Under control: Rights issues, control effects and the Takeovers Panel’s decision in Tempus Resources

Rights issues which have, or are likely to have, an effect on control or the acquisition of a substantial interest in a company may be unacceptable if not managed appropriately. The Takeovers Panel’s recent decision in Tempus Resources¹ (Tempus Resources Decision) together with ASIC’s report of having intervened in recent rights issues in which control may have passed to an underwriter serve as a timely reminder of this. In this article we take a look at the key factors the Takeovers Panel takes into account in these situations.

In brief

• In the Tempus Resources Decision a rights issue which coincided with a shareholder requisitioned meeting to replace the board was scrutinised to assess whether there were unacceptable control issues with the rights issue and if frustrating action against Takeovers Panel guidance had occurred.
• ASIC reported in late 2023 that it had intervened in pro rata rights issues undertaken by listed companies that may have resulted in control in the company passing to the underwriter. The underwriter in each case was a substantial shareholder or related party of the company.
• These recent developments serve as a reminder for companies to assess the potential control implications of their rights issues and to ensure that appropriate dispersion strategies and governance protocols are in place to manage them appropriately.

Control effects in right issues – the general position

The fact that control is affected by a rights issue does not of itself give rise to unacceptable circumstances. Shareholders invest in the knowledge they may be diluted if they do not participate in capital raisings and companies are entitled to manage their capital as they see fit. However, there are situations where the Takeovers Panel considers rights issues may give rise to unacceptable circumstances. 

In general directors should still carefully consider all reasonably available options to mitigate any effect on control.   

The Panel considers, among other things, whether the control effect exceeds what is reasonably necessary for the fundraising purpose. In considering whether a rights issue gives rise to unacceptable circumstances, the Panel considers:

• the company’s situation (available methods of raising funds, market factors, capital raising alternatives, the financial situation and solvency of the company and whether the company sought advice from financial advisers);
• the structure of the rights issue (size, price, discount to market, timing, underwriting, renounceability and dispersion strategy); and
• the effect of the rights issue (any effect on control, purposes, steps taken by the board to mitigate that effect, disclosure of a potential control effect and the response or likely response of shareholders).

To mitigate potential control effects of a rights issue, the Panel notes a company may consider:

• making a rights issue renounceable where an active market for the rights is likely;
• offering a shortfall facility; and
• some other, similarly effective, dispersion strategy for dealing with the shortfall rather than it going to the underwriter or sub-underwriter.

A dispersion strategy can also mitigate potential control effects by either:

• using several sub-underwriters;
• an underwriter or sub-underwriter receiving entitlements under the dispersion facility after all other requests have been satisfied;
• sufficient time and disclosure being given to shareholders and other investors to assess the rights or shares being offered; and
• external investors being able to take up shares offered under the dispersion strategy.

In the Panel’s experience, where there is a clear need for funds, a rights issue resulting in a control effect will generally not be unacceptable as long as it is structured appropriately with an appropriate dispersion strategy.

Tempus Resources and rights issues coinciding with shareholder meetings

The initial Panel declined to conduct proceedings based on a lack of support for the various assertions made. In its review application, the applicant made slightly different claims, including that the company had no need for funds, people associated with the underwriting and sub-underwriting intended to seek control of the company and that there were issues with the disclosures made in relation to the rights issue. These claims were made in circumstances where it appeared the rights issue had been launched around the time a requisition for a shareholder meeting to change the board had been received. These claims were rejected by the review Panel, which affirmed the decision of the initial Panel and declined to conduct proceedings.

On investigation by the Review Panel, the assertions did not turn out to be substantiated, including because the company did indeed require funds, the underwriter was a professional firm without any particular reason to support the company and the requisition for a general meeting to change the board was received after the rights issue launched. 

However the Panel has previously found there to be unacceptable circumstances due to the timing of a rights issue in relation to a shareholder meeting.  MMA Offshore Limited²concerned an equity raising that was announced just before the annual general meeting. The timeline for the equity raising provided that allotment and normal trading of new shares issued under the placement and institutional entitlement offer would occur before the meeting but the allotment of new shares under the retail entitlement offer would occur after the meeting. This meant that the shares issued to investors in the institutional component and placement would carry  voting entitlements, but not the shares issued under the retail entitlement offer. The Panel considered that the size and timing of the accelerated component of the equity raising would cause control issues. It emphasised this was particularly so where some institutions would obtain or increase substantial holdings as a result of the placement and institutional entitlement offer. The Panel found that the timing of the equity raising had the potential to distort voting at the meeting and that this was unacceptable. In lieu of making orders, the Panel accepted an undertaking from the company that it would postpone the annual general meeting.

ASIC Update and the risk of control passing to an underwriter

ASIC noted in its Corporate Finance Report published in September 2023 that it had intervened in pro rata rights issues undertaken by listed companies that may have resulted in control in the company passing to the underwriter. The underwriter in each case was a substantial shareholder or related party of the company.

ASIC noted that it will examine a rights issue closely if it is underwritten by a person who already controls the company, or is likely to control the company after the transaction on the basis that it considers that a transaction designed to give control to a holder or underwriter that is presented to the holders and the market as a rights issue will generally be contrary to the purposes in section 602 of the Corporations Act 2001 (Cth) (Corporations Act). ASIC noted it expects issuers to explore reasonable options and take available steps to minimise the potential effect of the rights issue on control of the issuer, including making genuine attempts to procure alternative underwriting arrangements.

The interventions mentioned above resulted in issuers agreeing to extend the offer period, procure additional sub-underwriters and provide further disclosure.

ASIC also noted that seeking approval from shareholders in accordance with item 7 of section 611 of the Corporations Act is another way that issuers can address the potential that a rights issue or underwriting may have an unacceptable control effect.

The Takeovers Panel’s decision in Energy Resources Australia (ERA)³ is an example (among others) of where this issue has been assessed before. The Panel made a declaration of unacceptable circumstances in relation to the affairs of ERA and its pro-rata renounceable entitlement offer, which was fully underwritten by North Limited, a wholly owned subsidiary of ERA’s largest shareholder, Rio Tinto⁴. The underwriting agreement contained a number of very long dated unusual undertakings from ERA in favour of the underwriter and if no other shareholders took up their entitlements, Rio Tinto would acquire voting power in ERA of approximately 95.6% in reliance on item 10 of section 611 of the Corporations Act.

The following measures were taken to assist with mitigating the control effects of the raise:

• entitlements were renounceable;
• there was a dispersion strategy in place for any shortfall shares; and
• ERA formed a committee comprising three directors independent of Rio Tinto to have and exercise all powers of the ERA board in relation to evaluating, negotiating and approving any proposed funding support agreement with Rio Tinto.

However, the Takeovers Panel found that the following factors meant that the above measures were insufficient:

• ERA failed to ensure the independence of the independent board committee. ERA’s managing director that was not independent of Rio Tinto attended each meeting of the committee and was involved in those meetings. Minutes were not taken in these meetings and no independent financial advisor was engaged. As such, the Panel considered that potential conflicts of interest were not sufficiently managed;
• the terms of the underwriting agreement effected the management of ERA and dealings with a major asset of ERA over the medium to long term i.e., undertakings regarding the use of funds raised by the entitlement offer for rehabilitation and that ERA will not deal with or create any new interest in certain assets without the prior written consent of the underwriter. These undertakings effectively continued until the substantial completion of the rehabilitation obligations (which were required to be completed by January 2026);
• the entitlement offer was highly dilutive and therefore minority shareholders were unlikely to participate; and
• aspects of the disclosure in the information booklet should have more closely reflected the disclosure in a document required for a control transaction regulated by Chapter 6 of the Corporations Act given the potential for Rio Tinto to increase its voting power in ERA above 90%.

Commentary

When considering a rights issue that could have potential control implications, companies should note that:

• the fact that control is affected by a rights issue does not of itself give rise to unacceptable circumstances; and
• what is needed is for the company to put in place dispersion strategies and robust governance arrangements that seek to mitigate potential control effects in form and substance.

1. Tempus Resources Limited [2024] ATP 1 and Tempus Resources Limited [2024] ATP 2.
2. [2017] ATP 21.
3. Energy Resources of Australia Limited [2019] ATP 25.
4. Rio Tinto Limited and Rio Tinto Plc.