A different way to effect a takeover

This article was co-authored with Ellen Pen¹.

Last month, Tap Oil’s largest shareholder, RISCO Energy, increased its interest in Tap Oil from 75.14% to 100% through a selective capital reduction and share cancellation. RISCO Energy achieved this without undertaking a traditional takeover or scheme of arrangement, notwithstanding Tap Oil was a public company to which the takeover rules apply. This saved time, money, and allowed the transaction to occur without Court involvement, thereby reducing execution risk.

Capital reductions used to effect takeovers are not common in Australia. In the last 10 years the authors are only aware of 7, the most recent before Tap Oil’s being in 2018. By way of comparison, over the last 10 years there have been 698 takeovers and schemes of arrangement.

A selective capital reduction involves a company selectively reducing its share capital by a determined amount. Where used to effect a takeover, the reduction is accompanied by the cancellation of all shares held by shareholders other than the major shareholder, thereby resulting in the major shareholder becoming the sole shareholder following the cancellation. The Courts have acknowledged the structure as an appropriate mechanism for achieving control.

The consideration received by minority shareholders is usually cash, either existing cash reserves or a loan from the major shareholder. Tax advice (and potentially a tax ruling) is generally recommended to ensure the consideration provides acceptable tax outcomes for minority shareholders, and that the consideration is treated as payment for cancellation of shares and not a dividend for tax purposes (which may be less advantageous from a tax perspective).

Shareholder approval (by special resolution) is required both: (i) for the capital reduction, where the major shareholder can vote in favour or against and minority shareholders can only vote against, and (ii) at a separate meeting, for the share cancellation, with only the minority shareholders able to vote. Given the voting requirements and thresholds, this structure is generally only viable where the major shareholder has an existing holding of >50%. If the major shareholder does not have a significant stake, the proposal could be voted down by minority shareholders who hold a relatively small interest in the company.

In addition, an explanatory statement must be sent to shareholders containing all material information in relation to the proposal. This is generally accompanied by an independent expert’s report containing the expert’s opinion as to whether the consideration payable to minority shareholders is fair and reasonable.

The requirements for a shareholder meeting and an independent expert’s report are not dissimilar to the prerequisites for a scheme of arrangement, although a capital reduction does not require the Court’s blessing, which is an obvious advantage.

Capital reductions have been subject to challenge in the Courts. Typically, on the basis the reduction is not fair. Where a reduction meets the strict requirements of the Corporations Act and sufficient disclosure has been provided to shareholders, it is likely to be upheld.

To date the authors are not aware of any challenge before the Takeovers Panel, although theoretically the Panel would consider it has jurisdiction to consider an application where the control impact of the reduction was unacceptable.

In 2018, Phileo Australia Limited offered its minority shareholders an “opt-out” option as part of its capital reduction. This may have been designed to reduce any risk of minority shareholder challenge on the basis shareholders had the same opportunity as the major shareholder. Query the benefit of this however as if the major shareholder still ended up with a >90% interest, it could proceed to compulsorily acquire the remaining shares in any event.

While rarely used, selective capital reductions offer a cost-effective and relatively straightforward means for a major shareholder to achieve absolute control. RISCO Energy’s recent takeover of Tap Oil is a good example of this in action and might just put the spotlight back on this alternate structure.