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Focus: Takeovers Panel moves to limit control impact of rights issues

4 March 2009

In brief: In a recent decision, the Takeovers Panel required the sub-underwriting arrangements for a rights issue to be restructured so as to decrease the ability of the sub-underwriter to acquire control of the issuer. As the global financial crisis drives an increased need for equity capital by companies, this decision highlights that the Takeovers Panel will nonetheless scrutinise the potential control impact of rights issues to see whether they give rise to unacceptable circumstances. Partner Tom Story (view CV) and Lawyer James Clifford report.

How does it affect you?

  • Directors need to take all reasonable steps to minimise the potential impact of a rights issue on the control of their company.
  • Where the underwriting arrangements for a rights issue could have a substantial impact on the control of the company:
    • the company should take steps to manage the control impact (for example, by offering the opportunity to underwrite the rights issue to a range of parties); and
    • the offer documents should adequately disclose the underwriter's intentions for the company, should it acquire control.

Introduction

The global financial crisis has created an environment where companies are increasingly in need of capital, but professional underwriters for rights issues are scarce. For many small-to-mid cap companies, this will leave related parties (such as major shareholders) as the only realistic source of underwriting.

In previous situations when related parties have underwritten rights issues, the Takeovers Panel (the Panel) has intervened if it felt that the rights issue was not genuinely accessible to shareholders or had been structured to avoid the takeover provisions in the Corporations Act 2001 (Cth).

This has recently occurred once again, with the Panel making a declaration of unacceptable circumstances in relation to a rights issue by Bisalloy Steel Group Limited (Bisalloy) that was sub-underwritten by a related party.

What was unique about this decision was that Bisalloy's rights issue satisfied many of the criteria that the Panel considers when determining whether rights issues are acceptable or not. These criteria are set out in the Panel's Guidance Note 17 – Rights Issues, and include issues such as the company's need for funding and the structure of its rights issue.

In this case, Bisalloy was in urgent need of funds, and its rights issue was renounceable and priced at a discount to the market price (although this discount dwindled after the announcement of the rights issue). Nonetheless, this was not enough to avoid a declaration of unacceptable circumstances.

Bisalloy's downfall was to agree to its related-party sub-underwriter's requirement that it sub-underwrite 100 per cent of the rights issue. The potential effect of this on the control of the company was significant – depending on the take-up under the rights issue, the sub-underwriter could have acquired up to a 44.4 per cent interest.

Faced with such a significant impact on the control of the company, the Panel had to make a declaration of unacceptable circumstances. But rather than stop the rights issue from proceeding – a decision that could have jeopardised Bisalloy's future – the Panel tailored its orders so that any substantial shortfall would not be concentrated in the sole sub-underwriter.

This decision shows that although the global financial crisis will mean companies increasingly need capital, they cannot ignore the control impact of a rights issue. In particular, companies need to avoid underwriting arrangements that give a related-party underwriter the opportunity to gain significant control.

Background

On 2 December 2008, Bisalloy announced a 4-for-5 renounceable rights issue to raise approximately $21 million for working capital purposes. The rights issue was fully underwritten by ABN AMRO Morgans and fully sub-underwritten by Anchorage BSG Pty Limited (Anchorage).

Anchorage was not an existing shareholder of Bisalloy, but was put forward as a potential sub-underwriter by Bisalloy's chairman, who had a personal interest in Anchorage. He held a substantial interest in the Anchorage Capital Partners 1 Fund (of which Anchorage was a wholly owned subsidiary) and was a director and substantial shareholder in Anchorage Capital Partners Pty Limited, the manager of the Anchorage Capital Partners 1 Fund.

The application to the Panel was brought by one of Bisalloy's major shareholders, Balron Nominees Pty Limited (Balron). Balron complained that with Anchorage sub-underwriting 100 per cent of the rights issue, there was the real potential that it could acquire control of Bisalloy.

Under the Corporations Act, such an acquisition would be permitted due to the exemption that allows shareholders to acquire a relevant interest in more than 20 per cent of a company by way of underwriting or sub-underwriting a rights issue.

The Panel made a declaration of unacceptable circumstances on the basis that:

  • the rights issue and sub-underwriting arrangements were likely to have a substantial impact on the control of Bisalloy; and
  • the independent directors of Bisalloy did not take all reasonable steps to minimise that potential impact.

The Panel ordered that, if Anchorage's relevant interest in Bisalloy exceeded 20 per cent, any remaining shortfall shares would have to be offered in equal proportions to Anchorage, Balron and Bisalloy's other major shareholder, Investors Mutual Limited (Investors Mutual). The effect of the decision was to limit the prospect of Anchorage gaining control of Bisalloy, and ultimately resulted in a situation whereby, following the rights issue, no Bisalloy shareholder was in a position to exert significant control.

Interest in Bisalloy before the rights issue Interest in Bisalloy after the rights issue
Anchorage (including the shares held by the Bisalloy chairman) 3.60% 19.10%
Balron 16.10% 19.48%
Investors Mutual 11.7% 11.95%

Separately, the Panel also found that Bisalloy did not sufficiently disclose what Anchorage's intentions would be were it to obtain a substantial shareholding in Bisalloy, and ordered Bisalloy to issue a supplementary prospectus.

Reasons for the decision

In reaching this decision, the Panel had to balance two competing interests. On one hand was Bisalloy's commercial need for capital, while on the other was the potential for Anchorage to obtain control of Bisalloy without having to pay a control premium.

The Panel considered the fact that Bisalloy urgently needed funds and had taken advice that demand for new investments from small and micro-cap fund managers would be limited. Despite these commercial imperatives, the Panel found that the sub-underwriting arrangements gave rise to unacceptable circumstances.

The crucial step that the independent directors failed to take was to not approach anyone other than Anchorage to offer the opportunity to sub-underwrite some or all of the rights issue. Tellingly, this decision was made despite the fact that:

  • if demand for the rights issue was low, Anchorage would acquire a substantial controlling interest in Bisalloy;
  • Bisalloy's financial advisers had told the company that the sub-underwriting should be offered to Bisalloy's major shareholders, along with Anchorage, on commercial arm's-length terms; and
  • Balron had previously indicated to Bisalloy that it was willing to assist with any equity fundraising.

From its submissions, it became clear that Anchorage was seeking to use the sub-underwriting to gain control of Bisalloy. It stated that a major reason it was attracted to the sub-underwriting opportunity was the prospect that 'it would end up with a holding in Bisalloy which... would give it some influence in the affairs of Bisalloy'.

With this evidence before them, it is not surprising that the Panel made a declaration of unacceptable circumstances. But if the Panel had prevented Bisalloy from completing the rights issue, this could have jeopardised Bisalloy's future.

Instead, the Panel carefully restructured the underwriting arrangements so that the commercial rationale for Anchorage's entry into the sub-underwriting arrangements – a desire for a substantial interest in Bisalloy – was satisfied, but, at the same time, prevented Anchorage from dominating Bisalloy's share register.

Conclusion

The Bisalloy Steel decision shows that directors need to pro-actively minimise the impact of a rights issue on the control of a company. There is no 'safe harbour' within which a rights issue will always be acceptable and companies cannot follow a checklist of steps to ensure that a rights issue will not give rise to unacceptable circumstances.

Directors should always consider whether the underwriting arrangements for a rights issue affect the control of the company. If they do, the Bisalloy Steel decision makes it clear that the directors must take positive steps to minimise that effect, dispersing underwriting risk so as to reduce the likelihood that any one underwriter will gain control of the company.

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