Reported Decision : 50 ACSR 29 (2004) 22 ACLC 1272 New South Wales Supreme Court CITATION : MIA Group Ltd [2004] NSWSC 712 HEARING DATE(S) : 02/08/04, 03/08/04 JUDGMENT DATE : 3 August 2004 JURISDICTION: Equity Division Corporations List JUDGMENT OF : Barrett J DECISION : Orders for the convening of meetings CATCHWORDS : CORPORATIONS - schemes of arrangement - correct characterisation for Part 5.1 purposes of options to subscribe for shares - whether options with different expiry dates and different exercise prices indicate distinct classes where all valued on consistent basis for consideration purposes - reconstitution of board of acquiring company - whether company can covenant to procure particular composition of its own board LEGISLATION CITED : Corporations Act 2001 (Cth), s.411 Re Asia Oil & Minerals Ltd (1986) 5 NSWLR 42 Re Austamax Resources Ltd (1985) 10 ACLR 194 Re BDC Investments Ltd (1987) 6 ACLC 85 Re BDC Investments Ltd (1988) 13 ACLR 201 Re Challenger International Ltd (2003) 48 ACSR 498 Re Cranswick Premium Wines Ltd (2002) 44 ACSR 713 CASES CITED : Re Kaz Group Ltd [2004] FCA 738 Re McConnell Dowell Corporation Ltd [2003] FCA 646 Re Niagara Mining Ltd (2002) 47 ACSR 364 Re NRMA Ltd (2000) 33 ACSR 595 Re Sonic Healthcare Ltd (2002) 43 ACSR 353 Sovereign Life Assurance Co Ltd v Dodd [1892] 2 QB 573 Thorby v Goldberg (1964) 112 CLR 597 PARTIES : MIA Group Limited - Plaintiff FILE NUMBER(S) : SC 3897/04 COUNSEL : Mr M B Oakes SC - Plaintiff Mr L B Hastings, Solicitor - DGA Group Ltd and I-Med Ltd SOLICITORS : Baker & McKenzie - Plaintiff Freehills - DGA Group Ltd and I-Med Ltd IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION CORPORATIONS LIST BARRETT J TUESDAY 3 AUGUST 2004 3897/04 - MIA GROUP LTD JUDGMENT 1 Before the Court are two applications by MIA Group Ltd ("MIA") for orders convening meetings under s.411 of the Corporations Act 2001 (Cth). The first is an application for orders for the convening of a meeting of members of MIA to consider a proposed Part 5.1 scheme of arrangement between MIA and its members. The second is an application for orders for the convening of a meeting of the holders of options to subscribe for shares in MIA to consider a proposed Part 5.1 scheme of arrangement between MIA and its optionholders. Together, the schemes will, if implemented, cause all shares in MIA and all options to subscribe for shares in MIA to become owned by DCA Group Ltd. 2 The proposal as a whole is in order to be placed before the members and the holders of options for their consideration. I do, however, wish to comment on a couple of matters. 3 The first is as to the correct approach to optionholders in the Part 5.1 context. MIA has proceeded on the basis that the optionholders are creditors and that the proposed arrangement between MIA and the optionholders is accordingly an arrangement between MIA and certain creditors of MIA. 4 That approach is consistent with thinking that developed in the 1980s with respect to a proposed arrangement between a company and holders of options to subscribe for shares. The thinking seems to have emerged first in certain decisions of the Supreme Court of Victoria in which no reasons were delivered. In Re Austamax Resources Ltd (1985) 10 ACLR 194, Franklyn J of the Supreme Court of Western Australia was referred to three such Victorian decisions, the first of Anderson J (1982), the second of Young J (1983) and the third of Gobbo J (1985). Franklyn J expressed reservations about whether the holder of such an option was properly to be regarded as a creditor, given that failure by the company to allot shares upon exercise of an option might, in some circumstances, not result in an award of damages. In the absence of full argument, his Honour ordered the convening of a meeting of optionholders but directed that each be served with a copy of his reasons for judgment, no doubt so that anyone minded to raise the question of the correctness of the classification at a later time might do so. 5 Some three months later, in Re Asia Oil & Minerals Ltd (1986) 5 NSWLR 42, Cohen J expressed similar reservations but ordered that a meeting of optionholders be convened on the basis of their being creditors. The same course was followed by Needham J, with some hesitation, in Re BDC Investments Ltd (1987) 6 ACLC 85. When, in the same proceeding, an order approving the scheme between the company and its optionholders was sought, Young J noted that the scheme had been agreed to by the optionholders and expressed the opinion that, upon an ex parte application, he should follow Re Asia Oil & Minerals Ltd: see Re BDC Investments Ltd (1988) 13 ACLR 201. 6 Thereafter, the same general approach was taken in a number of cases. The point never, so far as appears from the reports, became the subject of argument in any contested proceeding. In 2002, however, Lee J, in Re Niagara Mining Ltd (2002) 47 ACSR 364, expressed the opinion that optionholders cannot be considered "creditors", either present or contingent, but are, in the context of Part 5.1, to be regarded as "members" of the company. His Honour saw "member", in that particular part of the Act, as including what he termed "contingent members". Orders for the convening of a meeting of such "contingent members" were made under s.411. 7 Mr Oakes SC, who appeared upon the hearing of the present applications, drew my attention to a number of cases in which the "creditor" approach to optionholders had been taken after the decision in Niagara Mining. He mentioned Re Sonic Healthcare Ltd (2002) 43 ACSR 353, Re Cranswick Premium Wines Ltd (2002) 44 ACSR 713, Re McConnell Dowell Corporation Ltd [2003] FCA 646 and Re Challenger International Ltd (2003) 48 ACSR 498. As Mr Oakes observed, it does not appear from the judgment in any of those cases that the decision in Niagara Mining was brought to the court's attention. 8 In an application that came before Gyles J in May of this year, however, the conflict between the approach stemming from Re Austramax and that taken in Niagara Mining was mentioned: see Re Kaz Group Ltd [2004] FCA 738. His Honour dealt with the matter thus: "[T]hese proposals include a creditors' scheme to deal with option holders. That has become a common feature of these schemes and has been considered in a number of cases. I myself have considered it previously and have chosen to follow the predominant line of authority. Counsel for the plaintiff drew my attention to the decision of Lee J in Re Niagara Mining (2002) 47 ACSR 364; 202 ALR 56 in which his Honour, whilst noting that line of authority, elected to give consideration himself to the question as to whether an option holder is a creditor or a member and came down in favour of the view that an option holder is a member. In my opinion, at this stage of this application, it is appropriate I follow what might be called the main stream of authority which dates, at least in New South Wales, from Re Asia Oil and Minerals Ltd (1986) 5 NSWLR 42 and which has been followed (apart from Lee J's decision) fairly universally since then. I do not mean to suggest that the question is not a controversial one but it seems appropriate to follow, as I have said, the main stream." 9 I respectfully agree with his Honour's observations. Optionholders have, over two decades, been regarded in quite a number of cases as creditors for the purposes of s.411 and its predecessor, albeit with varying degrees of judicial reservation. That approach has, in one case, been rejected in favour of the "contingent member" classification. The question of the correct characterization has never been fully argued upon a contested application. All relevant applications have been unopposed, as this one is. It would be inappropriate, at this stage of this proceeding, to do otherwise than follow the clearly predominant trend. 10 The second point in relation to the options is that the voting entitlement of each optionholder is regarded as commensurate with the amount of the consideration for the acquisition of the particular person's options under the scheme, that being seen as the "amount" or "value" of the optionholder's "claim" for the purposes of s.411(4)(a)(i). There are several different series of options outstanding in the sense of various exercise prices coupled with various expiry dates. The consideration will, in each case, be calculated according to the Black-Scholes method. 11 The Black-Scholes option pricing method uses a mathematical formula to ascribe a value to an option by reference to a combination of factors including the applicable share price, the option exercise price, the time until option expiry and rates of return for the time being prevailing in the market. For present purposes, its significant feature is that it can be applied, at a particular time, to options having different exercise prices and different expiry dates so as to produce what are argued to be consistent relativities of value. 12 The description I have just given might be criticized by experts as too simplistic. For present purposes, however, the description is adequate to make me think, first, that its use for pricing purposes (and voting purposes) in the scheme of arrangement context is sufficiently reasonable, at least on a prima facie basis, to allow the proposed scheme in which it plays a part to go forward for optionholders' consideration on the basis proposed; and, second, that its use in this case as a pricing mechanism militates against any possibility that different strike prices coupled with different deadlines for option exercise equate with different classes of optionholders. 13 As to the first of these matters, I would say that if anyone should for some reason think that the particular approach to pricing and valuation involves unfairness, it will be possible for the matter to be raised if and when an application for approval of the scheme concerning options comes back before the court. At this point, no such possibility is so discernible as to cause me to hesitate in ordering that the meeting be convened. 14 In relation to the second matter, that is, the matter of classes, it is always necessary to go back to the question posed by Lord Esher MR in Sovereign Life Assurance Co Ltd v Dodd [1892] 2 QB 573, namely, whether different creditors have "different interests" in the sense that there prevails "a different state of facts existing among different creditors which may differently affect their minds and their judgment …". In the present case, consistent and indiscriminate application of the same pricing or valuation methodology to options having different characteristics in terms of exercise price and expiry, being a methodology that has regard to value criteria in one market at one time, should lay to rest any argument that those different characteristics so destroy community of interest as to indicate different classes. The matter is, to my mind, sufficiently clear to make it appropriate that a single meeting of all optionholders be convened on the basis that separate classes do not exist. Any contrary view can be agitated in due course should anyone see fit to raise it. 15 I mention finally a provision of the deed poll to be made by the external parties, DCA and its wholly owned subsidiary I-Med, in favour of members and optionholders of MIA. The deed poll contains a covenant by which DCA promises to take certain action to reconstitute its own board of directors. The relevant provision is in clause 4.6. It says that DCA must take all actions necessary to appoint three MIA nominees to the board of DCA, one of whom is a named person. 16 It is by no means clear that a company can itself give any effective covenant as to the composition of its own board of directors where the relevant power of appointment to fill vacancies resides with that company's directors. A decision by directors on the question whether they should exercise their power to fill casual vacancies on the board of directors can only be made by reference to particular persons eligible and available for appointment. A number of factors will influence the decision whether it is to the good of the company that a particular person be appointed at a particular time. Directors could not conscientiously (or effectively) fetter their discretion by contracting to appoint whomever a particular third party might in future propose: see the brief discussion on this subject generally in Re NRMA Ltd (2000) 33 ACSR 595 at [109] to [111] referring to Thorby v Goldberg (1964) 112 CLR 597. 17 These considerations alone are sufficient to call into question the effectiveness of the deed poll covenant – apart altogether from the question of the capacity of the company itself to make effective promises as to how its directors will in future exercise powers vested by the constitution in them as directors, as distinct from powers of the corporation exercisable through the instrumentality of the board of directors. Promises of that kind are, of course, distinct in their operation from conditions to which schemes of arrangement are commonly made subject. 18 It has been suggested that if and when the matter comes back before the court for approval of the schemes, it may be possible to produce evidence that the necessary resolutions of the directors of DCA have already been passed on a footing that involves the appointments taking effect automatically after the schemes take effect. That course, if followed, would leave to one side the question of the effectiveness of the covenant. 19 ASIC has confirmed by letter that it has had the requisite notice of these applications, as well as the opportunity for consideration required by s.411(2). At this point, ASIC reserves its position on the s.411(17) question. 20 Short minutes of orders for the convening of meetings of members and optionholders of MIA under s.411, together with ancillary orders, have been handed up. I make the orders in the short minutes. The orders may be taken out forthwith. ********** Last Modified: 08/06/2004 DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated.