“Tell him he’s dreamin’!” - Court declines to approve shareholder-approved scheme of arrangement

In a recent decision, the Supreme Court of Queensland has declined to approve a novel scheme of arrangement, despite it being approved by the requisite statutory majority. In this article, we consider the issues explored by the decision.

In brief

• A scheme of arrangement is an extremely versatile legal process capable of solving a wide variety of corporate issues (not just effecting takeovers) including demutualisations, demergers, reconstructions, amalgamations, creditor compromises and settling claims.
• Even if a scheme is approved by the requisite majority of shareholders or creditors (as applicable), it remains open to the Court to decline to approve it. Courts have stressed that they will not act as a rubber stamp.
• In the recent White Horses decision, the Court refused to approve a novel scheme of arrangement that would otherwise have resulted in the sale of the land owned by a home unit company due to the failure of the scheme company to comply with the variation of class rights procedure.

Background

In Re White Horses Pty Ltd (No 2) [2016] QSC 282, the Supreme Court of Queensland has declined to approve a scheme of arrangement, even though it was approved by the statutory majority of shareholders and was, in the view of the Court, fair and reasonable, not oppressive and not inconsistent with public policy.

The scheme company, White Horses Pty Ltd, was a home unit company. It owned land on which a low rise building containing 49 home units was situated. The 49 home unit owners held all of the shares in the company. The right of occupation for each home unit was provided for in the constitution and was supported by a lease between the company and each shareholder. 

The board of directors of White Horses formed the view that the building was at serious risk of dilapidation and had reached the end of its commercial life. Very substantial expenditure would be required to return the building to a safe state.

In light of the above, the directors proposed a scheme of arrangement under which White Horses would be authorised to sell the land to a developer and to surrender the leases attached to each home unit owner’s shares in White Horses. In exchange, the purchase price paid to White Horses by the developer would be distributed among the shareholders, with the company later being wound up.

Ten home unit owners (who held just 9% of the shares) voted against the scheme of arrangement and six of them appeared at the final court hearing and successfully objected to the scheme.

The issue

The White Horses constitution provided that, although resolutions at general meetings could be passed and adopted by a simple majority, resolutions regarding the sale of the land on which the building was situated had to be approved by a resolution passed “without dissent”.

In the face of a group of dissenting shareholders who were against the proposed sale, the directors sought to effect the sale by way of a scheme of arrangement (which does not require unanimity).

Classes – two different tests

A little confusingly, the “class test” for the purposes of a scheme of arrangement differs from the “class test” for the purposes of the variation of class rights procedure in the Corporations Act.

In the White Horses matter, the Court determined that:

• for the purposes of the scheme of arrangement procedure, all of the shareholders were in the same class and could, therefore, vote together; but
• each share parcel associated with a home unit in the building constituted a separate class of shares for the purposes of the variation of class rights procedures and that selling the land to a developer who intended to demolish the building would have varied those class rights – the relevance of this is discussed below.

Conflicts between schemes, company constitutions and specific statutory procedures

The Court noted the well-established propositions that a scheme of arrangement:

• may override a company’s constitution; but
• cannot override, or be used to the exclusion of, a specific statutory procedure applicable to the transaction. For example, if a scheme involves a capital reduction, the capital reduction provisions in the Corporations Act must still be complied with. Similarly, and relevantly to this case, if a scheme involves a variation of class rights, the variation of class rights procedure in the Corporations Act must be followed.

As noted above, the Court found that each share parcel associated with a home unit in the building constituted a separate class of shares. Accordingly, the rights attached to each of those share parcels, which included the right to occupy a specific home unit, could not be varied unless White Horses had, in parallel with the scheme of arrangement, complied with the variation of class rights procedure in the Corporations Act.

The Corporations Act specifies that rights attached to shares in a class can only be varied by special resolution of the company in combination with a special resolution of the members in that class. Accordingly, and fatally for White Horses, as each shareholder held shares in a separate class, White Horses required the unanimous consent of home unit owners to enable its directors to transfer the land to the developer and to surrender the lease attached to each parcel of shares.

As a result, despite White Horses securing the statutory level of shareholder approval for the scheme of arrangement, the Court could not approve the scheme as White Horses had not complied with the variation of class rights procedure.

Not the first time where a Court has knocked back a scheme

This is certainly not the first time a court has declined to approve a scheme despite its having had the blessing of shareholders. Other previous examples include:

• Zenyth Therapeutics - on the basis that inadequate disclosure had been made to shareholders;
• PR Finance - on the basis that target shareholders were not provided with the annual audited financial statements of the target company ahead of the scheme meeting (this had been promised in the scheme booklet and the statements were months late); and
• PCCW (a Hong Kong decision) - on the basis that the outcome of the ‘head count’ vote had been manipulated by share splitting.

Commentary

Although the White Horses scheme was knocked back on technical grounds, it serves as a useful reminder of just how versatile schemes of arrangement can be and the various uses to which they can be put. To date, those uses have included (in addition to effecting takeovers):

• re-domiciling companies (as happened with the Atlassian Group);
• reconstructions and amalgamations within corporate groups (such as occurred with the Fiducian Group);
• demergers (for example, the demerger from the Foster’s Group of Treasury Wine Estates);
• settlement of mis-selling claims (as happened with Card Protection Plan and AI Scheme);
• effecting compromises of financier claims against distressed companies (such as happened with Alinta, Centro, Nine Entertainment and Atlas Iron); and
• demutualisations (as occurred with GIO, NRMA and NIB).

In fact, a scheme of arrangement may extend to any subject matter that a company is otherwise able to agree upon with its members or creditors (acting unanimously). In other words, almost any arrangement which touches or concerns the rights and obligations of the company or its members or creditors may be effected under a scheme of arrangement.

Despite the White Horses decision, we have certainly not seen the limits of the potential uses for schemes of arrangement.