FEDERAL COURT OF AUSTRALIA Solution 6 Holdings Limited ACN 003 264 006, in the matter of Solution 6 Holdings Limited ACN 003 264 006 [2004] FCA 1049 CORPORATIONS – criteria for court's approval of scheme of arrangement – scheme of arrangement fair and reasonable – whether share capital reduction precludes approval of scheme Corporations Act 2001 (Cth), s411 Securities Act 1933 (United States and Federal), s3(a) Re Central Pacific Minerals NL [2002] FCA 239 followed Re Permanent Trustee Co Limited (2002) 43 ACSR 601; [2002] NSWSC 1177 followed Re Simeon Wines Limited (2002) 42 ACSR 454; [2002] SASC 204 followed IN THE MATTER OF SOLUTION 6 HOLDINGS LIMITED ACN 003 264 006 N865 OF 2004 JACOBSON J 3 AUGUST 2004 SYDNEY IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY N 865 of 2004 IN THE MATTER OF: Solution 6 Holdings LIMITED ACN 003 264 006 PLAINTIFF JUDGE: JACOBSON J DATE OF ORDER: 2 AUGUST 2004 WHERE MADE: SYDNEY THE COURT ORDERS THAT: 1. Orders be made in accordance with the Short Minutes of Order dated 2 August 2004. 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 865 of 2004 IN THE MATTER OF: Solution 6 Holdings LIMITED ACN 003 264 006 PLAINTIFF JUDGE: JACOBSON J DATE: 3 AUGUST 2004 WHERE MADE: SYDNEY REASONS FOR JUDGMENT 1 By its originating process filed on 26 May 2004 the plaintiff, Solution 6 Holdings Limited ("Solution 6") sought, inter alia, an order under subsection 411(4) of the Corporations Act 2001 (Cth) ("The Act") for the approval of three schemes of arrangement, namely schemes made between Solution 6 and its shareholders, its vested option holders and its unvested option holders. I made an order yesterday approving the schemes. These are my reasons. 2 The effect of the schemes, upon implementation, will be that all of the existing shares and options over shares in Solution 6 will be transferred to MYOB Limited ("MYOB") so that Solution 6 will become a wholly owned subsidiary of MYOB. Thus, the schemes involves a merger of the businesses and operations of Solution 6 and MYOB. 3 Solution 6 is a leading provider of practice management software to the accounting and other professions. The strength of its business lies in serving larger accounting practices. MYOB also provides practice management software but the strength of its business is apparently in the areas of small to medium businesses and smaller accounting practices. Accordingly, the rationale for the merger is to be found in the combination of the strengths of the respective complimentary businesses of Solution 6 and MYOB and the synergies which will flow from the merger. 4 The consideration for the share scheme is that Solution 6 shareholders are to transfer their shares in that company to MYOB in exchange for 0.55 MYOB shares for each Solution 6 share. 5 Shareholders in Solution 6 will also receive, as part of the scheme consideration, the sum of 20.7 cents per share as a capital return by way of an equal capital reduction. The reduction of capital has been approved by a resolution of the shareholders of Solution 6 in general meeting in accordance with section 256C of the Act. 6 Approval of the capital reduction and return of capital to shareholders of Solution 6 is one of the conditions precedent to the operation of the schemes of arrangement. Unlike former statutory regimes, which required approved of the court for a reduction of capital, no such requirement is contained in the Act. Nevertheless, for reasons referred to below, it is necessary for me to consider whether the capital return should preclude the making of orders approving the scheme. 7 Option holders will receive as the scheme consideration in exchange for their options, a number of shares in MYOB calculated in accordance with a formula. The effect of the formula is that the option holders will receive the intrinsic value of their options calculated on the basis of 0.55 MYOB shares for each Solution 6 share after taking into account the amount payable on exercise of the options (or a promise to pay that amount) and the 20.7 cents return of capital. 8 The evidence adduced yesterday indicates that the schemes were very strongly approved by those members and option holders who voted in person or by proxy at the meetings. At the share scheme meeting approximately 98.7 per cent in number and 99.97 per cent of the shareholders on the taking of a poll voted in favour of approving the scheme. At each of the meetings of option holders, 100 per cent of those present in person or by proxy lodged in accordance with the timetable fixed by the court voted in favour of the scheme. 9 Some adjustment would have to be made to the figures for option holders meetings if proxies received after the deadline were counted. However, even if they were taken into account the votes in favour of the schemes were considerably in excess of the statutory majority required under the Act. 10 In Re Central Pacific Minerals NL [2002] FCA 239 ('Central Pacific'), Emmett J described the statutory framework that regulates the adoption and approval of a scheme of arrangement between a company and its members. 11 His Honour observed at [4] that the pivotal provision is section 411(4), which provides that an arrangement is binding on a class of members and on the company if, and only if, at a meeting convened in accordance with an order of the court, a resolution in favour of the arrangement is passed by the requisite statutory majority. 12 In the case of a scheme of arrangement proposed between the company and its members the required statutory majority is:- * A majority in number of the members of that class present and voting either in person or by proxy; and * 75 per cent of the votes cast in favour of the resolution. 13 Where the scheme is proposed between the company and creditors the required statutory majority is a majority in number of creditors present and voting either in person or by proxy being a majority whose debts or claims against the company amount in the aggregate to at least 75 per cent of the total amount of the debts and claims of the creditors present and voting in person or by proxy. 14 The schemes of arrangement with option holders that were before me for approval proceed, in accordance with established authority, on the basis that the option holders are creditors. 15 As Emmett J said in Central Pacific at [6], there are three stages in the promulgation and giving effect to a scheme of arrangement. The court plays a role in the first and third of those stages. The three stages are as follows:- 1. the application to the court to convene a meeting; 2. the holding of the meeting to approve the scheme; 3. the application to the court to approve the scheme. 16 On 11 June 2004, I made orders convening meetings of shareholders and option holders to consider, and if thought fit, to approve the respective schemes. 17 As Emmett J said in Central Pacific at [8], the principles which relate to the exercise of the discretion conferred on the court at that stage require that the court would not convene a meeting unless the arrangement proposed was of such a nature, and cast in such terms, that the court would be likely to approve it on the hearing of an unopposed application provided that the scheme has received the requisite statutory majority. 18 The considerations, which govern the exercise of the discretion to approve an arrangement, ie, the third stage of the process, were referred to by Emmett J at [12] to [14]. They were also dealt with by Barrett J in Re Permanent Trustee Co Limited (2002) 43 ACSR 601; [2002] NSWSC 1177 ('Permanent Trustee') at [8] to [10]. 19 Emmett J pointed out that the court will generally take the view that shareholders are the best judges of whether an arrangement is to their commercial advantage but he noted that the court is not a mere rubber stamp. It will look at the scheme to ensure that it is reasonable. His Honour expressed the test this way at [14]. 'The court must be satisfied that the proposal is at least so fair and reasonable that an intelligent and honest person, who is a member of the class of security holders bound by the arrangement acting alone in respect of his or her interests, as such security holder, might approve it.' 20 Barrett J observed at [9] that in deciding whether to exercise the discretion to approve the scheme, the court must form a favourable view of the arrangement. He pointed out that this was established by a leading English authority in 1891 and he referred at [10] to a modern expression of the principle stated in similar terms to the passage from Emmett J's judgment which I have quoted in the previous paragraph. 21 In Re Simeon Wines Limited (2002) 42 ACSR 454; [2002] SASC 204 ('Simeon') Lander J summed up what must be established into two requirements. He said at [11] that the court's approval involves it being satisfied that all procedural matters have been complied with, and that the scheme is fair and reasonable to the members in a general sense. The same requirements apply to the approval of a scheme made with creditors. 22 I am satisfied that all the procedural requirements have been complied with. The meetings were convened in accordance with the orders I made on 11 June 2004 and the statutory majorities were obtained by very substantial, and indeed by almost overwhelming, proportions. 23 As to the question of fairness of the schemes, I have before me an affidavit of Mr R.J. Stewart, a co-author of an independent expert's report prepared for the purpose of considering the proposed merger. The report was put before me in evidence when I convened the scheme meetings on 11 June 2004. 24 The report states that the proposed merger is fair and reasonable and in the best interests of Solution 6's ordinary shareholders and option holders. Mr Stewart has sworn before me that he holds that opinion. The opinion is supported by appropriate criteria referred to in the body of the report. 25 No member or option holder has appeared before me to argue that the report is unreliable or defective. As Barrett J noted in Permanent Trustee at [19], it is not unknown for members to appear before the court and to argue that a report is unreliable or defective. 26 However, there was evidence before me of correspondence between Solution 6 and the solicitors for Mr Nicholas Fish ("Mr Fish") and a company associated with him about a claim for compensation made by Mr Fish and his company in the Industrial Relations Commission of New South Wales. The significance of the correspondence is that it raises an issue which I need to consider, namely, whether the capital return should have any impact upon the exercise of my discretion to approve the schemes. 27 The claim by Mr Fish and his company relates to a contract of employment between Solution 6 and Mr Fish and to a share sale agreement pursuant to which the consideration for the sale was paid in Solution 6 shares. The total claim is in the order of $19 million but the share sale component of the claim comprises the largest element. The amount claimed for this is approximately $17.3 million. 28 The effect of the correspondence is that Mr Fish's solicitors contend that the scheme documentation and the expert's report failed to adequately disclose the claim, that Solution 6's accounts should be adjusted to reflect the claim, and that after the capital return there was a real risk that Solution 6 would be unable to meet the claim made by Mr Fish and his company. These contentions are disputed by Solution 6. The correspondence is annexed to the affidavits of Mr Stewart sworn 30 July 2004 and Mr Gamble sworn 2 August 2004. Having regard to the nature of the present application I have no reason to doubt that all of the relevant correspondence has been put before me. The correspondence includes requests for undertakings sought by Mr Fish's solicitors but refused by Solution 6. 29 There are a number of reasons why I am of the view that none of the contentions made by Mr Fish's solicitors should prevent approval of the schemes. 30 First, section 256B of the Act provides that a company may reduce its share capital if the reduction is fair and reasonable to the company's shareholders as a whole and does not materially prejudice the company's ability to pay its creditors and it is approved by shareholders in a general meeting. 31 The question of whether the reduction materially prejudices the company's ability to meet its debts is for the directors to consider consistently with their fiduciary duties to the company. The evidence satisfies me that the directors of Solution 6 have considered that question and I am not aware of anything to suggest any want of proper consideration on their part. 32 Second, the question of the effect on creditors is one of materiality. The evidence shows that the authors of the expert report and the directors considered the claim by Mr Fish and his company on the basis of a materiality threshold of $5 million. Although the claim against Solution 6 was said to be for an amount well in excess of this, there was nothing in the evidence before me to suggest that the views of the directors and of the experts that the claim falls below the threshold is a view which cannot reasonably be taken. 33 Third, on 21 July 2004 the New South Wales Court of Appeal (Spigelman CJ, Mason P and Handley JA) held that the Industrial Relations Commission did not have jurisdiction to entertain the claim arising out of the share sale agreement; see Solution 6 Holdings Limited v Industrial Relations Commission of New South Wales [2004] NSWCA 200. This was adverted to by the Chairman of the meetings held on 27 July 2004 to approve the schemes. At each of the meeting the Chairman informed the meeting in words to the effect: 'The Court of Appeal decided that the Industrial Relations Commission has no jurisdiction to hear that part of the claim that relates to the share sale agreement and restrained it from doing so. This very significantly reduces the value of the claims by Mr Fish and Nisha Nominees that can be heard by the Industrial Relations Commission. Mr Fish or Nisha Nominees are entitled to make a special leave application to the High Court. The Court of Appeal's decision would not prevent Mr Fish or Nisha Nominees from litigating any other common law or statutory claim they may have in either the Supreme Court or the Federal Court. As at the date of this announcement they have not indicated that they propose to commence any such claim. It has been and is the directors' view that the claims are ambit in nature and Solution 6 will continue to vigorously defend the claims. In any case, Solution 6's ability to pay any judgment awarded against it, in respect of all of the claims referred to in this announcement will not be affected by the proposed schemes of arrangement and the capital return. The directors continue to believe that the claims do not, and will not, have a material impact on the value of Solution 6's business.' 34 Fourth, there was evidence before me in the explanatory memorandum that MYOB's intentions are, subject to corporate office and back office rationalisation, that no substantial changes will be made to the business of Solution 6 and there will not be any redeployment of the assets of Solution 6. 35 Fifth, Solution 6's financial report dated 10 June 2004 includes a cash forecast which shows a cash balance after the capital return of over $19 million. 36 Sixth, Mr Fish's solicitors were informed that the schemes were listed for hearing before me on 2 August 2004 at 2.15 pm. By letter dated 7 July 2004 the solicitors were informed that, as a shareholder, Mr Fish had the right to appear at the hearing on the application by Solution 6 for orders approving the scheme. Notwithstanding this, there was no appearance by Mr Fish or his company. His failure to appear is a further significant reason why I am of the view that the matters put forward by Mr Fish's solicitors in the correspondence should not preclude the making of orders approving the schemes. 37 The merger will affect shareholders and/or option holders who are resident in the United States of America. The issue by MYOB of its shares to scheme participants who are United States citizens or residents will be in breach of the registration requirements of the Securities Act 1933 (United States and Federal) ('the Securities Act') unless the issue falls within an exemption contained in the legislation. The exemption which will be relied upon is section 3(a)(10) of the Securities Act. 38 This issue arose in Central Pacific, Simeon and Permanent Trustee and was considered by Emmett J, Lander J and Barrett J in each of those cases. 39 In Central Pacific Emmett J dealt with the issue at [28]-[31] as follows: 'The securities in SPP that will be issued as consideration are subject to the Securities Act 1933 (US). However, s3(a)(10) of the Securities Act 1933, contains certain exemptions from compliance with that Act. The relevant requirement for the exemption for any security that is issued and exchanged for bona fide securities, is that the terms and conditions of such issuance and exchange have been approved by a court after a hearing upon the fairness of such terms and conditions at which all persons to whom it is proposed to issue securities in such exchange have had the right to appear. One of the requirements for the operation of s3(a)(10) is that the proposed issuer of securities in respect of which the exemption is to be claimed must advise the court whose order will be relied upon, that the issuer will rely on s3(a)(10) on the basis of the court's approval. That requirement has been satisfied. The evidence before me indicates that for the exemption to be effective, the court in question must have sufficient information before it to determine the value of both the securities to be surrendered and the securities to be issued in the proposed transaction. The exemption will be available only if the court in question both holds a hearing to determine whether the proposed terms and conditions are fair to all those who will receive securities in the exchange and to approve the fairness of the terms and conditions of the proposed exchange. Such a hearing must be open to everyone to whom securities would be issued in the proposed exchange and notice of the hearing in appropriate terms must be provided in a timely manner. It is not for this Court to express any view as to whether the procedures or processes of the Court are sufficient to satisfy the requirements of the exemption in s3(a)(10). However, it is clear that, on the hearing of an application for an order approving an arrangement under s411)(4)(b) of the Corporations Act, any security holder is entitled to be heard. The application for approval takes place in open court after formal notification and advertisement in daily newspapers circulating in Australia. Applications for approval may be opposed and indeed, there are instances of approval being refused in the light of opposition and submissions advanced at a hearing at the third stage to which I have referred.' 40 In Simeon Lander J dealt with the question at [21] to [26] as follows: The merger will affect persons who are resident in the United States. The issue by Brian McGuigan Wines Ltd of its shares to scheme shareholders who are United States citizens or residents pursuant to the proposed scheme will be in breach of the registration requirements of the Securities Act 1933, (United States and Federal) unless the issues fall within an exemption. Brian McGuigan Wines Ltd will seek to bring its offer in issue of shares to scheme shareholders who are United States citizens or residents within the exemption which is provided for in s3A(10) of Securities Act (supra). The requirements of that Act would be met if the following matters occur: 1. The securities, the subject of the exemption in the scheme, are issued in exchange for other securities. It is the fact that the scheme of arrangement does contemplate that the securities which would form part of the exemption will be issued in exchange for other securities. 2. The issuer [will] advise the court whose order will be relied upon, that the issuer itself will rely on s3A (10) on the basis of the court's approval. Mr Bagot, who appeared today on behalf of Brian McGuigan Wines Ltd, has advised this court that the order which I will make today will be relied upon by Brian McGuigan Wines Ltd to seek an exemption under s3A (10) of the Securities Act (supra). 3. The court has sufficient information before it to determine the value of the securities to be surrendered and those to be issued in the proposed transaction. This court has been fully informed of the value of the securities to be surrendered and the valuation placed upon the securities to be surrendered, and the expected valuation to be placed on those to be issued in the proposed transaction. That information is contained in the explanatory memorandum which has been tendered to this court as an exhibit to Mr Noack's affidavit. 4. The court holds a hearing to determine whether the terms and conditions of the transaction are fair to all those who will receive securities and approval of the terms of the exchange. It is an obligation in an application under s411(6) for this court to consider the fairness and reasonableness of the proposed scheme of arrangement. I have done that and in those circumstances there has been a hearing of the kind referred to in the fourth condition. 5. The hearing is open to everyone to whom the securities would be issued in the proposed exchange and a notice of the hearing in appropriate terms has been provided in a timely manner. R3.4 of the Federal Court (Corporations) Rules 2000 (Cth) (the Rules) requires that advertisements be placed in accordance with form 6 of the Rules and published in accordance with r2.11 of the Rules at least five days before the date fixed for the hearing of the application.' 41 In Permanent Trustee Barrett J, after quoting the passages from Central Pacific and Simeon which I have set out above, said at [14] 'In general, I agree with and adopt what was said by both Emmett J and Lander J, although with this qualification or note of explanation, namely, that Lander J's comments under items 1 to 5 of para23 of his judgment were, of course, dictated by the particular circumstances of that case and that, when his Honour refers at item 4 to a court exercising the s411 approval jurisdiction having an obligation to consider the fairness and reasonableness of the proposed scheme of arrangement, he is not, I think, in any sense suggesting that the court in some way actively enters into matters of valuation or embarks upon an examination of the question whether a particular price or consideration is or is not a fair and reasonable quid pro quo. The court does not act as a valuer.' 42 I too respectfully adopt the remarks of Emmett J and Lander J with the qualification as to Lander Js comments made by Barrett J in Permanent Trustee. Their observations as to satisfaction of the requirements of the Securities Act apply equally here. 43 As Barrett J said at [15], although the court does not act as a valuer, it receives assistance from the existence of an independent report from an unaligned expert. Here, Mr Stewart and his co-author have come to the view that the merger is fair and reasonable and in the best interests of Solution 6 shareholders and option holders. 44 Moreover, no notice of any appearance was received and no one appeared to argue that the merger is not fair and reasonable. 45 Having regard to Mr Stewart's evidence and to the absence of any opposition to the application made today as well as to the compliance with all procedural requirements I was satisfied that I should make the orders contained in the short minutes of order dated 2 August 2004. I certify that the preceding forty-five (45) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Jacobson. Associate: Dated: 13 August 2004 Counsel for the Plaintiff: Mr T F Bathurst QC appearing with Mr T Castle Mr M B Oakes SC for MYOB Ltd Solicitor for the Plaintiff: Minter Ellison Date of Hearing: 2 August 2004 Date of Judgment: 3 August 2004