FEDERAL COURT OF AUSTRALIA The application of GE Mortgage Insurance Pty Ltd [2004] FCA 154 INSURANCE – approval of scheme of transfer – compliance with legislative requirements – whether scheme capable of being approved with condition subsequent – whether discretion should be exercised to refuse scheme approval – no material unfairness to policy holders – scheme approved subject to modification Insurance Act 1973 (Cth) Part III Division 3A Corporations Law Corporations Act 2001 (Cth) s 17B Re Advance Bank Australia Ltd (1996) 22 ACSR 476 cited Re Vector Capital (1997) 23 ACSR 182 cited Re Castlereagh Securities Ltd [1973] 1 NSWLR 624 referred to Re Bellara Medical Products Ltd (1996) 14 ACLC 332 referred to Re NRMA Insurance Ltd (2000) 33 ACSR 595 applied Re Buka Minerals NL (1983) 8 ACLR 507 cited Ford's Principles of Corporations Law [24.030] THE APPLICATION OF GE MORTGAGE INSURANCE PTY LTD & ORS N 1992 OF 2003 HELY J 1 MARCH 2004 SYDNEY IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY N 1992 OF 2003 BETWEEN: GE MORTGAGE INSURANCE PTY LTD ACN 071 466 334 FIRST APPLICANT GE CAPITAL MORTGAGE INSURANCE CORPORATION (AUSTRALIA) PTY LTD ACN 081 488 440 SECOND APPLICANT GE MORTGAGE INSURANCE COMPANY PTY LIMITED ACN 106 974 305 THIRD APPLICANT JUDGE: HELY J DATE OF ORDER: 1 MARCH 2004 WHERE MADE: SYDNEY THE COURT ORDERS THAT: 1. The applicants bring in revised Short Minutes of Order to give effect to these reasons. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY N 1992 OF 2003 BETWEEN: GE MORTGAGE INSURANCE PTY LTD ACN 071 466 334 FIRST APPLICANT GE CAPITAL MORTGAGE INSURANCE CORPORATION (AUSTRALIA) PTY LTD ACN 081 488 440 SECOND APPLICANT GE MORTGAGE INSURANCE COMPANY PTY LIMITED ACN 106 974 305 THIRD APPLICANT JUDGE: HELY J DATE: 1 MARCH 2004 PLACE: SYDNEY REASONS FOR JUDGMENT 1 This is an application under Part III Division 3A of the Insurance Act 1973 (Cth) ('the Act') for confirmation of two schemes for the transfer of the Australian lenders mortgage insurance business ('LMI') of each of the first and second applicants to the third applicant. In the documents filed in support of the application, the first applicant is generally referred to as 'GEMI', the second applicant as 'GEMICO' and the third applicant as 'NEW GEMICO'. In these reasons I shall refer to the applicants by those descriptions. 2 The Australian Prudential Regulation Authority ('APRA') appeared at the hearing of the application. I was informed by Mr Murray, who appeared for APRA, that APRA has no objection to the schemes, or to the orders which the applicants propose should be made. He also informed me that APRA accepts that the procedural steps required by the Act and the prudential standards to be taken in association with the present application have been complied with. There is evidence to that effect, and I so find. 3 GEMICO is a subsidiary of GEMI. The ultimate parent company of each applicant in the United States is General Electric Company ('GE'). GE proposes to float approximately 30 per cent of the shares in Genworth Financial Inc ('Genworth'), another of its subsidiaries. Neither GEMI nor GEMICO is currently in the same corporate line of ownership as Genworth. The schemes enable the LMI businesses of GEMI and GEMICO to be transferred to NEW GEMICO and thus be part of the proposed float. That is the rationale for the schemes. The evidence establishes that there are commercial reasons for proceeding by way of asset transfer, rather than by means of a transfer of shares. 4 The general nature of the schemes and associated transactions are summarised in a document styled 'Outline of Submissions' which I have placed with the papers. As no policyholder has expressed any opposition to the schemes, and in the light of APRA's attitude to the proposed orders, I will not repeat or further summarise those submissions here. Subject to one possible qualification to which I shall immediately turn, I accept those submissions. There is ample evidence that the proposed schemes will not have any material adverse impact on the position of policyholders. 5 The possible qualification arises out of the fact that each scheme gives effect to the terms of a scheme Transfer Deed (recital C) which is a schedule to the scheme. Clause 2 of the Transfer Deed makes the parties' obligations under that deed conditional upon five specified matters, in addition to confirmation by the Court. Those matters are described as conditions precedent to completion. 6 The effect of Clause 3 of the schemes is that the schemes take effect on and from the Transfer Date, subject to the conditions in Clause 2 of the Transfer Deed having been satisfied. The 'transfer date' is defined so as to mean a date agreed by the applicants and approved by the Court. The parties have agreed on 31 March 2004 as the 'transfer date' (Exhibit 'BPD 1', Tab 11 Cl 3) and the proposed orders seek the Court's approval to that date. 7 The evidence establishes that with one exception the five conditions to which I have referred have been satisfied. The exception is Condition 2(e) which is as follows: '"(e) Capital injection": GEMIH has subscribed for additional capital in NEW GEMICO in an amount equal to the Relevant Amount.' 8 GEMIH is GE Mortgage Insurance Holdings Pty Ltd, a company incorporated in Australia, and the holder of the shares in NEW GEMICO. The 'Relevant Amount' is an estimate agreed between GMIH and NEW GEMICO of the amount of capital required to be subscribed for by GEMIH in NEW GEMICO such that, after the transfers under the schemes and business transfer agreements have been implemented, NEW GEMICO will have: - net tangible assets at least equal to the combined net tangible asset position of GEMI and GEMICO prior to the implementation of the schemes; and - capital sufficient to satisfy the requirements of the Standard & Poor's Australian lenders mortgage insurance capital model to achieve an AA rating. It is likely that satisfaction of the first of those requirements will also result in satisfaction of the second (Exhibit 'BPD 1', Tab 11 Cl 6). 9 GEMIH and NEW GEMICO have entered into an (undated) Subscription Agreement (Exhibit 'PHH 1', Tab 6). Under that agreement, GEMIH applies for, and at completion NEW GEMICO must issue to GEMIH, a number of shares in NEW GEMICO as equal to the 'Subscription Amount'. Clause 3.1 of that agreement provides that completion must take place prior to the transfer date provided for in the schemes. The 'Subscription Amount' means the Relevant Amount as defined in the Transfer Deeds, where such amount is calculated in accordance with par 7 of a letter agreement dated 10 February 2004 between the applicants and GEMIH. 10 Paragraph 7 of the letter agreement dated 10 February 2004 (Exhibit 'BPD 1', Tab 11) provides that the Relevant Amount for the purposes of the Transfer Deeds is the sum of: - the net tangible assets of GEMI as disclosed in the March management accounts; - the net tangible assets of GEMICO as disclosed in the March management accounts; and - the sum of $615,548,137. 11 To minimise the extent to which the estimates referred to in par 8 above are based on projected financial information of GEMI and GEMICO, as opposed to actual financial information, the parties have agreed that the estimates will be calculated on 25 March 2004 when the sub-ledgers for the month of March 2004 have been closed off and the management accounts for March have been prepared. This means that there will only be a period of six days (to the transfer date) for which projections will need to be made. 12 The Chief Financial Officer of the applicants, Mr Dean, has calculated an estimate of the Relevant Amount (current as at the date of his affidavit of 11 February 2004) of about $1,060,000,000. 13 Once the transfers have been effected, it is a requirement under Cl 4.3 of each scheme Transfer Deed that audited balance sheets be prepared for each of the applicants, and that these sheets be reviewed by an actuary. If that review identifies that the amounts transferred to NEW GEMICO based on the 25 March 2004 estimates are not sufficient to meet the scheme requirements, GEMI and GEMICO have undertaken as a term of the schemes to 'promptly contribute' such additional capital as may be required to meet that deficiency (the 'true up process'). Mr Dean's evidence is that the need for any significant adjustment as a result of the true up process is unlikely. Scheme confirmation 14 With the above introduction I can now state the possible qualification to which I earlier referred. It is whether the Court may, and, if so, whether the Court should confirm the schemes when at the time confirmation is sought the operation of the schemes is conditional upon GEMIH later subscribing for about a billion dollar's worth of shares in NEW GEMICO. This is not an issue which was raised by APRA, and APRA did not seek to put any submissions on the question. 15 The obligations of GEMIH under the Subscription Agreements have been underwritten by General Electric Capital Corporation ('GECC'). GECC is a wholly owned subsidiary of GE. GECC has an AAA credit rating and shareholders' equity of USD 43.819 billion. GECC has given an undertaking in favour of GEMIH and NEW GEMICO (Exhibit 'PHH 1', Tab 7) to ensure that GEMIH has sufficient funds available for it to satisfy its obligations under the Subscription Agreement. The undertaking is expressed to be enforceable by GEMIH and NEW GEMICO, and no other person. 16 I am satisfied that GECC has the financial substance to perform the undertaking which it has given. However, the companies involved are within the same corporate group, and it would be unrealistic to assume that in the perhaps unlikely event that GEMIH fails to perform its obligations under the Subscription Agreement, or GECC fails to perform its undertaking, that NEW GEMICO would take enforcement proceedings. 17 The orders which the applicants seek were the subject of some refinement during the course of argument. One of the difficulties which I had with the orders as originally proposed was that if the schemes were confirmed before the Subscription Agreement had been performed policyholders would not know whether the schemes had taken effect. There might also be some residual uncertainty as to the legal position in the perhaps unlikely event that the Subscription Agreement is not performed by the transfer date. 18 I attach a copy of the Short Minutes of Order which the applicants propose should be made. Paragraph 3A of the attached short minutes was included to accommodate the concerns which I had expressed in that respect. There is a typographical error in par 2 of the proposed Short Minutes, as the applicants seek confirmation of the schemes without modification. Confirmation of a conditional scheme 19 Before the 1998 amendments to the former Corporations Law, a proposed reduction in the capital of a company required confirmation by the Court. A question arose in that context as to whether the Court could confirm a conditional reduction of capital. As I understand the authorities, they are to the effect that the Court can confirm a conditional resolution for the reduction of capital, but cannot confirm a reduction of capital which, at the time when confirmation is sought, remains contingent or conditional upon some event: see, for example, Re Advance Bank Australia Ltd (1996) 22 ACSR 476: Re Vector Capital (1997) 23 ACSR 182. In Re Castlereagh Securities Ltd [1973] 1 NSWLR 624 at 629 Sir Lawrence Street reserved for closer consideration whether it was universally correct to say that a court cannot confirm a conditional reduction, however, this principle has been developed in later cases to have the effect that I have indicated. 20 The explanation for this principle is to be found in specific statutory provisions, which required that the order by which the reduction was confirmed to show the amount of the share capital of the company as altered by the order. As McLelland CJ in Eq observed in Re Bellara Medical Products Ltd (1996) 14 ACLC 332, the evident purpose of those provisions was to provide by a confirming order (at 333) 'clear and authoritative evidence of what the share capital is immediately after the order is made, as a result of the reduction'. This purpose cannot be fulfilled if at the time of the confirming order the contemplated reduction remains contingent upon the fulfilment of outstanding conditions. See also Ford's Principles of Corporations Law [24.030]. 21 The position is otherwise where the Court's approval is sought to a scheme of arrangement which is subject to conditions subsequent. Whilst ordinarily schemes qualify for approval only after all conditions are satisfied, in Re NRMA Insurance Ltd (2000) 33 ACSR 595 Santow J approved a scheme of arrangement even though the terms of the scheme were such that the scheme could still terminate after Court approval if a condition subsequent was not satisfied by a specific date. Important factors in determining whether to approve a scheme which is subject to a condition subsequent were described by Santow J as including (at 647-648) clarity, certainty and fairness, and whether the status quo is substantially restored if the condition subsequent is not fulfilled. In Re Buka Minerals NL (1983) 8 ACLR 507 McLelland J also accepted that a scheme of arrangement might be approved despite the presence of a condition subsequent. 22 Section 17B of the Act is couched in negative terms; no part of the insurance business of a general insurer may be transferred to another general insurer except under a scheme confirmed by the Court. The section contemplates that the scheme will be operative at the point of transfer, and that it will, prior to that point, have been confirmed by the Court. There is no reason for importing into this statutory scheme a principle grounded in specific statutory provisions and developed in relation to confirmation of reductions of capital, when the Act does not contain any provision to like effect. 23 In the present case, the condition subsequent will either be satisfied by the Transfer Date or it will not. If it is satisfied, then the transfer will occur under a scheme which has been approved by the Court. If the condition is not satisfied, then no transfer of assets could be made under the terms of the scheme which the Court has approved. 24 I conclude that the Court has power to confirm a scheme notwithstanding that its operation is subject to performance of a condition to be satisfied after the point of confirmation. This is so even though the condition is one which might not be satisfied. Discretion 25 The scheme summary approved by APRA and forwarded to shareholders includes the following (Exhibit 'CSM 2', Tab 6): 'At the time that the Policies are transferred to NEW GEMICO under the schemes, NEW GEMICO, in addition to meeting its capital adequacy requirements under the Act, will also have sufficient capital to be rated AA by Standard & Poor's ("S&P"), based on the current capital model for Australian mortgage insurance companies published by S&P. In addition, the net tangible assets of NEW GEMICO on the date of transfer will be no less than the combined net tangible assets of GEMI and GEMICO prior to the transfer.' 26 This is a brief, but substantially accurate, statement of the position, although the complexities involved in securing that outcome are not exposed. 27 It is sensible to delay the estimation of the relevant amount to a date which is as close as practicable to the transfer date for the reasons given by Mr Dean which are referred to in par 11 above. It is also reasonable not to require a subscription of about a billion dollar's worth of capital in NEW GEMICO prior to the Court approving the scheme under which that is to occur. There is no unfairness to policyholders in what is proposed. Either the relevant amount will be provided to NEW GEMICO on or prior to 31 March 2004 or it will not. There is, or will be, certainty as to the amount which is required to be paid, and as to when it will be paid. If it is paid the transfer of assets will have been authorised by a scheme which the Court has confirmed. If it is not paid then that scheme does not authorise a transfer to take place. The status quo will therefore be preserved in the unlikely event that there is a failure of the legally effective arrangements entered into by the applicants to ensure compliance with the condition. 28 I conclude that I should not, in the exercise of my discretion, withhold confirmation of the scheme by reason of the possible qualification referred to in par 14 above. The proposed orders 29 The form in which par 3A of the proposed Short Minutes of Order is couched raises a problem. Paragraphs (b) and (c) can and should be the subject of direct orders to that effect. However, a statement that the orders in pars 2 and 3 are made 'on the basis' specified in Cl 3A(a) and (d) is either devoid of legal effect, or of uncertain legal effect. 30 There is no need for a statement in terms of Cl 3A(a) because that is clearly the effect of the scheme. It is less clear whether the terms of the scheme achieve the result contemplated by Cl 3A(d). There is no express term in the scheme to that effect, and there is at least an available view that it is inconsistent with the provisions of Cl 2.2 of the Transfer Deed and Cl 5 of the scheme. 31 It should be pellucidly clear that if condition 2.1(e) of the scheme Transfer Deeds has not been satisfied by the Transfer Date, then the schemes will have no operation. I propose to confirm the schemes subject to their being modified to include a provision to the effect of the following: 'In the event that condition 2.1(e) of the GEMI scheme transfer deed is not satisfied by the Transfer Date then this scheme has no further operation.' I use the term 'further operation' rather than 'operation' because of the provisions of Cl 5 of the schemes. A corresponding modification should be made in relation to the GEMICO scheme. 32 The applicants should bring in revised Short Minutes of Order to give effect to these reasons. I certify that the preceding thirty-two (32) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Hely. Associate: Dated: 1 March 2004 Counsel for the Applicants: J Gleeson SC, P Brereton Solicitor for the Applicants: Freehills Counsel for APRA: M Murray Solicitor for APRA: Australian Government Solicitor Date of Hearing: 24 February 2004 Date of Judgment: 1 March 2004