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The information to be sent to target shareholders seeking their approval of a scheme of arrangement is required to include whether or not each director recommends approval of the scheme; or if a director does not wish to make (or consider they are justified in making) a recommendation, the reasons for not wishing to do so.
A bidder will typically require the target to agree in the Implementation Agreement for a proposed scheme that all target directors will recommend approval in the absence of a higher offer and – in the usual case – subject to an independent expert opining that the scheme if fair and reasonable and in the best interests of shareholders.
Gazal Corporation scheme
Gazal Corporation Limited (Gazal) was an ASX-listed company. The two largest shareholders were its Executive Chairman, Michael Gazal, with approximately 40%, and PVH Corp. (PVH) with approximately 22%. Gazal’s main business was a joint venture with PVH to distribute a number of PVH-owned brands in Australia, including CALVIN KLEIN and TOMMY HILFIGER.
PVH sought to acquire the 78% of Gazal that it did not already own via a scheme of arrangement.
The Implementation Agreement required that all Gazal directors recommend that shareholders vote in favour of the scheme (subject to the qualifications noted above).
Recommendation by Managing Director
Gazal had agreed with the Managing Director Pat Robinson that he would receive a bonus of $1.6 million if the scheme were implemented. The scheme booklet disclosed this in a number of places so that shareholders could take that into account.
Gazal’s approach was consistent with that of the Supreme Court of Victoria (Robson J) in Re SMS Management & Technology Ltd. The managing director of SMS Management was to receive a bonus if the scheme were implemented. The managing director made a recommendation to shareholders and ASIC expressed concern with that. However, Robson J considered it appropriate that the Managing Director make a recommendation as the “main moving force behind the company”.
The Gazal scheme was overseen by Justice Farrell in the Federal Court. Farrell J approved the scheme but commented that it would have been “better practice” for Mr Robinson to decline to make a recommendation for the reason that he would be receiving a benefit which other shareholders would not receive. That said, Farrell J considered it appropriate for each director (including any interested director) to provide a statement of their voting intentions.
Duty to give a recommendation? Or to avoid giving one?
If a target company director has a conflict of duties, the director should usually refrain from providing a recommendation. For instance, where the bidder is already represented on the target’s board by one of its own executives, the executive’s duties to the target (as a director) may be impossible to reconcile with their duties to the bidder.
It is less clear that a director should refrain solely because of a different pecuniary interest in the outcome of the scheme – provided that the director’s interest is clearly disclosed. It may be considered the responsibility of such a director to provide shareholders with that guidance, particularly where the director is one of the main moving forces behind the target company (as was recognised in SMS Management). If there is clear disclosure of any additional benefit to a director, shareholders can take that into account in assessing the weight to be given to the director’s recommendation.
To use an inverted example, if a managing director were minded to recommend that shareholders reject a hostile takeover bid, the likelihood that the managing director will be made redundant following the takeover (if successful) should not mean that they should be disqualified from recommending against.
But not all different director interests will disqualify a recommendation
It was a condition of the Gazal scheme that certain ‘key managers’ – including Mr Robinson and the Executive Chairman (and major shareholder) Michael Gazal – would agree to ‘roll over’ one quarter of their respective Gazal shareholdings into a newly-incorporated bid vehicle (Bidco) which would be majority owned by PVH. The key managers would then agree to sell their Bidco shares back to PVH in two tranches over the following two years. If the business underperformed, the sell-back price would be lower than the price received by other shareholders. If the business outperformed the sell-back price would be higher.
Farrell J did not suggest in the written decision that these ‘key manager’ arrangements should give pause to Mr Robinson and Mr Gazal in making a recommendation. However, at the first hearing (to order the scheme meeting) Farrell J observed that the ‘key manager’ arrangements could be considered akin to a carry-over of their long term incentive arrangements as senior executives of Gazal and as such were not a concern in this regard.
Farrell J approved the Gazal scheme notwithstanding her Honour’s view that it would have been “better practice” for Mr Robinson to decline to make a recommendation. Nevertheless, Farrell J’s comments should be borne in mind in future scheme negotiations:
In my view, the question of whether it is appropriate for all directors to make a voting recommendation should be considered at the time a scheme implementation agreement is executed and conditions crafted appropriately. While it may be true that it has become a common practice for a bidder to require unanimous and unqualified recommendations from the directors of the target company, that “practice” does not justify the bidder and the directors of the target failing to address the circumstances of each individual case.
In the absence of further authority, it would be prudent to follow the more conservative approach of Farrell J in Gazal where possible, notwithstanding Robson J’s comments in SMS Management and the discussion above.
A middle ground may be for all directors to provide a recommendation, but to give greater prominence to the disinterested directors’ recommendation and ensure that any time an interested director’s recommendation is referred to, the interest of that director is noted for shareholders to take into account. This might follow a two-step process that is also disclosed to shareholders – where the disinterested directors formulate the recommendation and reasons for and against it, without the interested directors influencing those assessments, and the interested director then confirms whether they agree.
 Clause 8301(a) of Schedule 8 of the Corporations Regulations 2001 (Cth).
 Re SMS Management & Technology Ltd  VSC 257 at .
 At .
 Re Gazal Corporation Limited  FCA 701 at -.
 A possible compromise is described at the end of this note.
 Re Gazal Corporation Limited  FCA 701 at .
This piece is designed to prompt thoughts of what changes may be required in private M&A documents in order to accommodate and allocate risks relating to COVID-19 and the fallout from this pandemic.
ASIC and ASX have both announced temporary changes to their respective regulatory regimes to facilitate capital raisings for listed entities in response to the economic impact of COVID-19.
Times are changing rapidly with the current flow of Coronavirus measures introduced to support businesses in debt and distress.