Australia: The Village Roadshow Scheme – Problems And Pitfalls

Village Roadshow Limited’s (VRL) attempt to buy-back all its preference shares by scheme of arrangement has given rise to a series of interesting court cases and an application to the Takeovers Panel. This newsletter comments on several important aspects to emerge from the story: the importance of correctly determining voting entitlements and of correctly responding to notices intended to uncover the ultimate controllers of shares.

VRL’s issued capital included a roughly equal number of ordinary shares and preference shares. The preference shares conferred typical voting rights (ie they only conferred a vote in limited circumstances, including when dividends are in arrears, on a capital reduction or on a variation of rights). VRL proposed that it would buy-back all of the preference shares under a scheme of arrangement.

The legislation required that the terms of the buy-back must be approved by ‘a special resolution passed at a general meeting of the company, with no votes being cast in favour of the resolution by any person whose shares are proposed to be bought back or by their associates’.

In its notice of meeting, VRL stated that only ordinary shareholders were entitled to vote and further stated that ordinary shareholders who also held preference shares were not entitled to vote for or against the resolution. Prior to the meeting, concerns were raised that this was incorrect and that many shareholders were being disenfranchised from their right to vote against the resolution. Nevertheless, VRL proceeded with the meetings and the resolution was passed on that basis.

Before Justice Mandie in the Supreme Court of Victoria, Boswell Filmgesellschaft mbH, a small holder of VRL shares, objected to the proposal. Justice Mandie largely agreed with Boswell’s objections and rejected the scheme on the basis that:

• VRL had incorrectly prohibited ordinary shareholders who also held preference shares from voting against the resolution: ‘The words mean what they say, and it is only votes in favour of the buy-back resolution which may not be cast.’

• The selective buy-back resolution had also enlivened the voting rights of the preference shares to vote against the resolution at the general meeting, but this was not stated in the notice of meeting. The voting rights of the preference shares had been enlivened because the buy-back resolution constituted either a proposal to reduce the share capital of VRL (this appears clear on the facts) or a proposal that affects rights attaching to the preference shares. (In reaching this view, Justice Mandie distinguished a number of accepted case precedents, and has arguably shifted the position in this area of the law. There is some debate as to whether this finding was correct.)

VRL announced it would appeal the decision but meanwhile proceed with a second scheme which addressed these points.

The scheme vote was supported by the requisite 75 per cent majority of preference holders as a class. However, with preference shareholders able to vote against (but not in favour of) the buy-back resolution, the general meeting vote required to approve the buy-back failed to achieve the required vote of 75 per cent, falling approximately three per cent short.

VRL, in an attempt to resuscitate the second scheme, made an application to the Takeovers Panel alleging unacceptable circumstances due to the failure of various parties (who voted against the scheme) to properly respond to beneficial tracing notices. VRL submitted that those parties were associates of one another and that their failure to respond to the tracing notices led to the market being uninformed.

VRL sought an order that the poll on the buy-back resolution be reconducted with the persons who had failed to respond to the tracing notices prohibited from voting. Given the shareholdings involved, such an order would likely have resulted in the resolution being passed.

The first issue the Panel needed to determine was jurisdictional—should it hear the matter given that the scheme process was currently before the courts? Continuing its historical willingness to enter into the fray, the Panel determined that it would hear the matter.

The Panel then decided that three parties, Schroders, Swiss First and 001Invest World Currency Fund Ltd, representing 6.57 per cent, 2.05 per cent and 1.56 per cent respectively of the ordinary shares in VRL, had failed to properly respond to the tracing notices, and that their failure constituted ‘unacceptable circumstances’. However, the Panel was not prepared to upset the buy-back vote as no nexus could be shown between the failure to respond to the tracing notices and the outcome of the vote. VRL could not establish that the vote would have been different had VRL received proper responses to the tracing notices.

The Panel, however, did make an order against the three parties who failed to respond to the tracing notices. The Panel ordered that their ordinary shares be vested in ASIC and sold. While this appears to be quite a severe order, it is not altogether surprising given the on-going failure of the parties to come forward and make full disclosure.

In making the order, the Panel, despite not concluding that any parties had acted in concert, has seemingly treated the three non-disclosing parties as if they were acting in concert, in assessing the appropriate order against each of the three parties. The Panel was concerned that ‘the shares to which this non-disclosure relates constitute approximately 10.2 per cent of the total number of ordinary VRL shares on issue and represents a substantial proportion of the free float’.

So while the failures by each of the three parties is individual, in assessing the harm caused the Panel grouped the parties together. Take, for example, 001Invest World Currency Fund Ltd, with just 1.56 per cent of the ordinary shares in VRL. Should the failure by that party be taken to be so acute, and so potentially damaging on the market, as to justify that party’s shares being divested? It is interesting to consider this question given the normal practice by listed companies is not to release the responses received to these tracing notices, and that substantial holder notices need not be lodged until a five per cent interest is achieved. There is a genuine possibility that VRL would not have disclosed the results of the tracing notices to the market had it received them, leaving the market unchanged. The Panel’s decision clearly demonstrates that a failure to comply with the beneficial tracing notice provisions of the Corporations Act can have real and significant consequences.

VRL’s appeal against Justice Mandie’s decision was rejected by the Court of Appeal. The court concurred with Justice Mandie’s view that the buy-back constituted a ‘proposal to reduce the capital of the company’. The court did not consider whether Justice Mandie was correct in determining that the buy-back resolution was a ‘proposal that affects rights attaching to the preference shares’.

• The prohibition against participating shareholders voting in favour of a selective buy-back (or capital reduction) means that, unless there is a significant shareholder able to vote in favour, dissident shareholders will have a great deal of leverage over the proposal. In these circumstances, selective capital reductions and buy-backs may, depending on the facts, be less suited to minority buy-outs compared to mechanisms which entitle all shareholders to vote or accept in support of the proposal, such as a normal transfer scheme or takeover bid.

• Companies must ensure voting entitlements are correctly determined and communicated to shareholders when conducting shareholder meetings.

• Investors should be aware that failure to respond to beneficial tracing notices could lead to a divestment of shares, particularly if their non-compliance happens to coincide with noncompliance by other investors.