Federal Court Rules Share Placement Invalid Due to Illegitimate Purpose

OUTCOME: Allowed

FEDERAL COURT OF AUSTRALIA

[RESPONDENT] [COMPANY] v [RESPONDENT] [COMPANY] [2008] FCA 1081

CORPORATIONS – shares – allotment – powers of directors – allotment for ulterior purpose [NAME] v [NAME] (1971) 123 CLR 614 [COMPANY] v [NAME] (1968) 121 CLR 483 [NAME] v [COMPANY] (1987) 162 CLR 285 [RESPONDENT] v [RESPONDENT[COMPANY], [COMPANY] and [RESPONDENT] [COMPANY] 432 of 2008

FINKELSTEIN J

22 JULY 2008

[RESPONDENT]

IN THE FEDERAL COURT OF AUSTRALIA

VICTORIA DISTRICT REGISTRY VID 432 of 2008

IN THE MATTER OF [RESPONDENT[COMPANY] [RESPONDENT]: [RESPONDENT]

[COMPANY] and

[RESPONDENT]

[RESPONDENT] OF ORDER: 22 JULY 2008

[RESPONDENT]

THE COURT ORDERS THAT:

1. Until further order, [RESPONDENT] [COMPANY] be and it is hereby restrained from exercising (whether by proxy or otherwise) the right to vote that attaches to its shares in [RESPONDENT[COMPANY].

2. Any further affidavit on which the parties propose to rely in relation to the relief that should be granted be filed and served on or before 4.15pm on 28 July 2008.

3. The parties exchange further short Outlines of Submission on or before 4.15pm on 30 July 2008.

4. The further hearing of this proceeding be adjourned to 31 July 2008.

5. Costs reserved. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA

VICTORIA DISTRICT REGISTRY VID 432 of 2008

IN THE MATTER OF [RESPONDENT[COMPANY] [RESPONDENT]

[COMPANY] and

[RESPONDENT]

JUDGE: FINKELSTEIN J

DATE: 22 JULY 2008

PLACE: [RESPONDENT] FOR

JUDGMENT 1 The [RESPONDENT], holds the largest parcel of shares in the capital of the first defendant, [RESPONDENT[COMPANY] ([COMPANY]). It acquired those shares on the [RESPONDENT] 14 May and 4 June 2008, at an average price of $0.085 per share. [RESPONDENT[NAME]'s shares together with those of its associate, [COMPANY], represent about 10.17 per cent of the issued capital. After its initial series of acquisitions [RESPONDENT[NAME] lodged a notice of substantial shareholding and on 12 June 2008 it gave notice that it would convene a meeting of [COMPANY] shareholders to consider replacing the board. The meeting will be held on 23 July 2008. [COMPANY] allotted a parcel of shares to [RESPONDENT] [COMPANY], the third defendant, at an issue price of $0.07 per share. The allotment gives [RESPONDENT[NAME] 13.04 per cent of the voting shares and reduces the [RESPONDENT]'s interest to 8.85 per cent. [RESPONDENT[NAME] contends that the allotment is invalid and seeks an order that the register of members be rectified. The ground upon which the relief is sought is that the power to allot shares was not exercised bona fide in the interests in [COMPANY] but for the illegitimate purpose of keeping the directors in office. 2 [COMPANY] is a holding company. Through its [NAME] collects and sells blood plasma. It employs 420 people who work out of 12 plasma collection centres in a number of US cities. The operations are not profitable. In the half year ended 31 December 2006 [COMPANY] lost US$8 million. During the same period last year (2007) it lost US$1.2 million. The decrease in losses was in part due to increased revenues. In the main, however, it resulted from the sale for US$5.9 million of two collection centres. 3 In December 2007 the then directors of [COMPANY] retained [COMPANY] to provide the company with strategic advice including advice in relation to the sale of assets. On 17 December 2007 [NAME] advised that [COMPANY] should dispose of the entirety of its business. The obvious purchaser was [NAME[NAME], a Swiss company that was [COMPANY]'s largest customer. [NAME] [NAME], a director of [NAME], commenced negotiations with [NAME]. This resulted in an offer on 12 February 2008 that [NAME] purchase the plasma centres and associated assets for US$45.6 million plus [NAME] at valuation, less any amount charged on the assets. 4 Around this time (February 2008) [NAME] (who later became chairman) and [NAME] replaced the former directors. The new directors decided that [COMPANY] should not accept the [NAME] offer. Still, something had to be done. [COMPANY]'s [NAME] position was precarious. In the absence of a sale of assets the group was insolvent and would be wound up. The new directors decided to continue negotiations with [NAME] to see whether a better arrangement could be achieved. 5 Within two weeks a new arrangement was concluded. It consisted of three separate agreements. First there was a management agreement pursuant to which [NAME] was appointed to manage the US operations. Second was a loan agreement under which [NAME] agreed to provide a US$37.1 million loan facility which would be used to pay existing debts and under which [NAME] agreed to lend [COMPANY] an amount equal to the operating costs of the [NAME] less the revenue received. Finally there was a put and call option which, subject to shareholder approval, gave [NAME] the option to purchase the shares in the [NAME]. The exercise price was around US$47.1 million. 6 The effect of the arrangement was that before any sale of the [NAME] to [NAME], [COMPANY] had funds to pay out its creditors with a resulting balance of approximately US$16 million of loan funds which it could draw down, and [NAME] was responsible for managing the US operations. If the sale of the [NAME] goes ahead, [COMPANY] would be required to repay its loan to [NAME] which would leave it with a balance of about $7 or $8 million in cash on my calculation and no other assets. 7 [COMPANY] paid out its creditors with the loan funds. It drew down the balance and placed the money on deposit with its banker. There was good reason to draw down the full amount under the loan facility. The rate of interest payable under the loan agreement was [RESPONDENT] 2 and 3 per cent, reflecting prevailing US interest rates. Funds deposited in an interest bearing account with an [COMPANY] attracted a much higher rate. 8 Following the announcement of the [NAME] transaction, [NAME] and [NAME] discussed with [NAME] [NAME] the desire of [COMPANY] to raise further capital. They told him that they wanted [COMPANY] to raise [RESPONDENT] $5 and $20 million which, together with the funds on hand following the completion of the sale of the [NAME], would allow the company to pursue other ventures. [NAME] [NAME] and [NAME] [NAME] had in mind that [COMPANY] would become an "investment vehicle". This required further capital. They asked for [NAME]'s assistance. 9 [NAME] [NAME] discussed a possible investment in [COMPANY] with [NAME] of [COMPANY], a [COMPANY]. [NAME] operates in the capital raising market and was looking to invest funds in the Asia-Pacific region. There was a telephone call [RESPONDENT] [NAME], [NAME] and [NAME] in March or April 2008. Nothing was agreed. Towards the end of April, [NAME]'s retainer was terminated. 10 [NAME] exercised its call option on 11 April 2008. This imposed an obligation on [COMPANY] to convene a meeting of its shareholders as soon as possible to consider whether they would approve the sale. [COMPANY] has retained [NAME] to provide an independent expert's report and [NAME] to produce an investigating accountant's report. It is anticipated that the reports will be to hand by the end of July and that the shareholder meeting will be held in early August 2008. 11 On 1 May 2008 another director joined the board of [COMPANY]. Ms [NAME], who has experience in human resources and employee relations, was introduced to [COMPANY] by one of its consultants, [NAME] [NAME]. She was told that the company was considering what to do following the sale of its US assets. She was also told that the company wanted to raise finance. Ms [NAME] spoke with [NAME] [NAME] who confirmed what she had been told by [NAME] [NAME]. She agreed to be appointed a director. 12 The directors (now [NAME] and [NAME] and Ms [RESPONDENT]) discovered on 19 or 20 May 2008 that [RESPONDENT[NAME] had acquired a substantial shareholding in [COMPANY]. They were concerned that [RESPONDENT[NAME] might want to take control of the company. Ms [NAME] said there "was a view that [taking control] probably was [RESPONDENT]'s intention". She also said the directors had "been caught on the hop" by [RESPONDENT[NAME]'s acquisition. The directors' suspicion about [RESPONDENT[NAME]'s motives were confirmed when on 23 May 2008 [COMPANY] received the requisition for the meeting that will consider replacing the board with [RESPONDENT[NAME]'s nominees. 13 There was a directors' meeting on 20 May 2008. The minutes make no mention of [RESPONDENT[NAME]. They do, however, record a resolution that at future meetings there will be tabled a "Top Twenty Shareholder Report, Shareholder Movement Report [and] all notices of changes in substantial shareholdings." Presumably the directors did not again want to be "caught on the hop". 14 On the same day as the meeting [NAME] and [NAME] met [NAME] [NAME] [NAME], [NAME]. The meeting had been arranged by [NAME]. He had known [NAME] for some years. Before the meeting [NAME] told [NAME] that he and [NAME] had recently become directors of [COMPANY], that [COMPANY] conducted a blood plasma business in the United States which had been "sending the company to the wall", that the business had been sold at a price which would leave the company with about US$27 million and that [COMPANY] was "looking for investors who might provide capital to the company for on-going activities in the future." 15 The meeting was held in [NAME]' office in Sydney. [NAME] [NAME] and [NAME] [NAME] were in attendance. Ms [NAME] did not go. She had been told that the purpose of the meeting was to discuss a capital raising. Ms [NAME] knew "in general terms" that [NAME] [NAME] and [NAME] [NAME] were looking to obtain extra finance with the assistance of a [NAME] adviser. She was happy to leave it to them to deal with the matter. In any case, Ms [NAME] had flown in from Perth to attend the board meeting and had to return later that day. She said if she had not needed to return to Perth she would probably have attended the meeting. 16 It is important to establish precisely what was said at the meeting. While three people attended only two, [NAME] [NAME] and [NAME] [NAME], have given evidence. I do not know why [NAME] [NAME] was not called. And [NAME] [NAME] tried to give the appearance of having only a vague recollection of the discussions. 17 According to his affidavit [NAME] [NAME] was told that [COMPANY]'s business "had been running down" but that if shareholders approved the [NAME] transaction "the company would have a future". He was also told that once the [NAME] transaction was completed there would be other opportunities for the company to consider. Importantly he said he was told that the company "did not want to touch the … [NAME] monies (held by the company as cash on deposit) as if shareholders did not approve the transaction, the company's overall position would be even worse [than it already was]." For this reason, [COMPANY] had to raise additional funds. [NAME] [NAME] also remembers being told that the company had a [NAME] who held about 7 per cent of the issued [NAME]. 18 [NAME] [NAME] made notes of the meeting. They record the number of shares [COMPANY] had on issue, the then current share price, details of what seem to be head office expenses and the expected receipts from the [NAME] transaction. There is a note in the top right hand corner which reads: "280 - 8% - 50%" It is not clear what this note is intended to record. [NAME] [NAME] said he could not remember. 19 [NAME] [NAME] had in mind approaching [COMPANY], an investment group operating out of London, as a potential [NAME] in [COMPANY]. [NAME] [NAME] had previously dealt with [NAME] [COUNSEL], an [NAME] representative. At approximately 6.02pm on 3 June 2008, [NAME] [COUNSEL] sent an email to [NAME] [NAME]. The contents of the email are important so I will set it out in full. The email reads: "AW, Suggest you have a look @ [COMPANY], listing in OZ, I know the fellow well there, same situation sort of as [NAME], Big Pile of Cash and liquids, Capped at 9 million, with 18 in cash, sitting at [NAME], The directors have few shares and want to do a placement to hold on, 15%, They have a group who has bought 7% and obviously want the shell We could do this 15%, they said board seat no problem and change of activity no problem, they don't want to lose their shell, Call me at home 61 2 9363 4828 TB" 20 This email is important both for what it says and for what it does not say. First, I will deal with the omissions. There are several things a prudent [NAME] would want to know about a company in which he was being offered a 15 per cent stake. They include such basic information as what the company does, and what are its assets and liabilities. In the case of [COMPANY] a prudent [NAME] would also want to know something about the [NAME] deal and the likelihood of it being approved by shareholders. He might also want to know what would happen to [COMPANY] if the sale of the [NAME] was not approved by shareholders. Not only would a prudent [NAME] want to know these things a sensible adviser would provide that kind of information. The email contains none of this information. [NAME] [NAME] did not have a satisfactory explanation for the omissions. He did say he thought [NAME] [NAME] would make his own enquiries. I do not believe that is what [NAME] [NAME] believed. 21 I do believe that if an [NAME] was being asked to take up shares in a "cash box" type company to assist management in maintaining control he might only be told enough to establish there is sufficient cash in the company to get back the purchase price. Although no price is mentioned in the email, the clear implication is that [COMPANY] has sufficient capital to enable [NAME] to recover the purchase price if things go wrong and it is wound up. 22 Enough was said in the email to attract [NAME] [NAME] interest. He replied to [NAME] [NAME] within three hours stating: "Let's do it boss". 23 When [RESPONDENT[NAME] obtained a copy of the email in response to a subpoena served on [NAME], it likely thought that its tender would result in success in the case. The legal principles involved are not in dispute. Directors of a company are only entitled to issue shares for reasons that relate to a purpose of benefiting the company: [NAME] v [NAME] (1971) 123 CLR 614, 640; [COMPANY] v [NAME] (1968) 121 CLR 483, 493. Raising capital when there is a need for additional funds is a legitimate purpose. Conversely, raising capital by the issue of voting shares for purposes, or for the predominant purpose, of buttressing the position of directors is an illegitimate use of the directors' power: [NAME] v [COMPANY] (1987) 162 CLR 285, 289. If the email reflects what [NAME] [NAME] was told by [NAME] or [NAME], the placement was not intended to benefit [COMPANY]. Its purpose was to keep the directors in office. 24 On this score, however, [NAME] [NAME] says that [NAME] [NAME] got it wrong. His evidence is that he did not tell [NAME] [NAME] that shares were to be issued so that the directors would not "lose [control of] the shell". He said that matter played no part in his discussions with [NAME] [NAME]. [NAME] [NAME] said that apart from telling [NAME] [NAME] about the [NAME] transaction he told him he was looking for investors so that [COMPANY] could "move forward into the future". He said that he had in mind two rounds of capital raising. According to the ASX Listing Rules, subject to certain exceptions a listed company is only permitted to issue up to 15 per cent of its capital unless it obtains shareholder approval. An allotment of 15 per cent of the capital on [COMPANY] would raise only around $1.35 million. This would not be enough to cover [COMPANY]'s annual operating expenses. It is for that reason [NAME] [NAME] said he was contemplating two rounds of capital raising. In reality, even a second round without shareholder approval would not raise enough for investment purposes. To avoid the listing rule restriction [COMPANY] would need to make a pro rata offer to existing shareholders. [NAME] [NAME] said that a pro rata issue would be "a highly desirable way to go" but that it is "a stretch" to think such a strategy might have worked, given the fall in [COMPANY]'s share price since most investors bought in. Nothing that [NAME] [NAME] has said suggests that he would seriously consider such a course. 25 Moreover, it is surprising that [NAME] [NAME] does not remember telling [NAME] [NAME] the company was anticipating two rounds of funding. [NAME] [NAME] said nothing about it in his affidavit. If, as [NAME] [NAME] would have it, there was a need for further capital to fund [COMPANY]'s future operations, surely this would have been discussed. 26 On the other hand, as I have said, the emergence of a substantial shareholder was discussed. [NAME] [NAME] was told that someone had acquired 7 per cent of the company. Although pressed by [NAME] [COUNSEL] who appeared for the plaintiffs, he was not able to give details of what was said. He was also pressed by [NAME] [NAME] to explain why he told [NAME] [NAME] that the directors wanted to hold onto the company, that they did not want to lose the shell and that they were willing to give a board seat to the person who took a placement. But [NAME] [NAME] could not explain why he had written these things. He was adamant that he had not been told "directly" what he had written. He could not, though, explain what was said that led him to form the view that what he had written was the position taken by the directors. 27 I am sure that [NAME] [NAME] was not guessing what the directors' motives were in seeking an [NAME]. A [NAME] of 24 years experience (which is how long [NAME] [NAME] has been in the industry) would not make the statements he did to a [NAME] unless he was confident they were true. I have no doubt that [NAME] [NAME] recorded what he was told or what was properly to be inferred from the comments made by [NAME] [NAME] or [NAME] [NAME]. The impression I have of [NAME] [NAME] evidence on this aspect is that he did not want to answer questions in a way that would harm [COMPANY]'s case. I should say that if [NAME] [NAME] was at any time told that [COMPANY] did not want to spend borrowed money to meet current expenses (in fact I doubt that he was told this), that comment was made in the context of exploring an excuse for a small capital raising. 28 Nothing I have said is intended to indicate I reject [NAME] [NAME] evidence that he wanted to create a future for [COMPANY] and to achieve that future it was necessary to complete the [NAME] transaction and to raise additional capital. The completion of the sale was well underway when [RESPONDENT[NAME] appeared on the register. A capital raising was a step that would logically be undertaken after the completion of the sale because in the unlikely event that shareholders voted against the sale there would be no need for any additional capital. The presence of [RESPONDENT[NAME] had the potential to thwart [NAME] [RESPONDENT] intentions. I think Ms [NAME] hit the nail on the head when, in answer to the question, "[T]he directors wanted to keep control of the company, didn't they?", she replied: "The directors would probably like to finish what they started in the company. That was probably more the motivation, yes." Put differently, while [NAME] [NAME] general objective was to further the interests of [COMPANY], his immediate object was to ensure that the directors were not removed so that the general objective could be achieved. 29 Several events confirm my view that what motivated the share issue was [NAME] [NAME] desire to keep himself and the other directors in office. The first requires reference to further facts. I have already pointed out that [NAME] [NAME] took only three hours to decide to take the placement. He appears to have made his decision without any detailed investigation of [COMPANY]. In his email [NAME] [NAME] offered to discuss the proposed placement by phone. [NAME] [NAME] did not bother to make the call. That suggests that the placement was not a normal commercial investment. This is confirmed by the speed with which [NAME] executed the subscription agreement. The document was prepared by [COMPANY] and sent to [NAME] [NAME] on 12 June 2008. It was immediately sent on to [NAME]. [NAME] executed the agreement and returned it the same day without negotiating any of the terms. Not only is this unusual, it suggests that the parties wanted to complete the placement as a matter of urgency. 30 The next event is the retainer by [COMPANY] of [COMPANY]. [NAME] is an organisation that provides "strategic shareholder communications advice and programs". It helps a company ensure that its shareholders "are aware and clearly informed about the merits of any proposals [put by the directors]." It encourages shareholders to "vote in favour of each resolution" put by the board. [NAME] was appointed on 13 June 2008, the day after the subscription agreement was executed. It was paid $60,000 on account of its fees. [NAME] [NAME] said that [NAME] was appointed to assist the company obtaining shareholder approval for the [NAME] sale. It transpired, however, that [NAME] was also soliciting shareholders to vote against the resolution to remove the board. This came to light on the last day of the trial. [NAME] [NAME] said this work was performed under a separate retainer with the directors. The problem with this evidence is that the first Ms [NAME] knew that it was being asserted that the directors had retained [NAME] was shortly before she began her evidence on the final day of the hearing. 31 It may be that one purpose for retaining [NAME] was to encourage shareholders to approve the [NAME] deal. Another, and perhaps more immediate purpose, was to prevent [RESPONDENT[NAME] obtaining control of [COMPANY]. 32 Finally there are [NAME] [RESPONDENT] dealings with [RESPONDENT[NAME]. It turned out that [NAME] did not take up any shares in [COMPANY]. Instead, on about 9 July 2008 it instructed [RESPONDENT[NAME] to take the placement and allocate the shares [RESPONDENT] its clients. It seems common ground that none of the clients (perhaps with the exception of one) is associated with [NAME]. When [NAME] [RESPONDENT] learned that the shares were to be taken by [RESPONDENT[NAME] he discussed the matter with [NAME] [RESPONDENT], an officer of [RESPONDENT[NAME]. He followed up the discussion with an email which read: Further to our conversation, we understand you are sending the substantial shareholder notice today. Also, can you please look at getting the proxy forms completed as well. We don't want to risk leaving this to the last minute Thanks & Regards………………..[NAME] 33 I am sure [NAME] [RESPONDENT] had in mind receiving a proxy from [RESPONDENT[NAME] that would support the [NAME] at the forthcoming meeting. In his evidence [NAME] [NAME] said that preparing the proxy form was merely "completing the transaction with [RESPONDENT[NAME]". It was much more than that. [NAME] [RESPONDENT] was wanting to secure a favourable vote from [RESPONDENT[NAME]. It is likely that [RESPONDENT[NAME] had agreed that it would vote against the removal of the board. That is why [NAME] [NAME] did not want "to risk leaving this [the return of the proxy form] to the last minute." 34 The result is that I must find that the share placement was for an ulterior purpose. I will hear the parties on the precise orders that should be made. In the meantime, as the shareholders' meeting will be held tomorrow I will restrain [RESPONDENT[NAME] from exercising the right to vote that attaches to its shares. I certify that the preceding thirty-four (34 numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Finkelstein.

Associate: Dated: 22 July 2008 Counsel for the [RESPONDENT]: [NAME]

Solicitor for the [RESPONDENT]: [COMPANY]

Counsel for the First Defendant: [redacted] [COUNSEL]

Solicitor for the First Defendant [NAME] of Hearing: 14 & 15 July 2008

Date of Judgment: 22 July 2008