corporations Law declaring, in effect, that despite non-compliance with Article 67(a) the convening of the general meeting and the passing of the relevant resolution were not invalid. That application was not opposed, and I granted it.
I am satisfied that all the formal requirements relating to this application have been complied with.
Whether the Court should confirm the Issue of the shares at a discount
The applicant has filed numerous affidavits, but the principal evidence came in the form of affidavits from Mr Sutton and another director of the Company, Mr Kian Gee Teh. Their evidence showed that the Company is a disclosing entity under s.111AC of
the Corporations Law. Its securities are "enhanced disclosure securities". Consequently, the Company is required to comply with the continuous disclosure requirements provided in Division 2 of Part 7.11 of the Corporations Law. By doing so, it gains the benefit of the enhanced disclosure regime, which includes being able to raise capital by a transaction specific prospectus: sec.1022AA (a section which came into force on 4 September 1994 via the Corporate Law Reform Act 1994). A comparison between the regulatory regime for ordinary prospectuses under s.1022 and that provided in respect of enhanced disclosure securities under s.1022A of the Corporations Law and the Corporations Regulations shows the potential for a substantially reduced amount of information to be required in a prospectus issued under s.1022AA. In particular, s.1022 requires a prospectus to include "... all such information as investors and their professional advisers would reasonably require, and reasonably expect to find in the prospectus, for the purpose of making an informed assessment of:
(a)the assets and liabilities, financial position, profits and losses, and prospects of the corporation; and
(b)the rights attaching to the securities".
This may be compared with, for example, s.1022AA(2)(b) which refers to the information required to be included in prospectuses for "Quoted ED Securities" as including:
"(b)... all such information as investors and their professional advisers would reasonably require, and reasonably expect to find in the prospectus, for the purpose of making an informed assessment of:
(i)the effect of the offer or invitation on the disclosing entity; and
(ii)the rights attaching to the securities; and
(c)... a statement that:
(i)explains that the disclosing entity, as such an entity, is subject to regular reporting and disclosure obligations; and
(ii)advises that copies of documents lodged in relation to the entity may be obtained from, or inspected at, an office of the Commission."
The rationale of the regime introduced by that section (and other sections) appears, in summary, to be that a full prospectus need not be lodged under s.1022 comprising information about the issuer itself. As the Australian Securities Commission Draft Practice Note 96.01 (issued on 3 January 1996) states:
"This information should already be known to the market through the issuer's disclosures made under its enhanced disclosure and continuous reporting requirements."
My assessment of the essence of the respondents' objections to the Prospectus is that those objections mainly do not concern information about the company itself. The objections go to the "transaction specific information".
In essence, the applicant says that it has over the years released to the stock market all notifiable information. For the purposes of the Issue it has lodged a transaction specific prospectus with the Australian Securities Commission, being a prospectus which complies with both general law and statutory requirements. The Company submits that the DE project is a core business objective which is viable and which will, if successfully developed, add significantly to share value. That project requires some injection of equity funds and some borrowings. This was, so it was submitted, a legitimate and sound commercial justification. So far as the discount was concerned, the Company considered that the price was fair, given the recent range of prices for its shares on the Australian Stock Exchange. The decision in principle to develop the DE project had been in place for some years as it had generally been regarded as a valuable potential asset of the Company. The underwriting of the Issue was at arm's length and in the best interests of all its shareholders. The Board's decision to proceed with the Issue and the DE project were business judgments which, although opposed by some shareholders, were made bona fide, on sufficient information and for a proper purpose. The applicant submitted that it was clear from the statements made in the Prospectus that at least half of the funds to be raised were going to be dedicated to the DE project. Although the Company is in a healthy state, it could not fund the DE project internally. Nor would it be prudent to borrow the whole amount required for the project. Finally, on behalf of the Company, it was submitted that there was no evidence to support the allegations of improper use of information and position and the implementation of a scheme to benefit the Underwriter at the expense of other shareholders. Nor was there any evidence to support the allegations of market manipulation.
The Objections
In their written particulars of objections, the respondents contended as follows:
.that there is no legitimate or sound commercial justification for the proposed issue other than to advance the interests of the Company's single largest shareholder, Hudson Timber and Hardware Ltd ("Hudson") via its underwriting agreement with the Company; [in his closing address, Mr A.C. Archibald, senior counsel for the respondents, said that the respondents "did not contend that the Issue was not bona fide in the interests of the Company" in the sense that the directors "addressing the issues before the company have determined that capital should be raised" and that capital raising can be seen to be a proper step in the
administration of the company. I shall return to that important matter below];
.the shareholders of the Company were not given sufficient information before voting on the resolution to enable them to form a judgment on the proposed issue;
.The objectives of the Issue are unclear. This was particularised as follows:
(a)the Company had given what were said to be three inconsistent reasons for the Issue. The first was on 2 October 1996 when it stated that funds were required for the construction of a Diatomaceous processing plant. The second was said to be on 4 October 1996 when the Company stated that the funds were partly required for the Diatomaceous Earth project and also for other investments. The third statement was that contained in the Prospectus and set out above;
(b)it was impossible for a shareholder to know how much of the funds being raised would be used for any particular purpose;
.the material did not identify any need for the shares to be issued at a discount, and in particular at a discount of 70% to par value and 50% to net asset backing per share;
.there was no need to issue the shares at a discount. The Company, so it was submitted, is in excellent financial condition;
.The proposed issue would result in a substantial lowering of the net asset backing per share and thus prejudice all shareholders except the Underwriter;
."the entire scheme", being the Issue and the underwriting will prejudice all shareholders except the Underwriter;
.the directors, and hence the Underwriter are in the position of knowing more information about the Diatomaceous Earth project than the rest of the shareholders;
.the market price of shares in the Company is not a reflection of their true worth;
.the Prospectus contains misleading information and does not contain enough information about the Diatomaceous Earth project.
The respondents' evidence was provided in the form of an affidavit of Mr Justin Bradley Willis, a chartered accountant. Mr Willis is the Partner-in-Charge of Arthur Andersen Corporate Finance Pty Ltd. Mr Willis exhibited to his affidavit a report prepared by him in relation to the Issue. In summary, Mr Willis' opinion was to the effect that:
(a)Insufficient information had been provided to shareholders for them to determine "on a reasonably finite basis" for what purpose and in what proportions the funds raised by the Issue will actually be applied;
(b)The level of public disclosure by the Company was generally insufficient to enable shareholders to determine whether or not to approve the Issue and whether to take up their entitlement to subscribe for new shares pursuant to the Issue;
(c)The information disclosed in relation to the Diatomaceous Earth project ("the DE project") was insufficient for shareholders to determine the potential effect of that project on the Company's cash-flows, earnings per share and future dividends;
(d)The effect of the issue would be to reduce the nett asset backing per share from 33.84 cents to 23.97 cents and to reduce the nett tangible asset backing per share from 33.70 cents to 23.90 cents;
(e)Recent market trading on the Australian Stock Exchange was at a significant discount to the Company's nett asset backing and nett tangible asset backing. Given a nett cash backing of approximately 10.24 cents per share and a current share price of 15.0 cents, the share market was attributing a low market capitalisation to earnings from the Company's current operations and the Company's other assets including the Diatomaceous Earth project;
(f)There were reasonable grounds to believe that the Underwriter may be receiving a benefit relative to other shareholders as a result of the amount of the underwriting fee as a percentage of the "actual potential underwriting exposure". Furthermore, so it was put, the Underwriter will subscribe for any shares not taken up by other shareholders at a significant discount to the nett asset backing and potentially their true intrinsic value;
(g)The Underwriter may have access to information concerning the potential future profitability and value of the Diatomaceous Earth project that has not been disclosed to other shareholders.
Apart from Mr Willis' evidence, the respondents relied upon matters which emerged in cross-examination of the applicant's witnesses upon the contents of their affidavits. The respondents contended that, having regard to all of the circumstances which were disclosed by Mr Willis' evidence and upon cross-examination of the applicant's witnesses, the Court should refuse to confirm the Issue. In his closing address, Mr A.C. Archibald QC who appeared, with Mr A.F. Mizen, for the respondents, summarised these matters under four headings being "Elements of Insufficiency", "Incorrect Information", "Prejudice", and "Underwriting". I propose to set out immediately below each matter raised under the first two headings and make any necessary factual findings and conclusions of law in respect of each individual matter. I shall deal with the matters of prejudice and underwriting towards the end of these reasons. TDS's objections, that insufficient information was provided to the shareholders and that the discount proposed for the shares in the Issue is too large, can be conveniently subsumed into the respondents' complaints.
A. Elements of Insufficiency
The Kaiser Report
Different Plant Design
It is convenient to deal with both these complaints simultaneously. The Kaiser Report was a feasibility report in relation to the DE project commissioned by the Company and received in May 1994. It was summarised in a letter released to the Australian
Stock Exchange by the Company on 6 May 1994 ("the May 1994 release"). In that letter, the Company stated that the Kaiser Report had shown the DE project to be "... an extremely viable and robust project which on a Low Case model involving a 10,000 tpa plant operating for a minimum life of thirteen years would return an average net profit of $4.5M per annum after tax". The respondents submitted that the Company's own documents showed that the Kaiser Report was fundamentally inaccurate and unreliable by reason of deficiencies in plant design. This had consequential effects impacting on operating costs. I accept that the applicant's documents show that by 11 April 1996 the directors of the Company had come to that conclusion. On 11 November 1996 the Company sued Kaiser in the Supreme Court of Western Australia for damages. The claims were based on breach of contract, negligence, and misleading or deceptive conduct, all arising from engineering services in respect of the proposed DE project and the preparation and some of the contents of the Kaiser Report. The respondents contended that the inaccuracies in and the unreliability of the Kaiser Report and the fact that the Supreme Court writ had been issued should have been disclosed to the shareholders.
I note that in its quarterly report dated 29 April 1996 to the Australian Stock Exchange Ltd, the Company included the following information:
"DIATOMACEOUS EARTH PROJECT
A total of $109,000 was expended on the project during the quarter. Preliminary Engineering work on a revised Processing Plant is being carried out by a firm of US Engineers and will be completed during the current quarter."
I infer that this was a reference to the work which resulted in a different plant design, which forms the subject of the second complaint above.
The shareholders should also have been told, so the respondents contended, that the current plant design for the DE project is different from the design summarised in the May 1994 release. The current design resulted from a report dated 26 April 1996 ("the VRR Report") commissioned by the Company from VRR & Associates Inc ("VRR"). The VRR design was of a plant having a capacity of 12,000 tonnes per annum, not the 10,000 tonnes per annum capacity plant which was the subject of the Kaiser Report.
Section 10 of the Prospectus reported to the Company's shareholders that during the financial year ended 30 June 1996 consulting engineers had undertaken preliminary engineering work for a diatomaceous earth plant. There was reference to preliminary engineering and design studies and discussions taking place with a view to engineers commencing the detailed engineering work for the plant. The question is whether, for the purposes of authorising the Issue, the Company's shareholders should have been told about the deficiencies in the Kaiser Report and the fact that a new design had been developed for the plant. The matter is one of degree. For reasons which I set out below in relation to the matter of "No Feasibility Study", I do not consider that detail of this type had to be provided to the shareholders before they could be said to be fully and fairly informed upon the matter upon which they had to vote. That matter was whether to authorise the issuing of the shares at the discount specified. Whether these details should have been provided to the shareholders to ensure that they had sufficient information to make an informed decision about whether to subscribe for some or all
of their entitlement to additional shares, is not something which I consider that I am required to decide. The applicant has indicated that it proposes to issue a supplementary prospectus dealing with the matter of the revised estimate of the time required for construction of the plant. It is for the directors and their advisors, possibly in consultation with the two principal regulatory bodies, to decide whether any additional information should be provided in the proposed supplementary prospectus.
No Feasibility Study
The applicant's evidence was that no feasibility study of the DE project had been performed. On behalf of the respondents it was said that whether it was necessary to "start from scratch" or modify the previous study, the necessary work had not been done. Until that further work was done, no informed view could be made about the feasibility of the new design. The respondents submitted that the shareholders should have been told about that matter.
The evidence discloses that the existence of diatomaceous earth reserves on the Company's mining tenements in sufficient quantities for large scale production has been confirmed and reconfirmed by numerous independent studies over the last 20 years. That would seem to be the first basic step in assessing the feasibility of "the DE project". The evidence also shows that revised preliminary engineering drawings have been prepared by VRR to reflect their recommended design for a plant to process the product of the mine. The evidence also shows that, apart from the work which led to the preparation of the Kaiser Report, there have been marketing studies over the years including reference to the need to obtain at least letters of intent from proposed
major customers. On the financial front, there is evidence (to which I refer further below) of approaches to financiers to fund the DE project. In my view, it might well have been misleading to give the shareholders the impression that the necessary work has not been done. If reference were made to the need for a further complete feasibility study, it would also have been appropriate to inform the shareholders of all the work that had been done over the years. In my opinion, even without that additional information, to set out the details of how much further work is required in the way of feasibility studies and the like would have shouldered the shareholders with an unnecessary burden of information - see Killen v. Marra Developments Ltd [1979] ACLD 608. Mr Sutton, in cross-examination, made it clear that the Company would not be committed (in the sense of final commitment) to the DE project unless it had all the requisite information. On the question whether the Company should have commissioned complete feasibility studies before seeking shareholder authorisation for the Issue, I have considerable sympathy for the view expressed by Mr Sutton (at p.132):
"At present we have put financial feasibilities and particularly financial feasibilities, on hold until we are able to raise the equity funding, on the basis that if we are unable to raise any further equity funding we don't want to have a liability of several hundred thousand dollars for a project feasibility which won't proceed."
The Site
The applicant's evidence showed that no decision had been made on the site for the plant. In 1994 the only site proposed was at the Company's property at Badgingarra. The shareholders, so the respondents contended, should have been told that this matter was still undecided.
It is true that Mr Sutton's evidence was that the board of directors of the Company has not made a decision on where the proposed plant is to be constructed (see p.82). It may be, that for the purposes of deciding whether to take up their entitlement, the Company's shareholders would require that information, though I have some reservations about that. But I have no hesitation in concluding that for the purposes of authorising the Issue at a discount, it was not necessary for the shareholders to be told that, although the Kaiser Report was based on locating the plant at Badgingarra, no decision had been made.
The Total Cost of the Project
The respondents submitted that no assessment had been made of the total cost of the DE project. The VRR Report contained an estimate of construction costs in the range of $12M to $16M. The respondents identified further costs at paragraph 3.2.11 of their preliminary written submissions. Mr Sutton's evidence was that the Board would not commit the Company to the project until it has a final feasibility study which included all costs. The respondents also submitted that it was insufficient to refer to the cost in the Prospectus as being "approximately $14 million". The shareholders needed this further information about the above range of cost before they could make a rational decision about the Issue. VRR states the figure of $14 million as being accurate to a degree of plus or minus 15%. The range is $11.9 million to $16.1 million. The Prospectus shows that the work undertaken in respect of the plant was "preliminary engineering work". In those circumstances it was in my view sufficient, for the purpose of deciding the matter in hand, to describe the cost as being "approximately $14 million".
Finance
The respondents submitted that the Company has not taken any steps to ascertain currently the availability of external finance for the DE project. The respondents also submitted that the shareholders should have been informed of the "resounding" rejections in 1994 and 1995 of applications for external finance, particularly given a quarterly report furnished by the Company to Australian Stock Exchange Ltd on 28 July 1994 which expressed optimism on the question of finance. I disagree. The evidence suggests that most of the previous approaches for finance had been on the basis of total loan funding. It is clear from Mr Sutton's evidence that the Company intends to use at least half of the nett proceeds of the Issue to fund the DE project. An application on that basis is, in my view, a very different proposition to be taken to the Company's financiers than those which were submitted in previous years. In my opinion there was no need to recite to shareholders the previous, unsuccessful attempts to raise loan funds. Apart from anything else, they could infer that that was the case. Otherwise the main reason for the Issue would not exist.
Forecasts
The respondents contended that some indication of the financial return expected from the DE project was appropriate and necessary. None had been given except a report released to Australian Stock Exchange Ltd on 12 September 1996 which referred to the DE project as being "extremely viable". The respondents described this information as "tainted" because it seemed to represent the conclusions of the Kaiser Report. At the 1996 annual general meeting Mr Sutton had been able to predict a return from the DE project of 25% per annum before tax, to state that the DE project would be profitable
in its first full year of production and that it would be profitable even with 100% debt financing. I accept that the evidence shows that there was such a report and that Mr Sutton made that statement at the annual general meeting. Mr Archibald said that the Company, "being able to go further" on the matter of financial forecasts, should have done so, but did not. Furthermore, it was invidious for those attending the annual general meeting to have the benefit of the information disclosed on that occasion which was not available to other shareholders.
Once again, I do not consider that, for the purpose of deciding whether to authorise the Issue at a discount, it was necessary for the shareholders to be provided with forecasts of this type. Given the preliminary stage of the engineering design, I infer that financial forecasts would probably have been heavily qualified and based on numerous assumptions which would have to be disclosed and explained. There has been considerable discussion on this issue in the context of information to be disclosed in prospectuses - see ASC Release 96/234 "To Forecast Or Not To Forecast" issued on 17 October 1996. The present context is different and I shall not repeat the nature of that difference.
Sales Tax
The respondents contended that the evidence showed that sales tax would, from about the commencement of the current financial year, have a significant impact upon the profitability of the Company's existing operations. Budgets had been redrawn to show losses for the current financial year, but there was nothing to show that this matter had been disclosed to the shareholders. The respondents submitted that this should have been done.
I think that this is a fair summary of the state of the evidence. Mr Sutton's evidence was that the Company hoped to offset this sales tax problem with savings in other departments. Once again, I do not consider that these matters had to be placed before the shareholders before deciding whether to authorise the Issue at a discount.
B. Incorrect Information
Whether Directors were investigating additional sources of funding
Section 2 of the Prospectus stated that the "... directors are investigating additional sources of funding to provide for the balance of the project." Mr Sutton and Mr Teh's evidence showed that no steps of that kind had been taken.
Taken literally, I think that the respondents have a point in this regard. However, it would be obvious to a shareholder reading the prospectus that the directors would have to investigate additional sources of funding. In my view, the statement should be regarded as including a statement of the directors future intentions. So viewed, it is not fair to characterise the statement as incorrect.
Whether a decision had been made to proceed with the DE project
The Prospectus suggested that a decision has been made by the Board of the Company to proceed with the DE project. Mr Sutton's evidence showed, so it was put, that the truth was otherwise. The Board was not committed to proceeding, but needed more information. In my opinion, this depends on how a shareholder would understand the reference to "the DE project". Given the history of the matter and the fact that it was obvious that loan finance had to be arranged, my view is that a shareholder would understand "the DE project" to include all the steps necessary to bring this long-awaited proposal to fruition. This would include proving up reserves (as I have mentioned, this has already been done), design work, securing supply contracts, obtaining loan finance and the like. In my view, the shareholders would understand that the Board's commitment was to do everything reasonably possible to develop the mine, build the plant and bring it into production. My assessment of the evidence is that that is what the Board has decided.
Whether there were financial models showing the viability of the DE project
The Company's release to the Australian Stock Exchange on 12 September 1996 referred to "recently updated financial models" as showing that the DE project was extremely viable. The evidence, so it was submitted, was that there are no such models. That indeed was the case so far as oral evidence was concerned. However, a reading of the extracts from the minutes of directors meetings discloses the following in relation to the meeting of 30 May 1996:
"DE project
P. Sullivan described the draft financial model that has been prepared. The model showed the project to be an attractive one although sensitivity analysis, particularly on sales volumes in the early years of the project, still had to be done.
P. Sullivan reported on this meeting (sic) with Chittering Shire about a possible site at Muchea.
It was agreed to develop the various aspects of the project in-house before considering Phase II of the engineering work and before starting to seriously examine funding of the project."
In final submissions, Mr Archibald stated that the respondents had subpoenaed documents that would answer the description of recently updated financial models, and nothing was produced. I do not think that that is a satisfactory basis for proof of this complaint. In fairness to Mr Archibald, his submission continued along the lines that apart from the non-production of documents, it was plain that nothing has been completed in a way that would allow any conclusion to be reached about feasibility based on the design contained in the VRR Report. I do not consider that that is correct, given the evidence of the Board discussions on 30 May 1996. In those circumstances, I do not think it has been established that the shareholders were given incorrect information in this regard.
The DE Plant's capacity
The Prospectus referred to the proposed plant as having a 12,000-15,000 tonne capacity. The VRR Report was in respect of a 12,000 tonne plant. The respondents contended that if the Company proposed to run the plant constantly above capacity to that extent then the shareholders should have been told this.
Once again, I consider that this matter may perhaps be one which might be considered appropriate to disclose to shareholders deciding whether to take up part or all of their entitlement to the Issue. In my view, whether the plant has a 12,000 or a 15,000 tonne capacity is not a matter upon which the shareholders require information for the purposes of deciding whether to authorise the Issue at a discount.
The time required for construction
The respondents referred to the fact that in the Prospectus (Section 10) the Company
had forecast that the time required for construction of the plant would be between nine and twelve months. The VRR Report indicated a period of eighteen months on a "fast track schedule" or twenty-four months on a conventional schedule. Although the Company was proposing to issue a supplementary prospectus to correct that information, this was, so it was put, too late so far as the vote at the annual general meeting was concerned.
It is true that there is this difference, which the Company proposes to correct by dealing with the matter in a supplementary prospectus. However, I regard the difference between a construction period of 18 months or 24 months as being in the same category as the difference between 12,000 and 15,000 tonnes per annum capacity referred to immediately above.
Reasoning
Is this a scheme (as the Respondents contended) to give the Underwriter control cheaply?
I have reviewed the documentation in evidence relating to the history of the DE project. That discloses that the project has been considered by the Company over approximately two decades. Other companies have expressed interest in the venture over the years. Some of those took options to explore its possibilities. At least one pilot plant was brought into operation. In the end, the various options were allowed to lapse, as did the project. In more recent years, there have been the two reports to which I have referred above, namely the Kaiser Report in 1994 and the VRR Report in May 1996. There is evidence of recent efforts on the Company's part to raise further
funds. I refer to the involvement in the last two years of Macquarie Bank Ltd and its subsidiary and, later, Porter Western Corporate Pty Ltd.
Whether there is an ulterior motive on the part of the Underwriter depends very much upon whether Mr Sutton is a credible witness. He denied that there was such a scheme. Mr Sutton was cross-examined at great length. I found him to be a credible witness. He is a broker of very considerable experience and is obviously very well versed in matters of corporate affairs. Mr Sutton said that the Underwriter had absolutely no interest in bidding for the Company and that its shareholding in the Company was in a portfolio with other strategic holdings. In the commercial world, many an acquirer of shares has disclaimed any interest in a take-over, has referred to his shareholding as a strategic investment but later has launched a bid for control. Mr Sutton was forthright and far from evasive in responding to intensive cross-examination. He is obviously well aware that a combination of the underwriting agreement with shareholders electing not to take up their entitlements may deliver him (through the Underwriter) greater control of the Company without the need for making a full bid or paying a premium for control. I accept his evidence which is, in essence, that this is not the sole or dominant purpose of the proposed Issue. I am not prepared to find such an ulterior motive and I do not do so. However, purpose is not everything. Effect or likely effect must be considered. If the shareholders of the Company wish to maintain the status quo so far as control is concerned, their interests can be protected to a significant extent by imposing a condition that there be a second round of offers to the shareholders. In that regard, I have not ignored the possible impact of such a decision on the underwriting agreement, but I have noted Mr Sutton's
disclaimer.
On behalf of the respondents, there was criticism of Mr Teh's evidence. In my view, much of that criticism was justified. Mr Teh appeared to be evasive and unconvincing in the witness box. His memory did not seem to match his obvious intelligence. However, he may have simply been responding, in a manner which he thought appropriate to the best interests of the Company, to an attack by minority shareholders on the conduct of its board of directors. But nothing given in evidence by Mr Teh persuaded me to disbelieve Mr Sutton's evidence. On the basis of Mr Sutton's evidence I am prepared to find, and I do find, that the Issue is put forward by the Board of Directors bona fide and in the belief that it is in the best commercial interests of the Company. That, in my opinion, is a most important threshold question in an application under s.190. I do not consider that it is the Court's function to form an opinion about whether the Issue is the best course available. It is necessary for the Court to be satisfied, as I am in this matter, that to make a "one for one" issue at a discount is a commercially appropriate course to follow; see Re Wintulichs Pty Ltd (unreported, Federal Court of Australia, Mansfield J, 26 November 1996 Judgment No. 866/96) and the cases there cited (at pp.13-16). The legitimate commercial purposes which I identify are those which the Company's board of directors put forward. The first purpose is to use not less than half the funds raised for the DE project. The second is to provide working capital (which would not necessarily exclude extra working capital required by reason of the development of the DE project). The third purpose is to provide funds for other investments to be identified by the Board. I would like to draw a distinction between identifying the making of a
"one for one" issue at a discount as being a commercially appropriate course [as part of the Court's duty under s.190(3)] and the making of an assessment of the merits of the proposals upon which the applicant proposes to expend the funds raised. I do not see that as generally being part of the Court's function under s.190. If the Court is satisfied that the directors are acting in good faith and that the moneys are being raised for a relevant and legitimate purpose, then judicial concern should, I think, move on to other matters, including prejudice to creditors and shareholders. In suggesting such a reasonably restrictive approach, I have regard to cases such as Harlowe's Nominees Pty Ltd v. Woodside (Lakes Entrance) Oil Co NL (1968) 121 CLR 483 (in particular at p.493). I have noted Mr Archibald's concession on the question whether the Issue was "bona fide in the interests of the Company", at page 12 of these reasons. However, it was a somewhat qualified concession and the Court is obliged to consider the matter independently of any concession.
I now turn to what I consider to be the remaining important considerations in the present matter.
Whether the Issue at a discount may prejudice existing or future creditors?
I have examined the balance sheet of the Company. It seems to be common ground that the Company is in good financial shape. I agree with that assessment. Looking at the working capital, it can be seen that current assets as at 30 June 1996 far exceeded current liabilities. There is evidence that cash on hand has, since balance date, been supplemented by receipt of a dividend of about $1.5 million from the administrator of a major debtor of the Company. This has raised the level of cash held by the
Company to approximately $4 million. There is no evidence that there has been any significant change in the relationship between the level of assets and liabilities whether current or otherwise since balance date. I think it is fair to say that the respondents have scrutinised the affairs of the Company most particularly since the announcement of this Issue. If there had been such evidence, I consider that I am justified in inferring that it would have been placed before the Court. The respondents submitted that there would be prejudice to creditors. They accepted that no creditor was complaining about the Issue. But, so it was contended, pursuit of the Issue "may be calculated to lead to greater risk to creditors". This was because the present "cash buffer" (being a reference to the $4 million cash held by the Company) would be eliminated. I do not think that there is any prejudice to creditors whether present or future in the fact that the Company proposes to make the Issue at a discount. The nominal capital of a company is not as commercially significant as it appears to have been in earlier times. I very much doubt whether creditors pay much attention to the nominal capital of a company nowadays when deciding whether to extend credit. There are so many better indicators of whether a company is likely to pay its debts. I should stress that existing creditors have had the benefit of extensive advertising in accordance with the relevant regulations. No creditor has objected.
Whether the Issue at a discount may prejudice existing or future shareholders?
The respondents submit that the result of the Issue would be a "dilution" in the nett asset backing of the shares which, in the event of a liquidation, would be prejudicial to shareholders. I accept that the evidence shows that there would be such a reduction.
If the Company were placed into liquidation any nett proceeds of realisation after payment of liabilities would be distributed pro rata between the shareholders without regard to how much had been actually paid (as contrasted with deemed to have been paid) in respect of those shares. This would be the case whether the winding-up took place in circumstances of solvency or otherwise. I accept that there appears to be an element of unfairness and prejudice in such a situation. But I have four reasons for holding, as I do, that this objection should not preclude confirmation of the Issue. First, there is no evidence that a winding-up is likely. Secondly, every shareholder is to be given an equal opportunity to participate in the Issue. Thirdly, to the extent that some shareholders may not sell their rights and simply let them lapse, I propose to order a "second round" of offers to be made to all shareholders or their assignees in proportion to their shareholding at the conclusion of the first round. I consider that this course (which was taken by Seaman J in Mallina I) will substantially reduce any risk of prejudice. It will also comply with both the letter and spirit of s.190(2)(d), though I should not be taken as suggesting that that sub-section requires such a course. Fourthly, so far as future shareholders are concerned, I propose to make an order similar to that made by McLelland J in Re "Air North-West" Pty Ltd.
Next, the respondents complained that the Underwriter, as the largest shareholder in the Company, is in a position to obtain a holding in excess of 20% of the issued capital without having to pay a "takeover premium" for control. Mr Sutton acknowledged, in cross-examination, that the Underwriter was likely to obtain at least a further 5% of the issued shares in the Company.
I take into account that the shareholders were given in the Prospectus full particulars of the Underwriter's 19.8% shareholding in the Company and what would happen if there were a partial or total shortfall in subscriptions to the Issue - see section 11.4. In my view, the answer to this complaint is that it lies in the hands of the shareholders to decide whether the Underwriter will be able to move past the 20% threshold. As mentioned above, the shareholders will have two consecutive opportunities to subscribe for shares. Mr Sutton's evidence was given at a time when it was anticipated that there would be only one such round. Furthermore, so far as there is reference to a further 5% of the issued shares being acquired, the Underwriter has always been free to acquire not more than 3% of the voting shares in the Company each six months under s.618 of the Corporations Law. I do not regard this heading of complaint as disclosing prejudice to the shareholders.
Finally, the respondents submitted that no attempt had been made to consider alternative measures to allow the DE project to proceed without any "dilution" of the nett asset backing per share; i.e. without shareholders being required to double their investment or suffer a "dilution" of their proportionate interest. In my opinion, this submission overlooks the long history of the Company's efforts to proceed with the DE project. That history extends over the last 20 years at least. In any event, the decision whether to develop the DE project by way of joint venture, sale upon terms requiring payment of royalties (as was suggested by the respondents) or by the Company itself, was one for the directors. Furthermore, the shareholders passed the resolution authorising the issue by a very substantial majority (71.1%). I think that I may take that factor into account, and I do so, without the risk of any suggestion that
the Court is "rubber-stamping" the proposed Issue. I do not consider that this complaint is a valid one.
Whether the discount is too high?
This was not the main complaint made by the respondents and Mr Rakich. However, it was certainly one of their main complaints. It was said that the material before the Court did not identify any need for the shares to be issued at a discount. Furthermore, the discount was too high when considered in relation to the nett asset backing and nett tangible asset backing of the shares. I have set out the particulars earlier in these reasons (at p.12). The applicant's unchallenged evidence was that during the three months immediately preceding the lodgment of the Prospectus, the highest sale price for the shares was 20.3 cents on 5 August 1996, the lowest was 14 cents on 21 October 1996, the last sale price on 23 October 1996 was 15 cents. It was common ground that the price of the Company shares over the three months to 27 November 1996 was in the range 14 cents to 17.5 cents, with a weighted average of around 15 cents. The evidence of an expert witness called by the applicant, Mr S.J. Scudamore, was to the effect that it would be unlikely that the Issue would be successful at a price in excess of 15 cents. Mr Sutton's evidence was to like effect and I regard him as an expert in the field. In a report dated 31 August 1995 ("the Porter Western Report") Porter Western Corporate Pty Ltd expressed the opinion that a share issue (to fund in part the DE project) would "... need to be priced at a reasonable discount to current market, most probably with attaching options" [see page 126 of Exhibit A12]. The Issue does not involve attaching options. The Company's shares were then being traded at 17 cents. That expert evidence seems to accord very much with common
sense i.e. if one can buy shares at around 15 cents on the market, why pay more by way of subscription for new shares? Mr Willis said that the answer to that question depended upon how many shares were available at a price of 15 cents. He referred me to evidence of sales during the three month period to 27 November 1996 showing a percentage of liquidity during that period of 8.56%. Liquidity, so Mr Willis explained in his report, is the number of shares traded as a percentage of total issued capital. I note that Mr Willis' report showed the liquidity of the Company's shares at 37.53% over the six month period and 78.78% over the twelve month period respectively to 27 November 1996. I appreciate that the respective weighted average price over those periods was 17.6 cents and 19.6 cents. Mr Willis made the point that the Issue was for about 41 million shares. The question is - to what extent would shareholders take up new shares in the Company at a price higher than 15 cents per share when there are sellers in the market at 15 cents and for the last three months 8.56% of the issued shares in the Company have changed hands at a weighted average price of 15.4 cents? There is a certain degree of tension between this particular head of complaint (pricing the shares too cheaply) and the complaint that more shares are likely to fall into the hands of the Underwriter. The higher the price is pitched, so it seems to me, the fewer the number of shares will be subscribed for. The opportunity for shareholders not wishing to take up their entitlement but to sell their rights will be correspondingly diminished. Too unrealistic a price (i.e. a significantly higher price) might be construed by the Australian Securities Commission as an abuse of the exemption for underwriters provided in s.622(3) of the Corporations Law - see NCSC Policy Statement Release 112, endorsed by ASC Policy Statement 61.35. I accept the applicant's evidence that the Issue would not be successful if the shares were priced at
more than 15 cents. I note also (in the Porter Western Report) that on the basis of the Company having accumulated losses of $11.6 million as at 30 June 1994 and a Share Discount Account balance of around $6 million there was a proposal to write off $0.30 per share. I take into account the fact that accumulated losses were reduced by $1,833,938 by 30 June 1996. However, the Porter Western proposal not only bears some degree of similarity of scale to the extent of the proposed discount for the Issue, but provides further insight about the lack of relevance of the par value of the Company's issued shares. It helps to throw into perspective the reality of that part of the Company's capital structure. I appreciate that the market is not always a fair indicator - see, for example Kingston & Anor v. Keprose Pty Ltd (No. 2) (1988) 6 ACLC 111 and Catto v. Ampol Ltd (1989) 7 ACLC 717. But those were somewhat unusual cases with factual circumstances very different to those in the present matter. Furthermore, there is nothing to suggest that information of a character which would enhance the Company's share price has been withheld from the market. I find that the level of discount is justifiable. I now turn to whether there has been demonstrated a need for the Issue.
The VRR Report suggests that the DE plant is likely to cost at least $14 million to construct. The shareholders were told this. They were not told that the range of costs was between $12 million and $16 million, nor were they told that there will need to be provision for some further items of cost including working capital for the new project. However, for present purposes I do not consider that matters. Given the size of those figures and the fact that the Company has $4 million in cash available, it is obvious that if the DE project is to proceed further funds will be required. The Company's
history includes unsuccessful approaches to financiers for loan capital to fund the DE project. In those circumstances, I conclude that if the DE project is to go ahead, the materials before me demonstrate a need for the Issue. I accept Mr Sutton's evidence to the effect that the prospects of raising the balance of loan funds are likely to be enhanced by the fact that shareholders have contributed equity capital to the same end. I appreciate that not all of the new equity funds are earmarked for the DE project.
Whether the shareholders were given sufficient information
The next matter is whether the shareholders of the Company were provided with sufficient information to enable them to make a reasoned decision before the resolution was passed. The respondents and Mr Rakich contend (and this was not really in issue) that the directors of the Company were under a duty to provide this information, being a duty imposed by both the Corporations Law and at common law, as a fiduciary duty.
I take into account the fact that there is a long history concerning the DE project in the affairs of the Company. I have examined the information which has been provided to shareholders either directly via annual reports and the like or through the Australian Stock Exchange. The stream of information started no later than 1974. In that year the Company and its effective co-owner at the time (which happened to be Biala) granted an option to Broken Hill Proprietary Ltd ("BHP") to acquire an interest in the proposed project. BHP explored the relevant tenements and constructed a small wet concentration plant on the site. BHP also constructed a pilot plant which commenced production in May 1975. Although, at BHP's request, the option exercise period was extended, BHP did not exercise that option. In 1980 the Company became the sole
owner, through a subsidiary company, of the relevant tenements. Thereafter, over the years, the diatomaceous earth reserves were proved and confirmed by various third parties who expressed an interest in taking part in the development of the project. These included Pancontinental Mining Ltd in 1987 and Beechboro Holdings Ltd in 1990. Those two companies executed agreements with the Company which I understand to have contained options to acquire an interest in the DE project. The options were not exercised. The Board of the Company had decided in as early as 1980 to develop the DE project and bring it into commercial production. In that year a feasibility study was commissioned from Jacob's Engineering Inc. The annual reports for over 20 years sent to shareholders and the more frequent reports contain many references to the efforts which the Company was making to get the DE project off the ground. I appreciate that many of the shareholders in November 1996 may have had only a recent connection with the Company. However, the reports in recent years contain more frequent references to the DE project and more information about the efforts being made by the Company to advance it.
The following passage from the reasons for judgment of Young J in Devereaux Holdings Ptd Ltd v. Pelsart Resources NL (No. 2) (1985) 9 ACLR 956 at p.958 is most helpful in relation to the assessment of the information put before shareholders:
"... one does not adopt the legalistic approach of a 19th century examiner of titles searching for a base fee nor does one approach the question in what counsel aptly described as a nit-picking way, but one asks what effect will the information provided have on the ordinary shareholder who scans or reads the document quickly, not as a lawyer, but as an ordinary man or woman in commerce or as an ordinary investor. One asks, viewed in such a way, will the information fully and fairly inform and instruct the shareholder about the matter upon which he or she will have to vote?"
I think it is worthwhile to emphasise that the matter upon which the shareholders had to vote, at the annual general meeting on 14 November 1996, was whether to authorise the issue of the above number of shares at a discount. It is not simply whether the Company should raise further equity capital.
While I have some reservations (possibly unfounded) on the question whether the shareholders have been provided with sufficient information to make an informed decision about whether to subscribe for some or all of their entitlement to additional shares, I am satisfied that they had sufficient information before the resolution approving the Issue was passed. In summary, that information included the following:
.the Board of the Company had decided to proceed with the DE project;
.the Board had caused preliminary engineering and design studies to be carried out which indicated that the production plant would cost approximately $14 million to build;
.the Board had decided to raise further equity capital of about $6 million on the basis of a one-for-one issue to existing shareholders;
.those funds would be applied primarily to finance the DE project. By using the word "primarily" the Board conveyed to its shareholders, in my opinion, that at least half of the funds so raised would be thus applied. The balance would be used for working capital and other investments;
.the total funding required for the DE project would exceed the amount raised by the rights Issue and the Board was investigating additional sources of funding to provide the balance needed for the DE project;
.the share price information (see p.11 of the Prospectus) was as I have summarised above in respect of the period to 23 October 1996. It was made sufficiently clear to the shareholders that if the Issue were to be successful the subscription price would need to be at a discount to par which would make it approximately the
current market price.
Bearing in mind that it was only because the proposed Issue was to be at a discount, that the shareholders were called upon to vote on the matter, I consider that they had sufficient information to make the decision whether the Issue should be made at a discount.
Underwriting
The respondents submitted that the evidence showed that there appeared to have been no effort whatsoever to identify the availability of another underwriter. If another underwriter had been identified then, so it was put, the risk of the prejudice referred to above could have been avoided. If there had been evidence that no other underwriter would have agreed to underwrite the Issue, then a case of necessity may well have been made out. There was no suggestion of any endeavour to find an underwriter who would not proceed to control without paying a premium for it. The respondents submitted that the evidence showed that there had been no negotiation of any kind with the Underwriter, in particular in relation to its fee. Mr Archibald said that I should reject Mr Teh's evidence in that regard. Significantly (so far as the Underwriter's interest in this matter is concerned) in his final address Mr Archibald conceded that the respondents did not contend that this was a deliberate plan but simply that it was the natural commercial effect of the arrangements. The respondents also complained that, given the likelihood that the shareholders associated with Mr Teh would exercise their entitlement, the Underwriter was being paid a fee disproportionate to the risk involved. The underwriting fee charged by the Underwriter is 5%. Even Mr Willis (see p.26 of his report) said that a typical underwriting fee for a capital raising such as the Issue
would be in the order of 3% to 6%. Mr Willis calculated the actual fee as being 7.5%. To do this he excluded the shares on offer to Mr Teh and the Underwriter. Mr John William Farey, a director of the Underwriter, swore an affidavit which was admitted into evidence. Mr Farey was not cross-examined upon his affidavit and, after due consideration of his interest in the matter, I accept his evidence. Mr Farey swore that the Underwriter's board of directors considered the fee of 5% to be the market rate for a rights issue for a company of the applicant's standing. He said that the Underwriter was not and is not prepared to underwrite the Issue for a lesser fee. He said, further, that the Underwriter did not take into consideration whether Mr Teh would be taking up his entitlement and that it was difficult to say with any certainty what shares (if any) the Underwriter would be required to take up. Mr Farey concluded his affidavit by pointing to the fact that any shortfall which the Underwriter will be required to subscribe will not be at a discount to actual market value, that the Underwriter has not obtained any benefit or advantage as a result of Mr Sutton's position, and that the underwriting of the Issue was not a "scheme". My assessment is that the underwriting fee is not an excessive one in all the circumstances. I accept Mr Archibald's submission that there does not appear to have been any negotiation in respect of the underwriting fee. I disregard Mr Teh's evidence in that respect. There were hints (see p.31 of Mr Willis' report and paragraph 14 of the respondents' submissions dated 28 November 1996) that the Underwriter may have had access to information concerning the potential future profitability and value of the DE project that has not been disclosed to other shareholders. In my view, the evidence does not bear out that suggestion.
Conclusions
For the above reasons I propose to confirm the proposed Issue, subject to conditions. Those conditions will relate to appropriate notice to be given in the event that the Company makes any further Issue within the next five years and a condition which will give the shareholders two opportunities to take up entitlements. I propose to follow the course taken by French J in Esmeralda in respect of the time in which the shares are to be issued. I will extend that time, under s.190(2)(c) to twelve weeks from today. I will make orders granting leave to the parties and the intervenors to make submissions on the question of costs of the application. I will decide that question on receipt of those submissions and without hearing oral argument.
In view of the concerns which have been expressed by the respondents and Mr Rakich about the information supplied to shareholders, there will also be an order that a copy of the proposed minute of orders which precede the above reasons, and a copy of these reasons, are to be served on the Australian Securities Commission and the Australian Stock Exchange Limited on or before 10 January 1997.
I certify that this and the preceding forty
(40) pages are a true copy of the Reasons for
Judgment of Justice Carr.
Associate:
Date: 24 December 1996
Counsel for the Applicant: Mr P.I. Jooste (with him Mr D.P.Hely)
Solicitors for the Applicant: Hely Edgar
Counsel for the Respondents: Mr A.C.Archibald QC (with him Mr A.F.Mizen)
Solicitors for the Respondents: Alan Mizen
Mr P.B. Rakich appeared, by leave, for the intervenor TDS Investments Pty Ltd
Counsel for Hudson Corporate Pty Ltd, intervening by leave: Mr D.P.Mohen
Solicitors for Hudson Corporate Pty Ltd: Atanaskovic Hartnell
Dates of Hearing: 10-12 December 1996
Date of Judgment: 24 December 1996
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