Interest Classes in Schemes of Arrangement

Published 1 October 2016

Introduction

Schemes of arrangement under Part 15 of the Companies Act 1993 (“schemes”) are statutory Court-approved procedures that allow for the reorganisation of the rights and obligations of shareholders and companies. Section 236A, which was inserted into the Companies Act in July 2014, requires that the Panel be notified of a proposed scheme that would affect voting rights of a Code company, and provides for the Panel’s involvement before final orders are sought from the Court. In most cases, scheme applicants seek from the Panel a no-objection statement for the applicant to provide to the Court.[1]

The Panel views schemes as a legitimate and valuable means for undertaking corporate transactions in New Zealand. The Panel’s approach to schemes is set out in its Guidance Note on Schemes of Arrangement and Amalgamations. Since July 2014, the Panel has been involved with five schemes. This article outlines developments in relation to determining “interest classes” for schemes involving Code companies.

Interest Classes: Section 236A and Schedule 10

In order for a proposed scheme which affects the voting rights of a Code company to be approved by the Court, section 236A of the Companies Act requires that the proposed scheme is approved in accordance with section 236A(4) by:

(a) a resolution approved by a majority of 75% of the votes of the shareholders in each interest class entitled to vote and voting on the question; and

(b) a resolution approved by a simple majority of the votes of those shareholders entitled to vote.

This means that each interest class has to meet the paragraph (a) threshold for the scheme to be able to be approved by the Court. For this reason, the scheme applicants will usually desire to have fewer interest classes.

Section 236A(5) states that interest classes may be determined in accordance with the principles set out in Schedule 10 of the Act. This requires an assessment of whether there are separate interest classes, and how they should be determined.

Schedule 10 provides that:

“…an interest class may be determined in accordance with the following principles:

(a) shareholders whose rights are so dissimilar that they cannot sensibly consult together about a common interest are in different interest classes:

(b) shareholders whose rights are sufficiently similar that they can consult together about a common interest are in the same interest class:

(c) the issue is similarity and dissimilarity of shareholders’ legal rights against the company (not similarity or dissimilarity of any interest not derived from legal rights against the company):

(d) if the rights of different shareholders will be different under a proposed arrangement or amalgamation, then those shareholders are in different interest classes.”

The Panel’s position on interest classes is illustrated below.

New Zealand Oil & Gas Limited

In November 2014, New Zealand Oil & Gas Limited (“NZOG”) made an application for an order from the Court for approval of a proposed scheme. The Court considered whether interest classes should be determined according to section 116 of the Act.[2] Section 116 sets out the “meaning of classes and interest groups”, and was interpreted by NZOG as an alternative to the “permissive” terminology of Schedule 10.[3] The Panel made submissions to the Court on this matter.

Although the interest classes, as determined by NZOG under section 116, would not have been different had they been determined under Schedule 10, the Court agreed with submissions from the Panel that the provisions of Schedule 10 are to be treated as requiring a “mandatory form of consideration”[4] when determining the interest classes of shareholders for the purpose of section 236A. Section 116 provides for “interest groups” and not interest classes, and Schedule 10 should be applied for the purpose of determining interest classes for a Code company in a scheme.

Michael Hill International Limited

Michael Hill International Limited (“MHI”) was a New Zealand registered company, and was listed on the NZX. In early 2016, MHI was proposing to re-domicile to Australia. This was to occur by way of two interdependent transactions:

(a) an acquisition under rule 7(c) of the Takeovers Code by a new Australian-incorporated company (“ListCo”) of all the shares in Durante Holdings Pty Limited (“Durante”), the holding company of the Hill family interests in MHI, in exchange for shares in ListCo; and

(b) a scheme of arrangement.

The scheme would involve ListCo acquiring from each of MHI’s shareholders (excluding Durante) all of their shares in MHI in exchange for shares in ListCo. Each shareholder would be issued the same number of shares in ListCo as they held in MHI (the “scheme share swap”).

MHI wished to settle with the Panel the interest classes for the purposes of the scheme. In MHI’s view, there were two interest classes.

It was clear that Durante was to be in a separate interest class for the purposes of the scheme, because Durante was not a participant in the scheme (i.e., because Durante’s share swap was to occur under the Takeovers Code). The question for the Panel was whether the remaining shareholders should vote in a single interest class, (being the “non-Durante shareholders”), or in two interest classes – one being non-Durante shareholders who would participate in the scheme share swap, and the other being non-Durante shareholders (based in certain overseas jurisdictions) who would not participate in the scheme share swap (the “excluded shareholders”).

The scheme share swap was to be conducted as follows:

(a) the proposed share swap would be available to any shareholder in respect of whom ListCo was satisfied that ListCo shares may lawfully be issued and allotted to the relevant shareholder without registration of a full prospectus;[5]

(b) the excluded shareholders would have those ListCo shares which would otherwise have been issued to them, issued and allotted instead to a nominee, with a direction to sell the relevant shares;[6]

(c) the nominee would hold those shares for the excluded shareholders and would be bound to sell those shares in an orderly manner over the month following the implementation of the scheme;

(d) the excluded shareholders would be entitled to the gross proceeds of the sale of their ListCo shares; and

(e) the costs of the sale would be met by MHI.

In summary, because of the difficulties of implementing the share swap in a number of different regulatory environments, varying according to where each shareholder resided, MHI had proposed that the shares held by excluded shareholders were to be sold. In return, those shareholders would receive the market price for the shares, with the goal of their being in a position whereby they could, if they wished, immediately acquire shares in ListCo without additional cost.

The Panel considered whether the non-Durante shareholders and the excluded shareholders could be in the same interest class by assessment of each principle of Schedule 10 of the Companies Act:

(a) Shareholders whose rights are so dissimilar that they cannot sensibly consult together
One of the reasons the Panel grants exemptions for financial products (“scrip”) as the consideration for a takeover offer is that the nominee process required by the conditions of the exemption ensures that the consideration offered is economically equivalent for all shareholders. By using a similar nominee process for the proposed scheme, all of the non-Durante shareholders (including the excluded shareholders) were to receive either ListCo shares or the cash equivalent. This meant that their rights were not so dissimilar that they could not sensibly consult together with a view to their common interest. 

(b) Shareholders whose rights are sufficiently similar that they can consult together
In this case, because there were only two interest classes, this principle is effectively the converse of principle (a). The Panel considered that the rights of the non-Durante shareholders and excluded shareholders were sufficiently similar because each were offered economically equivalent consideration. 

(c) Similarity and dissimilarity of shareholders’ legal rights against the company
This principle makes it clear that it is not rights (or commercial interests) as amongst shareholders that must be weighed up for the purposes of determining interest classes, but rather the shareholders’ legal rights as against the company the subject of the scheme. In this case, the legal rights of each non-Durante shareholder as against MHI were the same, because MHI was responsible for ensuring that ListCo issued shares in itself to either the non-Durante shareholders or to the nominee.

(d) Different rights of different shareholders
On its face, this principle provides that shareholders’ rights must be ‘not different’ in order to form one interest class. For this fourth principle to fit consistently with the previous three principles and the common law, an element of materiality must be involved in the assessment. Accordingly, adopting a purposive interpretation of Schedule 10 means that a materiality threshold must be implied in the concept of ‘different rights’. Otherwise, additional interest classes would be required for immaterial differences in rights as between shareholders.

The legal rights of the non-Durante shareholders participating in the scheme share swap were not materially different from those of the excluded shareholders, and vice versa.

In the High Court’s first hearing in respect of the scheme on 24 May 2016, Asher J had to consider whether the excluded shareholders should be treated as a separate interest class from the other non-Durante shareholders, for the purposes of the scheme.

In line with the Panel’s preliminary determination of two interest classes, Asher J approvingly cited the expansive approach taken by the Australian courts in Hills Motorway Ltd,[7] and held that

“while there will be a definite point of distinction between those shareholders who can swap shares and those who cannot, the overriding issue to be determined at the upcoming meeting will be whether the change of domicile is in the shareholders’ interests. To that extent all the shareholders [excluding Durante] will have a relative commonality of interest.”[8]

On that basis, Asher J determined that the excluded shareholders would not form a separate interest class from the other non-Durante shareholders.

Scott Technology Limited

In October 2015 the Panel considered a scheme of arrangement involving Scott Technology Limited (“Scott”) and JBS Australia Pty Limited (“JBS”), an Australian meat processing company and subsidiary of JBS SA (the “scheme”). The scheme included a rights issue undertaken by Scott, in which all New Zealand-resident shareholders would be entitled to subscribe for new Scott shares.

The Panel considered that there were two interest classes for the purpose of the scheme, because overseas shareholders could not participate in the rights issue. There was no process equivalent to the nominee process described above to give them economically equivalent rights to New Zealand shareholders. The rights of the New Zealand shareholders and the overseas shareholders were therefore so dissimilar that they could not sensibly consult together.

Conclusion

One of the factors that the Panel considers when deciding whether to provide a no-objection statement for a scheme is whether the applicant has adequately identified the interest classes.

Applicants must apply the principles of Schedule 10 of the Companies Act in making this assessment. Schedule 10 requires consideration of the legal rights of shareholders as against the Code company, and an assessment of similarity and dissimilarity of those rights.

In the context of a scheme involving scrip, the use of a nominee process, such as that utilised in the MHI scheme, which places excluded shareholders in effectively the same economic position vis-à-vis the Code company as non-excluded shareholders, may help to reduce the number of interest classes in the scheme.

Footnotes:

[1] A no-objection statement from the Panel indicates to the Court that the Panel has no-objection to the scheme, based on the information given to the Panel by the applicant and having regard to the Panel’s Guidance Note on Schemes of Arrangement and Amalgamations.

[2] New Zealand Oil & Gas Limited [2015] NZHC 39

[3] Ibid at [17].

[4] Ibid at [18].

[5] The term ‘prospectus’ is used generically to describe any similar such disclosure document

[6] It was understood that the excluded shareholders would amount to around 50 shareholders (some of whom held fewer than 10,000 shares) who had addresses outside Australasia.

[7] [2002] NSWSC 897, (2001) 43 ACSR 101.

[8] Michael Hill International Limited [2016] NZHC 1114 [24 May 2016] at [11].