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Focus: Australian foreign investment rules to catch convertible notes

27 August 2009

Chinese language version

In brief: As foreshadowed by the Treasurer in his announcement of 12 February 2009, the Federal Government has introduced into the House of Representatives a Bill to amend the Foreign Acquisitions and Takeovers Act 1975 (Cth) as it applies to the acquisition of shares or voting power in Australian companies by foreign investors. Partners Alex Ding and Phillip Cornwell (view CV) and Lawyer Tim Cardiff report on the key features of the amendments.

How does it affect you?

  • If the amendments to the Foreign Acquisitions and Takeovers Act 1975 (Cth) (the FATA) are implemented as currently drafted:
    • the existing compulsory notification regime will be extended to a greater range of foreign investment transactions, including transactions made by way of convertible notes and other more sophisticated financing instruments or structures; and
    • the amendments will operate retrospectively from 12 February 2009, so that the Treasurer must be notified, within 30 days after the amendments take legislative effect, of any proposal entered into after that date that would require compulsory notification under the amended regime (unless the Treasurer was already notified under the voluntary notification regime).
  • Foreign investment transaction structures will need to be reviewed to determine if they will be subject to the amended FATA.
  • Deal timetables for affected transactions entered into after 12 February 2009 may be impacted by these amendments. Parties to such transactions should consider whether it may be prudent to make a voluntary notification to the Treasurer now, rather than waiting until these amendments become law.
  • Entities that are not currently considered foreign investors to whom the current FATA applies will need to review their capital structure to determine if, for future transactions, they will be deemed foreign investors for the purposes of the FATA. Similarly, companies may need to review the terms of any foreign ownership restrictions in their constitutions.
  • Convertible note and other mezzanine debt underwriters and investors will need to consider whether any associated grant of equity options (or 'warrants') should be subject to Foreign Investment Review Board (FIRB) approval.

Purpose of the amendments

The Treasurer has said:1

In light of the growing use of more complex investment structures, the Government intends to clarify the operation of the foreign investment screening regime.

The Government will amend the [FATA] to ensure that it applies equally to all foreign investments irrespective of the way they are structured.

The Federal Government's objective is to ensure that the FATA applies to any investment by foreign investors where there is any possibility that the type of investment structure being used will deliver, either currently or at some time in the future, influence or control over an Australian company.

The Government is concerned that various modern transaction structures and financing arrangements do not currently fall within the scope of the FATA. Such structures and arrangements allow control events to arise in a variety of ways other than through the traditional acquisition of shares and exercise of voting power; that is, in ways not previously contemplated by the FATA.

For instance, the issue of convertible notes or debentures to foreign investors investing in Australian companies does not, of itself, trigger the compulsory notification requirement for share acquisitions under the FATA.2 An example of such a transaction is China Investment Corporation's (CIC) recent investment in Goodman Group, which includes a $500 million issue of perpetual, unsecured, subordinated securities exchangeable into Goodman Group's securities.


Application to share acquisitions

The FATA gives the Treasurer power to assess, and to prohibit, certain proposed foreign investments in Australian companies and assets to ensure that they are not contrary to the national interest. FIRB assists, and provides recommendations to, the Treasurer in assessing foreign investment proposals.

Section 18 of the FATA gives the Treasurer the power to prohibit proposed acquisitions of shares, and similar interests, in an Australian company that would result in a foreign investor acquiring a controlling interest in the Australian company and that the Treasurer decides would be contrary to the national interest. It also gives the Treasurer the power to order the unwinding of completed share acquisitions, and acquisitions of similar interests, that resulted in a foreign investor acquiring a controlling interest in the Australian company and that the Treasurer decided is contrary to the national interest.

Section 26 of the FATA requires compulsory notification by a foreign investor to the Treasurer of any agreement to acquire a substantial shareholding in an Australian company. FIRB will examine the proposal, and the Treasurer has 40 days within which to approve the transaction and notify the foreign investor. If the agreement is signed before being approved, the agreement must be conditional on obtaining the approval. It is a criminal offence not to comply with these requirements.

Investments, made through the acquisition of shares, in Australian companies whose total assets are valued at less than the monetary thresholds are exempt from the Treasurer's powers to prohibit or to order the unwinding of an acquisition of shares and from the compulsory notification regime.3

'Substantial interest'

'Substantial interest' and 'aggregate substantial interest' are the key concepts underpinning the reach of the FATA's application to the acquisition of shares in Australian companies by foreign investors. These concepts are threshold elements of the term 'controlling interest' under s18 and of the term 'substantial shareholding' under s26 of the FATA. Also, the concept of substantial interest underpins the test for determining who is deemed to be a foreign investor.

A substantial interest in a company is where a person, alone or together with any associates, is in a position to control at least 15 per cent of the voting power of a company or holds interests in at least 15 per cent of the issued shares in a corporation. An aggregate substantial interest is where two or more persons together, including with any associates, hold at least 40 per cent of the voting power or issued shares.

A substantial interest therefore comprises either a control of voting power or the holding of an interest in issued shares, or both, to the relevant percentage level.

Compulsory notification of share acquisitions

It should be noted that the compulsory notification regime currently applies to the acquisition of a substantial shareholding, rather than to the acquisition of a substantial interest. A substantial shareholding includes only the acquisition of interests in shares where a person already holds a substantial interest, or where a person will hold a substantial interest as a result of that acquisition of the interests in shares.

The key amendments

Substantial interest

The amendments will broaden the definition of substantial interest through the introduction of two new elements:

  • 'potential voting power', which will include any voting power that might come to exist in the future and that might be cast at a general meeting; and
  • including in the calculation of a person's percentage holding of interests in issued shares all rights that a person has to the issue of shares (by way of transfer or acquisition under a convertible note or an option) by deeming that those rights have been exercised.

Adopting these two elements will extend the application of the FATA to transaction structures that include agreements having the potential to provide some measure of future influence or control to foreign investors, such as through the acquisition of convertible notes, whether exchangeable into previously issued shares or convertible into previously unissued shares.4 Under the current FATA, a convertible note will generally only result in a substantial interest if it is converted. But under the FATA amendments, the issue of a convertible note may, of itself, be an acquisition of a substantial interest.

Further, it has been common for investors in mezzanine or subordinated debt to seek to enhance their return by requiring the issuing company to grant options to subscribe for shares. The driver has not been to gain control but, rather, to participate in the 'equity upside'. The investors are commonly overseas-owned investment funds and financial institutions, so the issue of approval under the FATA will now have to be considered at the time of financial close.

Equity derivatives may also be affected, but not if, as is common, the parties elect for cash settlement rather than physical delivery of the underlying shares.

Compulsory notification

All references to 'substantial shareholding' and 'interests in shares' in s26 of the FATA will be changed to 'substantial interest', to ensure that the compulsory notification regime applies to the full range of transaction structures that will be captured by the expanded definition of substantial interest. This will be supported by the introduction, into the scope of the types of agreements requiring compulsory notification, of the new concepts of 'potential voting power' and of deeming that rights to interests in shares have been exercised at the time of entering into the agreement, rather than on the actual exercise of the right.

These amendments will considerably expand the scope of transaction structures that require compulsory notification to the Treasurer.


The amendments will apply retrospectively from 12 February 2009. However, a transitional period will apply between that date and the date on which the amendments become law. The Treasurer will need to be notified (under s25 of the FATA) within 30 days of the amendments becoming law of any agreements entered into during the transitional period that would fall under the scope of the amended FATA.

Failure to give this notice will constitute a criminal offence punishable by a fine and imprisonment for up to two years.

What has not changed

Control threshold percentages constituting substantial interests:

  • the 'substantial interest' threshold continues to be set at 15 per cent; and
  • the 'aggregate substantial interest' threshold continues to be set at 40 per cent.

Monetary thresholds for exempt transactions – there continues to be no requirement to notify the Treasurer of acquisitions in Australian corporations valued below the current monetary thresholds.5

The screening process – these amendments will not change the screening and examination procedure undertaken by FIRB.6

What does this mean for those involved in foreign investment?

Fundamentally, these amendments will considerably broaden the scope of foreign investment transactions involving the acquisition of shares, and similar interests, that will be subject to the Treasurer's prohibition and divestment powers, and to the compulsory notification regime.

Transaction structures

This means that issuers, foreign investors, investment banks, underwriters and financial advisers will need to consider carefully whether the amended FATA applies to their transaction structure and whether it requires compulsory notification, in which case they should consider whether the Treasurer is likely to exercise the power to impose conditions on the transaction.

Deal timetables

Where the transaction structure will require compulsory notification, changes to deal timetables will need to be considered.

Defining foreign investors

The scope of entities that will be considered as foreign investors will increase as a result of the amendments, since the concept of substantial interest underpins the test that determines who is a foreign investor for the purpose of the FATA. Some entities may become foreign as a result of the amendments, because that entity's foreign security holders may hold (to the required percentage) the types of rights or interests that now come within the scope of substantial interest.

Companies with foreign ownership restrictions in their constitutions, designed to stop them being foreign persons, will need to review their constitutions to determine if those constitutional restrictions are sufficiently broad to deal with these new types of securities that will be subject to the FATA.

Consequences of granting options

Now it is the grant, rather than the exercise, of the equity options inherent in convertible notes that will need to be the subject of the traditional 'subject to FIRB approval' clause, at least where the issuer is of a size that takes it over the threshold. Where the convertible notes are initially issued to domestic investors,7 the sale of those notes may need to be subject to a FIRB clause.

This need not necessarily delay the closing of convertible note transactions, at least where the investors are willing to take FIRB risks, as the grant of the options could be made the subject of a condition subsequent covering FIRB approval. It is worth remembering that the legislation is focused on actual or potential voting power, so other structures, such as synthetic equity, or non-voting shares, may be open for consideration as a fall-back.

  1. See the Treasurer's press release of 12 February 2009.
  2. However, current policy, rather than statute, requires prior approval and notification for 'proposals where any doubt exists as to whether they are notifiable'. So, funding arrangements that include debt instruments having quasi-equity characteristics may well be notifiable under that policy and assessable under the Australian Government's foreign investment guidelines.
  3. In September 2009, the minimum monetary threshold applicable to the acquisition of shares will increase to $219 million for non-US investors and to $953 million for US investors. See our Client Update on this change.
  4. This is notable, since, in Canwest Global Communications Corporation v The Treasurer (1997) 15 ACLC 1258, Hill J confirmed the decision in Equiticorp Industries Ltd v ACI International Ltd (1987) 5 ACLC 237 that, for the purposes of the FATA, a person who held an option over unissued shares did not have an interest in any shares.
  5. The Treasurer has separately announced changes to the monetary thresholds.
  6. See a description of FIRB's screening and examination procedure.
  7. Or, for example, where the initial issue is to US enterprises and it is below the higher US enterprises monetary threshold.

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