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Voting Hands. Gazal decision prompts scrutiny of director benefits in schemes.

Gazal decision prompts scrutiny of director benefits in schemes

Authors: Deanna Carpenter, Elizabeth Phillips

Key take-aways

  • Whether a director will be entitled to a bonus or benefit in relation to a scheme should be considered at the outset of drafting a scheme implementation deed.
  • Scheme booklets must include prominent disclosure of any bonuses or benefits directors may receive, however such disclosure will not necessarily cure ‘apprehended bias’ or permit a director to make a recommendation.
  • It appears that all subsequent communications with shareholders, whether by way of announcements or telephone canvassing, must also disclose any bonuses or benefits directors may receive.
  • Directors who are to receive a bonus or benefit which is conditional on the scheme being approved by shareholders:
    • should exercise caution in making recommendations and generally should not do so;
    • should not be appointed as chairpersons of the scheme meeting due to the perception of ‘apprehended bias’; and
    • may still make statements relating to their voting intentions in relation to shares they control.

Re Gazal Corporation Ltd [2019] FCA 701

On 24 May 2019, the decision of Farrell J in the matter of Re Gazal Corporations Ltd [2019] FCA 701 (Gazal) was published. From this decision, novel principles scrutinising the actions of directors who are entitled to receive bonuses and benefits in relation to schemes of arrangement have arisen, discussed further below.

In Gazal, Farrell J assessed the appropriateness of recommendations by directors who have an interest in the ultimate outcome of a scheme. Here, one executive director was to receive a $1.7 million bonus if the scheme became effective.

This bonus payment was disclosed in multiple places within the scheme booklet.

The executive director in question provided a recommendation that shareholders vote in favour of the scheme. Gazal submitted it would be a breach of the scheme implementation agreement for the executive director to refrain from making such a recommendation.

Farrell J noted that ‘Directors who are interested in the outcome of the scheme because they stand to receive a bonus or benefit (other than as a shareholder) only if the scheme proceeds should exercise caution in making recommendations and, in my view, generally should not do so.’

Farrell J suggested that the executive director should have declined to make a recommendation and explained the reason for doing so was that he stood to receive a substantial benefit that other shareholders would not receive. Her Honour further observed that to avoid the circumstance where a scheme implementation agreement requires directors to make a recommendation in situations where they should refrain from doing so, the appropriateness of all directors making a voting recommendation should be considered at the time the agreement is negotiated.

It was noted however, that these comments do not preclude directors with clear pecuniary incentives in the scheme proceeding from making statements in relation to what their own voting intentions might be with respect to shares they control.

Farrell J cautioned that although the scheme in Gazal was ultimately approved, this is not to be considered the necessary outcome in all cases where an interested director makes a recommendation.

Re Nzuri Copper Ltd [2019] WASC 189

Vaughan J considered the application of Gazal in Re Nzuri Copper Ltd [2019] WASC 189 (Nzuri) on 29 May 2019 and also closely scrutinized the bonuses payable to certain directors.

In Nzuri, Vaughan J declined to make an order that the executive directors of the company be appointed as chairperson (and alternate) of the proposed scheme meeting because the ‘test for apprehended bias is an objective test of possibility as distinct probability.’

The two executive directors of Nzuri would obtain bonus payments should the scheme of arrangement be approved by Nzuri shareholders in the amount of $240,000 each under ‘change of control’ provisions within their executive services agreements.

This benefit was disclosed prominently in the scheme booklet in multiple places.

Despite this disclosure and Vaughan J remarking that ‘there is nothing to suggest that [the executive directors] have been or will be influenced by the collateral benefit’ he noted that there was still an issue of ‘perception.’

Vaughan J also referred to Farrell J’s observations in Gazal and agreed with her Honour’s concerns regarding recommendations by directors receiving a bonus or benefit as a result of a scheme. However, despite the executive directors in Nzuri making recommendations in the scheme booklet, Vaughan J granted the orders to convene the scheme meeting on the basis that the benefits:

  • were not out of the ordinary and within the scope of what might be considered commercially not unreasonable i.e. one year’s salary;
  • arose under pre-existing contracts executed well before the scheme implementation deed;
  • linked to the possibility that their employment might be terminated upon the scheme becoming effective (without notice or payment in lieu of notice) and therefore there is a not unreasonable commercial rationale for the payment; and
  • were the subject of fulsome and prominent disclosure in the scheme booklet.

His Honour noted that Nzuri entered into the scheme implementation deed well before the Gazal decision, so it is uncertain whether future post-Gazal schemes would adopt the reasoning in Nzuri.

Ruralco Holdings Limited [2019] FCA 878

On 5 June 2019, Farrell J again considered these issues in Ruralco Holdings Limited [2019] FCA 878 (Ruralco).

In this scheme, one of the executive directors stood to receive a cash payment of approximately $2.46 million upon the scheme becoming effective.

This interest was disclosed in multiple places in the scheme booklet.

Ruralco sought to distinguish the payments to be made to the executive director from the bonus payments in Gazal on the basis that the Ruralco payments were pursuant to an executive performance plan and not made by virtue of and to incentivise the recipient to work towards a scheme becoming effective. Farrell J did not accept this reasoning, as the proposed payments were nevertheless dependent on the shareholders voting in favour of the scheme and had an incentive effect supportive of the scheme.

The orders to convene the scheme meeting were nonetheless made as there was disclosure of this payment throughout the scheme booklet in every place were the recommendations of the directors were mentioned (save for on the front cover).

Significantly, Farrell J  noted that while the scheme booklet had been approved for dispatch, any bare statement of the director’s recommendation (i.e. without disclosure of the executive director’s interest) in other communications with shareholders such as telephone canvassing may be a circumstance which could lead a court at the second court hearing to decline to approve the scheme if the court could not be assured of the integrity of the outcome of the shareholder vote.

Navitas Ltd [No 2] [2019] WASC 218

Most recently, on 21 June 2019, Vaughan J heard an application for final approval of the scheme of Navitas.

The Navitas board of directors had approved one-off special exertion fees to be paid to the non-executive directors as a result of the increased and sustained workload and time commitment required of the non-executive directors in connection with the scheme. These fees were not conditional on the scheme being implemented, and would be payable prior to the implementation of the scheme. The amounts were determined using time-based methodology and had regard to, amongst other things, advice obtained from an independent board remuneration and governance consultant.

The entitlement to special exertion fees was clearly disclosed in the scheme booklet.

His Honour concluded that the special exertion fees did not raise a concern in this matter, as the fees were not conditional on the scheme proceeding. There was therefore no inducement operating to incentivise the non-executive directors to support the scheme.

Separately, a $750,000 payment to Navitas’ managing director would be accelerated if the scheme was approved by shareholders. This entitlement was also disclosed in the scheme booklet. Vaughan J ultimately concluded that although ‘a question did arise’ as to the managing director joining the board’s recommendation of the transaction given this interest, it was not a sufficient reason to decline to approve the scheme. His Honour noted that:

  • the interest was properly disclosed;
  • there was reasonable commercial rationale for the benefit; and
  • the managing director was one of six directors, no other director stood to receive a similar benefit, and shareholders were likely to have given weight to the collective recommendation of the directors rather than the fact that the managing director had provided a recommendation.

Concluding remarks

The Corporations Regulations require that scheme booklets include a statement outlining whether each director recommends the acceptance of the scheme or recommends against acceptance and, in either case, his or her reasons for this recommendation. Alternatively, a director may decline to make a recommendation or consider that they are not justified in making a recommendation. In that case, the director must explain his or her reasons for not making a recommendation.

In our experience, shareholders apply considerable weight to a unanimous board recommendation, and it is unusual for directors to decline to make a recommendation unless there is a clear conflict of interest. Such a conflict may include a target director also sitting on the board of the bidder, or being a substantial shareholder of the bidder.

A successful control transaction will commonly have the consequence of delivering value to shareholders, while doing the target directors out of a job. It is common for directors, particularly executive directors, to be compensated in some manner for driving the company to a successful control transaction. Such compensation often takes the form of a bonus payment or accelerated vesting of incentive securities. It has also been standard market practice, at least in Western Australia, for such directors to not decline from making a recommendation to shareholders by reason of such compensation. Of course, should the directors conclude that such compensation constitutes a ‘material personal interest’, the relevant director must not attend or vote at board meetings where the transaction is being considered, unless the other directors have passed a resolution permitting the director to attend and vote.

We consider that whether any bonus payments or other compensation constitutes an interest that ought to preclude a director from making a recommendation should be considered on its facts, and on a case by case basis, rather than as an overall principle. An interest that the board has concluded does not constitute a ‘material personal interest’ ought not, in our view, preclude the director from making a public recommendation of the transaction. Further, a director having a personal interest in a transaction does not absolve them of their duty to act in the best interests of the company as a whole.

It is important for target shareholders to be aware of any potential bonus payments due to directors in connection with a control transaction. We believe it is appropriate for such disclosure must be clearly and prominently disclosed in the scheme booklet, such as in the chairperson’s letter and the key information sections towards the front of the booklet.

While these recent decisions relate only to schemes of arrangements and there has been no indication whether these principles would apply to other types of transactions, it may only be a matter of time before regulatory authorities consider applying such principles in the contexts of other types of control transactions such as takeovers.

This is an area of law that should be closely monitored as it is likely to continue to develop in future judgements.

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