Zenyth Therapeutics Ltd v Smith
[2006] VSC 436
•15 November 2006
| IN THE SUPREME COURT OF VICTORIA | Not Restricted | |
AT MELBOURNE
COMMERCIAL AND EQUITY DIVISION
No. 8297 of 2006
| ZENYTH THERAPEUTICS LTD | Plaintiff |
| v | |
| DR PETER SMITH | Defendant |
---
JUDGE: | Dodds-Streeton J | |
WHERE HELD: | Melbourne | |
DATE OF HEARING: | 31 October 2006 | |
DATE OF RULING: | 15 November 2006 | |
CASE MAY BE CITED AS: | Zenyth Therapeutics Ltd v Smith | |
MEDIUM NEUTRAL CITATION: | [2006] VSC 436 | |
---
CORPORATIONS – Schemes of arrangement – Share scheme approved – Related option scheme considered not fair, but nevertheless reasonable, by independent expert – All series of options included within single class – Consideration for some series less than independent expert’s valuation – Whether misleading information or inadequate disclosure on option holders’ alternatives – Whether independent expert’s explanation of reasonableness deficient.
---
APPEARANCES: | Counsel | Solicitors |
| For the Plaintiff | Mr N.J. O’Bryan SC Mr S.G.E. McLeish | Minter Ellison |
| For the Defendant | Mr J.G. Santamaria QC Mr C.E. Shaw | ResourcesLaw International |
HER HONOUR:
INTRODUCTION
The plaintiff, Zenyth Therapeutics Ltd (“Zenyth”), by originating process dated 23 August 2006, sought approval of two proposed schemes of arrangement pursuant to s.411(4) of the Corporations Act 2001 (“the Act”). The proposed schemes were, first, a scheme of arrangement between Zenyth and its shareholders (“the share scheme”) and secondly, a scheme of arrangement between Zenyth and its option holders (save for holders of a certain series of options issued in July 2006) (“the option scheme”). The application for approval of the share scheme was unopposed. The application for approval of the option scheme was opposed. In its application made on 31 October 2006 for approval of both schemes, the plaintiff relied on the following affidavits:
the affidavit of Robin Fry sworn 26 October 2006,
the affidavit of Timothy Heughan sworn 26 October 2006,
the affidavit of Terrence Gunn sworn 26 October 2006,
the affidavit of Rodney Dawson sworn 26 October 2006,
the affidavit of Russell Davis, sworn 26 October 2006,
the affidavit of Alberto Colla sworn 26 October 2006,
the affidavit of Alberto Colla sworn 30 October 2006, and
the affidavit of Mr Andrew Nash, sworn 31 October 2006.
On 12 September 2006, I made orders for, inter alia, the convening and holding of the meetings of the shareholders and option holders of Zenyth to consider, and, if thought fit, approve the proposed schemes of arrangements, such meetings to be held on 23 October 2006.
The following affidavits were sworn in support of the application for orders and directions convening the meetings:
the affidavit of Thomas Read sworn 23 August 2006,
the affidavit of Andrew Nash sworn 7 September 2006,
the affidavit of Alberto Colla sworn 7 September 2006,
the affidavit of Alberto Colla sworn 11 September 2006,
the affidavit of Alberto Colla sworn 12 September 2006.
As was apparent from those affidavits and the exhibits thereto, including the Explanatory Booklet (containing the material constituting an explanatory statement and an independent expert’s report), Zenyth is a public company limited by shares and listed on the Australian Stock Exchange. It is a biotechnology company.
THE SHARE SCHEME
On 17 July 2006, Zenyth and CSL Limited (“CSL”) jointly announced that they had entered an agreement pursuant to which CSL proposed to acquire 100% of Zenyth’s issued shares through the share scheme.
Pursuant to the share scheme, Zenyth will merge with CSL, a much larger company, with cash resources of over $500 million. CSL will acquire 100 per cent of the issued shares in Zenyth in return for cash consideration.
The consideration under the share scheme is a payment of 82 cents per share, together with a proposed special distribution in specie of Zenyth's holding of shares in Avexa Limited (“Avexa”), another biotechnology company. A resolution for the approval of the special distribution was ordered to be put at a general meeting of Zenyth to be held on 23 October 2006. Pursuant to the special distribution, the Zenyth shareholders would receive one Avexa share for every six Zenyth shares. That would raise the total consideration under the share scheme to $0.855 for each Zenyth share.
In the Explanatory Booklet, the directors of Zenyth unanimously recommended that the shareholders vote in favour of the share scheme in the absence of a better proposal and noted that no better proposal had been received.
The directors unanimously considered that the expected advantages of the share scheme and the special distribution outweighed the potential disadvantages and risks.
Key reasons for the directors’ recommendation of the share scheme included:
A substantial premium would be obtained over the trading prices of the Zenyth shares prior to the announcement of the CSL acquisition proposal.
The implied value of the total consideration (being 85.5 cents per share) represented a 58% premium to the closing price of Zenyth on 14 July 2006, which was its last traded price prior to the announcement of the CSL acquisition proposal. It also represented a 78% premium to the volume weighted averaged price of Zenyth shares of 48 cents in the one month period to 14 July 2006.
The share scheme consideration provided certainty of value and near certainty of timing, and would be paid approximately four weeks after the date of the share scheme meeting. Zenyth’s most advanced project portfolios were in the preclinical phase and had not yet acquired regulatory approval. The share scheme consideration would offer Zenyth shareholders an immediate and certain return at an attractive premium on projects that would take considerable time to develop. CSL, a considerably large company, would assume all the benefits and risks of the projects and was better placed to absorb any failures.
Further, the independent expert had concluded that (in the absence of a more favourable proposal) the share scheme and the special distribution were in the best interests of Zenyth shareholders.
Although an independent expert’s report was not statutorily required, an independent expert’s report dated 7 September 2006, by Deloitte, was obtained and included in the Explanatory Booklet. The independent expert concluded, inter alia, that in the absence of a more favourable proposal, the share scheme and the special distribution proposed in relation to the Avexa shares were in the best interests of Zenyth shareholders.
The independent expert assessed the fair value of Zenyth shares in the range of 77 to 98 cents. It concluded that the implied value of the total consideration for Zenyth shares as at 4 September 2006 was 85.5 cents, which was just below the mid point of the independent expert's range of valuations. The independent expert stated that, in the absence of a higher offer, the share scheme was fair and reasonable, and in the best interests of shareholders.
The share scheme meeting was held on 23 October 2006. Mr Davis, the Chairman of the meeting, by his affidavit sworn 26 October 2006, deposed that the share scheme meeting was duly convened, that there was a quorum, that the resolution was put, and that Mr Heughan of Computershare, the returning officer, advised that the statutory majorities required by s.411(4)(ii) were secured. More than 75% of the votes cast by members were voted in favour of the share scheme resolution. Thus, 99.97% (over 96 million) of the votes cast by members were in favour of the share scheme, and only 0.03% (about 33,000) of the votes cast were against it. A majority in number of the members present and voting (either in person or by proxy) voted in favour of the share scheme resolution. The total number of members who voted was 868. Of those, 857 (being 98.73%) voted in favour of the share scheme. Eleven members (1.27%) voted against the share scheme.
The general meeting of Zenyth, also held on 23 October 2006, considered and passed the resolution for the special distribution of Avexa shares. Over 96 million votes were cast: 99.97% were voted in favour of the resolution for the special distribution and 0.03% were voted against it.
At the inquiry by Master Efthim pursuant to Rule 16.6 of the Supreme Court (Corporations) Rules held on 27 October 2006, Master Efthim enquired, inter alia, whether the share scheme meeting was duly convened and held, and whether the resolution approving the share scheme was duly passed in accordance with the order convening the meeting. The Master relevantly declared that the resolution in relation to the share scheme was duly passed at the court ordered meeting, and that the share scheme meeting was duly convened and held.
The affidavit of Mr Colla sworn 30 October 2006 exhibited the letter of ASIC dated 30 October 2006 to the plaintiff’s solicitors, Minter Ellison, which stated, under s.411(17)(b) of the Act, that ASIC had no objection to either the share scheme or the option scheme, on the basis that ASIC was satisfied that the schemes had not been proposed for the purpose of enabling any person to avoid the provisions of Chapter 6 of the Corporations Act. The affidavit of Mr Nash sworn 31 October 2006 deposed that all conditions precedent to the share scheme (other than court approval) had been satisfied or waived.
The statutory majorities in relation to the share scheme required by s.411(4)(ii) of the Act were overwhelmingly obtained in relation to the share scheme, the meeting was found to have been convened and held, and the resolution passed, in accordance with the order convening the meeting. ASIC, as stated in its letter dated 30 October 2006, did not oppose the share scheme, the conditions precedent to the share scheme (other than court approval) were waived or satisfied, the directors and the independent expert considered the share scheme to be fair, reasonable and in the best interests of shareholders, and to carry the advantages and benefits adverted to in the Explanatory Booklet, including the Chairman's letter and the independent expert's report.
As the authorities reiterate, the Court, in this context, has a discretion not to approve a scheme, but its role is supervisory. It must be satisfied that there is an absence of oppression and that the scheme is one capable of being accepted by shareholders.[1] Where there is no opposition either from members or from ASIC and no reason to suppose that there has been inadequate disclosure, the Court generally proceeds on the basis that the members are the best judges of their commercial interests.[2] In the present case, I was satisfied that the share scheme should be approved. I made orders accordingly on 31 October 2006.
[1]Re Amcor (2006) 34 ACSR 199; Re Sonodyne International Ltd (1995) 15 ACSR 494.
[2]Re Hudson Conway Ltd (2000) 32 ACSR 657.
THE OPTION SCHEME
In contrast to the share scheme, the option scheme was opposed. Dr Smith, a holder of two series of options, objected to the option scheme. He sought, and was ordered, to be added as a defendant to the proceeding.
The option scheme is directed at ensuring that CSL achieves 100% ownership and control of Zenyth. Relative to the shareholding, the total value of the options is small, ranging between $900,000 to $1.1 million.
The approval of the share scheme is a condition of the option scheme, although the approval of the share scheme was not conditional upon the approval of either the option scheme or the special distribution.
Zenyth, at various dates between 14 November 2001 and 24 February 2006, issued 14 series of options to senior executives and employees. The 14 series of options are the subject of the option scheme.
A further series of options issued on 6 July 2006 to certain senior executives are not subject to the option scheme. The holders of that series undertook to agree to exercise their options and to participate in the share scheme.
The option scheme provides for a payment of cash consideration from Zenyth for the cancellation of each option. The consideration payable by Zenyth varies between $0.01 (one cent) and $0.5196 (51 cents), depending on the issue date, exercise price and expiry date of the various options on issue.
The consideration for the cancellation of the options payable under the option scheme has been calculated by the company using the Black‑Scholes option valuation method. The consideration under the option scheme, and the valuation produced by the company’s application of the Black‑Scholes valuation method, are one and the same.
Although they differ in date of issue, price of exercise and expiry date, the holders of the 14 series of options have been classified as creditors and included in a single class for the purposes of the option scheme.
In the Explanatory Booklet, the directors unanimously recommended that, in the absence of a more favourable proposal, the Zenyth option holders vote in favour of the option scheme.
The key reasons for the unanimous recommendation of the directors were that:
Most options were substantially “out of the money”. That is, the options can be exercised only at a price significantly higher than Zenyth’s share price immediately prior to the announcement of CSL’s acquisition proposal on 17 July 2005 (54 cents) and indeed, for a number of months preceding it.
The option scheme provided immediate value whereas some options may not be exercisable for some time, or not exercisable at all, given their exercise price relative to the price at which the shares were trading prior to the CSL announcement.
The Explanatory Booklet stated that the directors believed that the option scheme consideration was fair and provided immediate compensation for cancellation of the options.
It stated that the consideration (which equated to the value) had been reached by the company selecting the greater of one cent per option or the result obtained by applying the Black‑Scholes option valuation method.
The independent expert also valued the 14 series of options using the Black‑Scholes method. However, the inputs used in applying the Black-Scholes method of option valuation may vary. The independent expert and the company used different inputs. The company used a hypothetical Zenyth share price of 83 cents and assumed a hypothetical share price volatility of 9%. The independent expert used a spot price of 86 cents (compared with Zenyth’s hypothetical share price of 83 cents). It also used a share price volatility of 50% (compared with Zenyth’s hypothetical share price volatility of 9%).
The independent expert’s use of different inputs produced different valuations from the company’s valuations for most of the series of options. For six series, the independent expert produced a lower value than the company’s valuations. For two series, the independent expert reached the same value as the company’s valuations. For the six remaining series, the independent expert produced higher values than the company’s valuations. For those series of options, the option scheme consideration was less than the independent expert’s valuations.
The independent expert stated that “we have used the Black‑Scholes methodology since Zenyth does not pay dividends and whilst vested shares can be exercised at any time, the Black-Scholes model provides the maximum theoretical value for the option. Under option pricing theory, the value of an option is generally maximised by delaying its exercise to the latest possible date (ie maximising the time value).”
The independent expert set out the following table:
The independent expert concluded that “based on the number of options outstanding and the fair market value of each option, the total value of the options is $1.1 million, which compares with the amount being offered by Zenyth under the option scheme of $0.9 million”. There was thus, on the basis of the independent expert’s valuation, a total shortfall of $200,000 in the consideration offered under the option scheme. The independent expert stated that “because the value of the consideration offered for six of the series is less than our assessed valuation, it is our opinion that the option scheme is not fair”.
The company, in the Explanatory Booklet, acknowledged the independent expert’s conclusion that the option scheme was not fair, because for six series of options, the option scheme consideration was less than the independent expert’s assessed value. The company, however, justified its own valuations (which differed from those of the independent expert due to the different inputs, particularly the volatility rate, used in applying the Black‑Scholes method). The Explanatory Booklet stated that the company considered that its hypothetical price of 83 cents fairly represented the prevailing market price of Zenyth shares on the Australian Stock Exchange (reflecting the control premium inherent in the share scheme consideration) between the date of the CSL merger announcement and the date of the Explanatory Booklet. It further stated that the company’s hypothetical share price volatility of 9%, being the historical volatility of the share price since the CSL acquisition proposal was publicly announced, was considered reasonable for the future.
The option holders are senior executives, non‑executive staff and ex‑employees. The independent expert valued:
(a)the total options held by the senior executives at $751,300, compared with the company’s valuation, and consideration under the option scheme, of $695,492;
(b)the total options held by non-executive staff at $120,123, compared with the company’s valuation, and consideration under the option scheme, of $60,032;
(c)the total options held by ex-employees at $176,000, compared with the company’s valuation, and consideration under the option scheme, of $109,785.
Thus, all categories of current and former executives and employees would receive total consideration under the option scheme which was less than the independent expert’s valuation of the categories. Some individual option holders within each category would receive more consideration, while others would receive less consideration under the option scheme than the independent expert’s valuation.
However, the burden of the shortfall between the option scheme consideration and the independent expert’s valuation fell more heavily on the current non‑executive staff and the former employees than it did on the senior executives.
The defendant, Dr Peter Smith, is a former employee. He holds two series of options issued -
(a)on 16 October 2004, exercisable until 16 October 2007, at an exercise price of 84 cents per option; and
(b)on 19 January 2005, exercisable until 19 January 2010 at an exercise price of 84 cents per option.
The options were issued to Dr Smith as part of his remuneration during his employment by Zenyth as its Chief Executive Officer from 17 October 2003 to 20 May 2005, when he resigned. Under the independent expert’s valuation, Dr Smith’s options are valued at $134,000, but the consideration he would receive under the option scheme is $65,400. There is thus a difference of about $68,000.
Although the independent expert considered that the option scheme was not fair, it concluded that it was reasonable, and, on balance, in the best interests of the option holders. In relation to reasonableness, the independent expert referred to ASIC Policy Statement 75, under which an offer is considered reasonable if it is fair or, despite not being fair, but considering other factors, shareholders should accept the offer in the absence of any higher bid before the close of the offer.
The independent expert stated that it had assessed the reasonableness of the share scheme and the option scheme by considering other advantages and disadvantages of the share scheme and the option scheme to shareholders and option holders.
The independent expert concluded, on reasonableness:
“The major disadvantage of the share scheme and the option scheme is that the shareholders and option holders will lose the ability to participate in the large upside potential if a project, or a number of projects, are commercialised.
In our view, this disadvantage is offset by the ability of a shareholder and option holder to realise the current potential in Zenyth’s project pipeline, at a fair value, without undertaking the risks associated with maintaining an interest in the company.
The option scheme as a whole is not fair (as the value of the consideration offered for six of the series is less than our assessed valuation). As all but one series of option holders are receiving a value in excess of the intrinsic value of the options, incorporating an element of time value, and as the option scheme provides an opportunity to realise a value for the options which would otherwise be difficult to achieve, in our view, the option scheme is reasonable.”
In paragraph 8.5, it reiterated:
“In our opinion, the option scheme is not fair but reasonable to option holders and on balance it is in the best interest of the option holders. An individual option holder’s decision in relation to the option scheme may be influenced by his or her particular circumstances. If in doubt the option holder should consult an independent adviser.”
The independent expert, in para 8.4, stated that:
“The option scheme provides option holders with an opportunity to realise a value for their options, the majority of which were ‘out of the money’ prior to the announcement of the proposal. As the options are neither listed on a stock exchange nor assignable/tradeable, in the absence of the option scheme holders of options currently have limited opportunities to realise value for the options.”
The option scheme, for all but one series of options (series 1), provides option holders with a value in excess of the intrinsic value of a Zenyth share implied in the proposal. Intrinsic value represents the excess of the price of a Zenyth share under the proposal over the exercise price of the option. The holders of series 1 options could achieve a better return by exercising their options and participating in the proposal.”
At the option scheme meeting held on 23 October 2006, the resolution for the approval of the option scheme was put and passed. The statutory majorities required by s.411(4)(i) were overwhelmingly obtained. 91.75% of the value of the option holders’ claims ($804,910) was voted in favour of the resolution. 96.97% of the option holders who voted in person or by proxy (32) voted in favour of the option scheme and 3.03% (1) voted against it.
After the vote, the returning officer mistakenly advised the Chairman of the meeting that 31, rather than 32, option holders had voted in favour of the option scheme and he erroneously calculated the percentage voting in favour on the basis of the number of options, rather than the value of the options. The Chairman announced to the meeting the result of the poll conveyed to him by the returning officer. The errors conveyed the impression that the vote in favour of the option scheme was less favourable than it was. After the conclusion of the meeting, the returning officer became aware of the errors made in reporting the results to the meeting.
At the inquiry pursuant to Rule 16.6 of the Supreme Court (Corporations) Rules, Master Efthim, by order dated 27 October 2006, declared that save for the irregularity constituted by the error in reporting the results of the poll to the option scheme meeting, the option scheme meeting was duly convened and held in accordance with the relevant order and the resolution approving the option scheme was duly passed.
All series of options a single class
In the present case, the classification of the holders of the 14 series of options as creditors within a single class was not disputed. The appropriateness of the Black-Scholes method of valuation of the options was also undisputed.
In Re MIA Group Ltd,[3] as in the present case, there were several different series of options with different prices and expiry dates, the consideration for which was calculated according to the Black‑Scholes method. The option holders were treated as creditors and all series of options were included in a single class.
[3](2004) 50 ACSR 29.
Barrett J noted that the consistent approach of relevant authority from the 1980s was to classify option holders as creditors, despite an absence of full argument and varying degrees of judicial reservation. In Re Niagara Mining Ltd,[4] Lee J had disagreed with that approach and expressed the view that option holders should be regarded as “contingent members”. Like Gyles J in Re Kaz Group Ltd,[5] Barrett J chose to follow “the clearly predominant trend”[6] of treating option holders as creditors, noting that “the question of the correct characterisation has never been fully argued upon a contested application”.
[4](2002) 47 ACSR 364.
[5][2004] FCA 986.
[6](2004) 50 ACSR 29 at [2].
Given that the option holders were classified as creditors, Barrett J further noted that “the voting entitlement of each option holder is regarded as commensurate with the amount of the consideration for the acquisition of the particular person’s options under the scheme, that being seen as the ‘amount’ or ‘value’ of the option holder’s ‘claim’ for the purposes of s.411(4)(a)(i)”.[7]
[7]At [10].
Barrett J also approved, provisionally at least, both the inclusion of the different series of options in a single class and the Black‑Scholes method of valuation. His Honour stated:
“[11]The Black-Scholes option pricing method uses a mathematical formula to ascribe a value to an option by reference to a combination of factors including the applicable share price, the option exercise price, the time until option expiry and rates of return for the time being prevailing in the market. For present purposes, its significant feature is that it can be applied, at a particular time, to options having different exercise prices and different expiry dates so as to produce what are argued to be consistent relativities of value.
[12]The description I have just given might be criticized by experts as too simplistic. For present purposes, however, the description is adequate to make me think, first, that its use for pricing purposes (and voting purposes) in the scheme of arrangement context is sufficiently reasonable, at least on a prima facie basis, to allow the proposed scheme in which it plays a part to go forward for optionholders’ consideration on the basis proposed; and, second, that its use in this case as a pricing mechanism militates against any possibility that different strike prices coupled with different deadlines for option exercise equate with different classes of optionholders.
[13]As to the first of these matters, I would say that if anyone should for some reason think that the particular approach to pricing and valuation involves unfairness, it will be possible for the matter to be raised if and when an application for approval of the scheme concerning options comes back before the court. At this point, no such possibility is so discernible as to cause me to hesitate in ordering that the meeting be convened.
[14]In relation to the second matter, that is, the matter of classes, it is always necessary to go back to the question posed by Lord Esher MR in Sovereign Life Assurance Co Ltd v Dodd [1892] 2 QB 573, namely, whether different creditors have ‘different interests’ in the sense that there prevails ‘a different state of facts existing among different creditors which may differently affect their minds and their judgment … ‘. In the present case, consistent and indiscriminate application of the same pricing or valuation methodology to options having different characteristics in terms of exercise price and expiry, being a methodology that has regard to value criteria in one market at one time, should lay to rest any argument that those different characteristics so destroy community of interest as to indicate different classes. The matter is, to my mind, sufficiently clear to make it appropriate that a single meeting of all optionholders be convened on the basis that separate classes do not exist. Any contrary view can be agitated in due course should anyone see fit to raise it.”
Whether information on compulsory acquisition misleading
In the present case, the defendant acknowledged that the statutory majorities had been handsomely obtained at the meeting of option holders on 23 October 2006 and that the meeting was properly convened and held in accordance with the relevant order. It was not contended that the irregularity noted by Master Efthim was relevant.
It was acknowledged ASIC did not oppose the option scheme and that all the conditions precedent to the option scheme, including the approval of the share scheme, had been satisfied or waived.
Dr Smith opposed the option scheme principally on the basis that there was insufficient disclosure in the Explanatory Booklet about the rights of option holders in the event that the share scheme proceeded but the option scheme did not, and their options (or shares obtained by the exercise of those options) were compulsorily acquired. Further, he submitted that the price to be paid was unfair to many of the option holders, including himself.
The defendant’s written submissions stated that the material on compulsory acquisition in the Explanatory Booklet was “misleading by omission. No detail was given to option holders in respect of their rights in the event of a compulsory acquisition – including their entitlement to have their shares acquired at fair value, that value being determined by an independent expert approved by the Australian Securities and Investments Commission.
This omission is critical to the decision making of the option holders. As the material is preserved, the option holders are left with the impression that if they do not accept the scheme, their options or any shares which they obtain from the exercise of those options will in any event be compulsorily acquired. In fact, such acquisition will be at an independently assessed fair market value. That may be a considerably better result for the option holders in the future than what is presently being offered under the scheme. This should have been made clear to the option holders in the Explanatory Booklet if it is material to the making of a decision by an option holder as to whether to agree to the option scheme. It having not been, the scheme should not now be approved.”
At the hearing of the application, Mr Santamaria, senior counsel for the defendant, referred in particular to the following paragraphs of the Explanatory Booklet:
Paragraph 2.6(e) of the Explanatory Booklet states:
If all of the conditions and approvals for the Option Scheme are satisfied or waived (see Section 7 of this Explanatory Booklet), the Option Scheme will bind all persons who are registered as Zenyth Optionholders as at the Option Scheme Record date, including those who do not vote on the Option Scheme and those who vote against it.
Conversely, if all of the conditions and approvals for the Option Scheme are not satisfied or waived (as applicable), Zenyth Optionholders will continue to hold their Options. However, if the Share Scheme becomes Effective, the right of the Optionholder to continue to hold an Option (or any Share issued on exercise of an Option) will be subject to CSL’s power to compulsorily acquire (or cancel) all Options or Shares issued on exercise in accordance with the compulsory acquisition requirements of Chapter 6A of the Corporations Act (see Section 5.3 of this Explanatory Booklet concerning CSL’s intentions in these circumstances.
Paragraph 2.6(b) of the Explanatory Booklet contains other statements to the same effect.
Section 5 of the Explanatory Booklet states:
“Information from CSL.
These intentions are based on the information concerning Zenyth, its business and the general business environment which is known to CSL at the time of the preparation of this Explanatory Booklet …
Final decisions regarding these matters will only be made by CSL in the light of information and circumstances at the relevant time. Accordingly, the statements set out in this section 5.3 are of current intention only, which may change as new information becomes available to CSL or as circumstances change. …
(d)Option Scheme Not Effective
If the Share Scheme becomes effective but the option scheme does not become effective, CSL intends to offer Zenyth optionholders cash in return for the cancellation of their options ( on the same basis as the cash consideration available under the option scheme). Following this process, it is intended that any outstanding Zenyth options will be compulsorily acquired by CSL in accordance with the compulsory acquisition requirements in Chapter 6A of the Corporations Act.”
Mr Santamaria argued that the statements conveyed a sense that opposition to the scheme was futile. It was, he said, incumbent on the proponent of the option scheme to give to the option holders a fair account of what the alternatives were, but it had failed to do so. As such, the overwhelming vote in favour of the option scheme was vitiated, because it was based on misleading information or inadequate disclosure.
Mr Santamaria did not concede that Chapter 6A would entitle CSL to compulsorily acquire the options in the present case. He submitted that the relevant provisions of Chapter 6A were obscure, but because the expanded definition of a “90 per cent holder” in s.664A(2) of the Act would arguably confer rights pursuant to s.664A(3) on CSL, the defendant did not press its objection to the material in the Explanatory Booklet on that ground.
Mr Santamaria submitted that the Explanatory Booklet stated accurately, and a reader would understand, that if the share scheme proceeded but the option scheme did not, the option holders would, in the first instance, retain their options (and might choose, where applicable, to exercise them and obtain shares) although both the options (or the resultant shares) would be held in a de‑listed company. CSL would then offer the option holders, by private treaty, the same consideration which was offered under the option scheme, in return for the cancellation of their options. If an option holder rejected CSL’s private treaty offer, his or her options would then be compulsorily acquired pursuant to Chapter 6A of the Act. Mr Santamaria contended that the Explanatory Booklet thus conveyed the impression that, if the share scheme were implemented, but the option scheme were rejected, the option holders could not hope for any more consideration than was being offered under the option scheme, and that the options would, in any event, be compulsorily acquired.
Mr Santamaria submitted that, by stating that the options would be subject to compulsory acquisition under Chapter 6A, but failing to disclose that a Court could not approve a compulsory acquisition under Chapter 6A unless fair value (as assessed by an independent expert) were offered, the Explanatory Booklet misleadingly omitted information that was material for the purposes of s.411(3) of the Act.
Mr O’Bryan, senior counsel for the plaintiff, contended that the Explanatory Booklet’s statements on what would occur if the option scheme failed were accurate and adequate. The inclusion of any further material would only confuse the readers, given the difficulties posed by the provisions of Chapter 6A and the many different variables and contingencies which applied.
Mr O’Bryan submitted that compulsory acquisition under Chapter 6A applied, as, on a proper analysis, it covered both shares and options. Chapter 6A did not, however, guarantee that option holders would be offered, or receive, a fair value for their options. The statutory procedure required an independent expert’s report as to whether the terms proposed a fair value for the securities within terms of s.667A 1(b). Only if a holder of more than 10% of the securities subject to compulsory acquisition objected would the matter go before the Court. Time limits also applied. Although the Court could not confirm the compulsory acquisition unless the acquirer established that fair value was offered, the acquirer was not obliged to offer an amount which a particular independent expert decided to be a fair value.
Mr O’Bryan further submitted that the methodology for calculating fair value under s.667C of the Act was complex and unusual. The “fair value” pursuant to s.667C was not equivalent to “fair value” determined under the Black‑Scholes method or any other accepted valuation methodology. A calculation of fair value under s.667C would require the valuation of Zenyth as a whole. In the present case, that exercise would be subject to the uncertainties generated by the change of control effected under the share scheme. The valuer would then allocate the value among the classes of issued securities, taking into account various specified factors. The valuation process involved difficulties of interpretation, speculation and uncertainty.
Further, under Chapter 6A, the acquirer was restricted to an identical cash offer to all security holders in the class acquired.
Mr O’Bryan submitted that the provisions of Chapter 6A did not ensure any better outcome in future for the option holders than was available under the option scheme. On the contrary, the rejection of the option scheme would expose the vast majority of option holders who had voted for it to uncertainty, as CSL had not given an unqualified undertaking to offer the same amount as the option scheme consideration by private treaty, but had only expressed a current intention to do so. If CSL did rely on compulsory acquisition under Chapter 6A, the consideration, as determined by a nominated independent valuer, could well be below the current offer under the option scheme.
Mr O’Bryan submitted that the Chapter 6A provisions were so complex and generated so many “twists and turns”, contingencies, variants and uncertainties of outcome, that it was impossible, in the context of the Explanatory Booklet, to convey meaningfully to option holders what the future might hold.
Section 411(3) of the Act provides that the draft explanatory statement must set out “Such information as is prescribed and any other information that is material to the making of a decision by a creditor or a member of the body whether or not to agree to the proposed compromise or arrangement, being information that is within the knowledge of the directors of the body and has not previously been disclosed to the creditors or members of the body.”
The prescribed information for a creditors’ scheme is set out in Part 2 of Schedule 8 of the Corporations Regulations.
In Phosphate Cooperative Co v Shears,[8] Brooking J found that an explanatory statement was misleading in various respects.
[8][1989] VR 665.
His Honour stated:
“The law proceeds on the basis that a member is entitled to consult his own interests and, in considering what is material for the purposes of the explanatory statement or the conduct of the meeting or any purpose relating to the consideration of the arrangement by members, one must always bear this in mind. If the directors, or an expert engaged by them to report, mistakenly forms the view that a certain consideration is not material when in fact it is, that mistake cannot conclude the matter. If a fact would tend to influence a sensible member’s decision on whether the scheme is in his interests, then it is ‘material’ for the purpose of s.316(1)(a)(ii) of the Code.”[9]
[9]At 689.
In Re Pheon Pty Ltd,[10] White J stated:
“What a creditor needs to have is information which bears upon his chances of obtaining a better deal than the one presently being offered under the scheme. The creditor needs to have in his possession sufficient facts to enable him to make a sensible commercial judgment in his own interests whether it is better to go along with the scheme or take his chance of getting say 20¢, 30¢, 40¢, etc in the dollar”.[11]
[10](1986) 4 ACLC 669 at 674.
[11]At 675.
His Honour acknowledged that:
“ … the Court must leave it to the commercial good sense of the creditors to judge what is reasonable in their interest. After all, it is their money which is at stake. However, what is commercially reasonable for them can only be judged after a full appreciation of the relevant facts and a full consideration of what their chances are if another avenue of recoupment, namely, through a winding up, is followed.”[12]
[12]At 676.
In Re Pheon Pty Ltd, the explanatory statement referred to remedies under the principle in Hardoon v Belilios (which enshrines a trustee’s right to an indemnity from the trust property and any beneficiary who is sui juris) as a “possibility” but “by no means settled or clear” and advised creditors to seek their own independent advice on the matter.
White J acknowledged that:
“Although an explanatory statement is a commercial document which does not normally contain legal advice, the reference to Hardoon v Belilios was justified in this case. Nevertheless, the reference was, as will be seen, inadequate and misleading and deflected attention away from other important factual matters requiring disclosure”.[13]
[13]At 671.
His Honour considered that it was insufficient for the explanatory statement “to make a vague and discouraging reference to the principle of Hardoon v Belilios”. He stated:
“The discouraging reference to the principle in Hardoon v Belilios is in itself misleading in what it says and in what it fails to say. It tends to mislead in suggesting that there is any doubt about the validity of that principle. It tends to mislead in failing to give the factual basis upon which a commercial judgement might be made about the value of the liquidator’s indemnity. … Further, by concentrating attention on the principle in Hardoon v Belilios, cl 22 distracted attention away from the equally wide principle permitting, and the equally wide potential basis for, recovery of benefits as sec 120 settlements.”[14]
[14]At 677.
His Honour further stated:
“The explanatory statement should fairly disclose whether [the creditors] have as much or more to gain from the scheme than a winding up. This information must not remain locked in the breasts of those associated with the debtor company or the promoters of the scheme. To use another analogy, the factual cards must not be played close to the chest but laid face upon the table in good lighting conditions. The disclosure policy of the Code appears to be a manifestation of the legislation which insists upon the truth-in‑lending, the truth-in-selling, the truth-in-advertising, the discouragement of insider trading and the like. … The independent scrutiny of the Court should ensure full and fair disclosure of all relevant material for the benefit of the scattered and disorganised creditors whose debts are often for relatively small amounts and who are usually not in a position to discover the truth about any scheme or the prior financial position of a failed company. The legal costs of obtaining the necessary information might well be greater than the crumbs of benefit being offered in the scheme.”[15]
[15]At 682.
In Re Crusader Ltd,[16] Thomas J recognised that in the context of schemes, “the courts are concerned with the notion of a fair picture being presented”.[17] His Honour recognised that where a scheme involved “difficult questions of commercial judgment and matters of degree and conjecture as to future prospects there is room for a range of opinions” and, as such, “perfection is hardly obtainable”.[18]
[16](1995) 13 ACLC 1008.
[17]At 1014.
[18]At 1014.
His Honour adopted the recognition of Black CJ, Van Doussa and Couper JJ in Fraser v NRMA that dealing with every formulation, possibility or contingency could be counter productive and render the document unintelligible. Their Honours stated:
“If every possible formulation of the commercial objective of the proposal, and arguments for and against every theoretical possibility, were set forth the total package of information to members would be likely to confuse rather than to illuminate the issue for decision, even for people having a familiarity with corporate law and commerce. The need to make full and fair disclosure must be tempered by the need to present a document that is intelligible to reasonable members of the class to whom it is directed, and is likely to assist rather than to confuse.”[19]
[19]Fraser & Anor v NRMA Holdings Ltd & Ors (1995) 13 ACLC 132 at 144 per Black CJ, von Doussa and Cooper JJ.
The extent of the disclosure required in any given case is a question of fact. It depends not only on the nature of the scheme,[20] but on the total context in which information is presented or omitted.
[20]Re National Bank Ltd (1966) 1 All ER 1006; (1960) 1 WLR 819.
In the present case, the expert (whose independent status would lend force to its conclusion) considered that six series of options would be acquired at an undervalue through the option scheme, which was consequently not fair. The company disagreed. The option holders were confronted with competing valuations and opinions on the fairness of the scheme. On a fair reading of the Explanatory Booklet, the only alternative to the option scheme was the prospect of an identical offer from CSL by private treaty and, if that were not accepted, subsequent compulsory acquisition, with no suggestion of more generous terms. In my opinion, in such circumstances, it was material for the option holders to know that the compulsory acquisition of their options under Chapter 6A (if objected to by people holding at least 10% of the securities covered by the compulsory acquisition notice) could not be approved by the Court unless they were offered “fair value” within terms of s.667C in the opinion of an independent expert nominated by ASIC; and further, that the acquirer would bear the legal costs of a proper and reasonable objection. Such information would bear on their “chances of obtaining a better deal than the one presently being offered under the scheme”.[21]
[21](1986) 4 ACLC 669 at 674.
While the procedure under Chapter 6A did not ensure any better outcome than that available under the option scheme, and could result in a worse outcome, it afforded a chance of obtaining a better deal than the one being offered under the option scheme.
The opportunity for a full consideration of what the option holders’ chances were under “another avenue of recoupment” did not require the certainty of a better result under Chapter 6A, but simply sufficient information to alert them to the prospect. The information in the Explanatory Booklet was presented in such a way as to indicate that opposition to the option scheme could not produce a different outcome or improve their prospects.
As in Re Pheon Pty Ltd, the reference to compulsory acquisition was discouraging, and misleading in what it failed to say. There was at least a real prospect, although not a certainty, that if the option scheme did not proceed, the options could not be compulsorily acquired other than for consideration estimated as “fair value” by a nominated independent expert. In contrast, under the option scheme, six of the 14 series of options would be acquired for less than the independent expert’s valuation.
While, as Mr O’Bryan contended, Chapter 6A poses problems of construction and imposes limitations, in my opinion, the plaintiff exaggerated the difficulty of distilling an accurate summation of its principal features and potential effect in a form comprehensible to the option holders.
As the authorities emphasise, the option holders or members are dependent upon the propounder’s willingness to “lay the factual cards … face upon the table in good lighting conditions” rather than holding them “close to the chest”. It was not, in my opinion, sufficient, in the context of the present option scheme, simply to advert to the application of compulsory acquisition without including any reference to the principal safeguards of that process. It was not appropriate to leave the option holders to obtain advice about compulsory acquisition at their own initiative and expense, particularly when there was no suggestion that they might gain any advantage. The option holders were not provided with the full information necessary to enable them “to make a sensible commercial judgment in [their] own interests whether it was better to go along with the scheme or take [their] chance.”.[22]
[22][1989] VR 665 at 689.
Under a scheme of arrangement, corporate control and the expropriation of interests may be achieved by means of a considerably smaller majority than that required for a takeover under Chapter 6 of the Act. Full and fair disclosure is essential. Proponents of schemes should adopt a liberal approach when determining the degree of disclosure necessary to fulfil their obligations.
In the present case, the unusual conjunction of circumstances, including the independent expert’s conclusion that the scheme was not fair, combined with the reference to a subsequent identical offer by private treaty followed by compulsory acquisition, necessitated some further explanation of the potential positive application of Chapter 6A. As the disclosure was inadequate, the very large vote in favour of the option scheme is vitiated. CSL’s expressed intention to make an identical offer by private treaty, while not a guarantee, suggests that there would be, in any event, a further opportunity to accept the terms of the option scheme.
Independent Expert’s conclusion that option scheme reasonable – whether confusing or deficient
Mr Santamaria also argued that the independent expert’s explanation of why the option scheme was not fair, but nevertheless reasonable, and on balance in the best interests of option holders, had a tendency to mislead or confuse and failed to accord with the required level of disclosure.
The defendant’s written submissions stated:
“The objector objects to the Court approving the option scheme on the following bases:
(b)The independent expert’s report prepared by Deloitte which is included in the explanatory booklet, has said that the consideration being offered is unfair (in the sense that it does not represent fair value for the options being cancelled) but is none the less reasonable. However, when the Court considers the reasons which are advanced by Deloitte as making the scheme a reasonable one, the Court will see that the reasons are largely incomprehensible and incoherent and to the extent that they are reasons, they are spurious.”
Mr Santamaria contended that the independent expert’s valuation of the options and hence, its conclusion that the option scheme was not fair, were valid. He submitted that the company had selected an unduly short time frame (being the period between the announcement of the proposal and the date of the Explanatory Booklet) for determining the volatility rate. Trading was controlled during that period, as shares would not be purchased at a price above the scheme consideration. According to established criteria, the historical period for measuring volatility should be, to some extent, commensurate with the future term of the options, which, in the present case (for some series) extended to 2012. The independent expert’s selection of a longer time span was preferable, as it was reasonably based on a two year period and took into account the experience of comparable biotechnology companies and the Australian Stock Exchange.
The defendant contended, however, that the independent expert’s conclusion that the option scheme, although not fair, was reasonable and on balance in the best interests of option holders:
(a)was not plainly or sufficiently explained at the level appropriate for the audience;
(b)was unjustifiable and therefore, the option scheme was not, as a matter of substance, reasonable and in the best interests of option holders, as none of the reasons advanced could “really make an offer which is ajudged by Deloitte to be not fair, as the consideration is less than the value of the options, reasonable.”
At the hearing, Mr Santamaria acknowledged that it was not the Court’s legitimate function to determine which, if any, of the competing valuations of the options was correct and, as such, whether the option scheme was not fair. Rather, he contended that, as the documentation hampered, rather than facilitated, the option holders’ choice, the Court should exercise its discretion to decline to approve the option scheme.
The defendant submitted that the independent expert’s explanation of reasonableness was carelessly expressed, failing, at points, to distinguish between share holders and option holders; and, at other points, was unduly dense and difficult to understand.
More particularly, the defendant argued that the independent expert advanced three distinct reasons for why the option scheme was reasonable which were, on analysis, inadequate and unconvincing.
First, the independent expert referred to the fact that most option holders were “out of the money”, in the sense that the exercise price of their options exceeded the market value of the shares. Mr Santamaria contended that because options can usually be exercised at a future date, their value must, of necessity, take account of the fact that the “strike price” might, at some future date, be less than the share price. The fact that that date had not yet arrived could not render reasonable an offer to purchase the options at an undervalue.
Secondly, the independent expert stated the options were not marketable, because they were not transferable. The independent expert, had however, already discounted the value of each option by 30% due to the lack of marketability, in the context of determining their value. In concluding that the option scheme was reasonable, it again relied on the non‑marketability of the options, thus apparently applying that factor twice. As non‑marketability had already been taken into account to reduce the value of the options, the same factor could not render reasonable an offer of consideration which was less than the already discounted value of the options.
Thirdly, the independent expert stated that, for all but one series of options, the option scheme consideration exceeded the intrinsic value of the relevant options. That was a particularly significant factor in the independent expert’s conclusion that the option scheme was reasonable. Mr Santamaria submitted, however, that the independent expert’s explanation of reasonableness, in its totality, was inadequate, because it suggested an association between market value and intrinsic value which did not exist. It ignored the fact that the value of an option existed by reference to the entitlement to exercise it in futuro.
Mr O’Bryan disputed the independent expert’s valuation and its opinion that the option scheme was not fair, but defended its conclusion on reasonableness. He contended that the independent expert’s volatility rate of 50% was clearly untenable, as the share price of Zenyth had stabilised at 82 or 83 cents following the announcement of the share scheme. It was inappropriate, he said, to compare a company with a share price effectively underwritten by a proposed scheme (which incorporated a premium on the share price) with a company in the ordinary course of trade.
Mr O’Bryan submitted that, viewed as a whole, the independent expert’s report was straightforward and its conclusion on the reasonableness of the option scheme reflected a similar factual foundation to that of Re Rancoo Ltd.[23] He argued that fairness was properly confined to questions of value, while reasonableness related to “the overall commercial parameters of the transaction, including particularly, whether there is or is not likely to be a better alternative in another world for the particular security holders.”
[23](1995) 17 ACSR 206.
In Re Rancoo Ltd, an independent expert considered that a selective reduction of capital was not fair but reasonable. The unfairness was constituted by the fact that the expert valued Rancoo “taking account of the fact that it is to sell part of its business to AC Neilson Holdings” and valued its shares after the sale at 17 - 24 cents. However, 35 cents per share was to be paid to the shareholder whose shares were to be cancelled in the reduction of capital. The expert therefore concluded that the reduction was not fair.
The independent expert nevertheless considered the reduction of capital reasonable, having regard to a number of other factors, including the fact that part of the company’s research business was to be sold to a purchaser associated with the shareholder whose shares were to be cancelled, and that the reduction of capital was an integral step in the sale.
The price to be paid by the shareholder in Re Rancoo Ltd was an overvalue, not an undervalue, as in the present case. The shareholder was to receive between $107,250 and $175,500 more than its shares were worth. That was counterbalanced, however, by the expert’s conclusion that the company was receiving considerably (about $1.9 million) more from the shareholder’s associate for its research business than the research business was worth.
In Re Rancoo Ltd, Hayne J referred to ASIC Policy Statement 75 and expressed reservations about the attribution of different meanings to the concepts “fair” and “reasonable”. He acknowledged the difficulty in accepting that an offer which was not fair could still be reasonable.
Hayne J stated:
“Policy statement 75 expresses the views of the commission about the expression “fair and reasonable”. It does so in a way that seeks to attribute different meanings to the words “fair and reasonable”. The policy statement does not treat the expression “fair and reasonable” as a single portmanteau statement conveying a meaning to the listener but, rather, seeks to take each element of the expression and attribute a different meaning to it. Thus, the policy statement expressly contemplates the circumstance that an expert might conclude that a particular offer is not fair but nevertheless is reasonable.
I must say that, for myself, I find the proposition that an offer may be ‘not fair’ and yet still ‘reasonable’ one which presents some difficulty. Perhaps that view stems from the impression I have that the expression ‘fair and reasonable’ is but a single expression intended to convey a single overall meaning which is not to be identified by reference to particular constituent elements.”[24]
[24]At 208.
Hayne J observed that “the net effect of the two transactions is thus, an effect which leads to the overall benefit of the remaining shareholders of Rancoo by a considerable sum, and it is on that basis that the expert concluded that the selective capital reduction is reasonable”. [25]
[25]At 209.
Despite his reservations, Hayne J confirmed the reduction of capital, which was unopposed. He stated that “Thus the reduction that has been proposed is a step that is to be taken, as a part of that overall transaction”.[26]
[26]At 209.
There is great force in Hayne J’s reservations about an offer which, although not fair, is nevertheless reasonable. Although Re Rancoo Ltd constitutes an example of a reduction of capital which was recognised to be such, persuasive applications of the distinction are likely to be rare.
Courts should adopt a cautious approach to the approval of any scheme which the independent expert considers “not fair”, particularly when it may involve expropriation at an undervalue. In my opinion, a scheme involving an offer of an undervalue, which is not fair, should generally not be considered reasonable unless it is accompanied by some positive compensatory feature. The fact that the security holders are unable to exact fair, or better, consideration through any avenue alternative to the scheme would not necessarily render an unfair scheme reasonable in the relevant sense.
In Re Rancoo Ltd, the party whose shares were cancelled received more than their estimated value. In the present case, the holders of six series of options will receive less than their value as estimated by the independent expert. Moreover, the option holder’s scheme is not, as in Re Rancoo Ltd, part of an interconnected “swings and roundabout” process, whereby those deprived of full value for their options (in the expert’s view) will receive a compensating windfall as part of a total series of transactions. There is no apparent overall benefit to the option holders from a related transaction.
The company disputes the independent expert’s valuations and its conclusion that the option scheme is not fair.
The material before the Court does not enable it to determine which of the competing valuations and assessments are valid. The Court cannot, therefore, conclude that the option scheme is not fair. Similarly, the Court is not equipped to evaluate whether the scheme is, if not fair, nevertheless reasonable. Its legitimate role is limited to an assessment of the independent expert’s explanation for its conclusion.
In my opinion, the independent expert’s conclusion that the scheme is reasonable, and in the option holder’s best interests, is not clear or logically compelling. The long term option holders would expect to be “out of the money” and the benefits of a present sale at an undervalue are unclear. The independent expert appears to have taken the non-transferability of the options into account twice, in relation to both the value of the options and the reasonableness of the option scheme, without any explanation. The explanation of why consideration of less than market value is rendered reasonable because it is greater than intrinsic value, is unclear. Further, the independent expert does not consider the potential impact of Chapter 6A of the Act.
In Phosphate Co-Operative Co v Shears[27] Brooking J observed that “generally speaking, the outcome of an application for approval of a scheme of arrangement is not to be determined by whether the judge finds the expert’s report persuasive: whether the report is persuasive is a question for the members. But if the judge takes the view that the report has a tendency to mislead or confuse, then that is another matter.”
[27][1989] VR 665 at 684.
In the present case, the inherent conceptual difficulty of the divorce of reasonableness from fairness is reflected in the independent expert’s reasoning. It is not apparent why the stated reasons render the option scheme reasonable, either in the sense that positive elements of interconnected transactions secure a net benefit compensating for the perceived want of fairness, or in any other established sense applicable in this context.
The deficiencies of the independent expert’s explanation fortify my conclusion that the Court should not, in its discretion, approve the option scheme in its present form.
SPECIAL INTEREST - QUARANTINING OF VOTES
Given the conclusions I have reached, it is unnecessary to consider whether the continuing employment status of some of the option holders constituted a valid basis for quarantining their votes.[28] There was, however, in my opinion, no cogent evidence to support the contention that the continuing employment of certain option holders was such as to constitute a special or divergent interest.
[28]In the Matter of Cheuron (Sydney) Ltd [1963] VR 249.
CONCLUSION
In my opinion, for the reasons set out in detail above, the option scheme should not be approved in its present form. I am prepared, however, to hear any submissions consequent upon that conclusion.[29]
[29]On 17 November 2006, the Court, pursuant to section 411(b) of the Corporations Act (2001) Cth approved the option scheme modified to provide that the consideration payable to each of the option holders was the greater of the valuations of their options determined by the company or the independent expert. On that basis, no option holder received consideration which was less than the valuation of the independent expert.
16
2
0