Revised draft guidance on rights issues26 March 2018
The Takeovers Panel has released a consultation paper on a rewrite of Guidance Note 17: Rights Issues (GN17). The main amendments to GN17 look to provide clarity on mitigating potential control effects on listed companies and the operation of shortfall facilities. It also clarifies that a rights issue will generally be acceptable if there is a clear need for funds, provided an appropriate dispersion strategy has been implemented.
Submissions on the revised draft GN17 are due by 6 April 2018.
Interaction with other legislative instruments
Under s 606 of the Corporations Act 2001 (Cth) (Corporations Act), a person is prohibited from acquiring a relevant interest in a listed company's voting shares if that person's voting power in the company would increase to above 20% via the transaction, otherwise known as the 20% Rule.
Section 611 of the Corporations Act provides exceptions to this prohibition—in the context of a rights issue, the relevant exceptions are items 10, 10A and 13. These exceptions allow major shareholders of a company to participate in a rights issue without breaching the 20% Rule. In addition, acquisitions by underwriters or sub-underwriters of the rights issue are also exempt from the 20% Rule. For many companies, the only realistic underwriting option may be a major shareholder. Although this is not unacceptable of itself, the company needs to carefully consider a dispersion strategy to mitigate any potential control effects arising from the major shareholder acting as the underwriter.
Although the Panel doesn't seek to narrow the extent of the exceptions, it will scrutinise rights issues and underwriting arrangements that might have a potential control effect on a listed company, in particular, looking closely at any dispersion strategy a company has implemented.
One of the mechanisms commonly used to mitigate potential control effects is a shortfall facility. The revised draft GN17 provides that when offering a shortfall facility, a company should consider:
- allowing shareholders or others the opportunity to apply for extra shares in advance of any allocation to an underwriter
- ensuring any cap on shareholders' participation in the shortfall facility does not materially restrict the ability of shareholders to participate or the effectiveness of the facility to mitigate any control effect, and
- directors should not exercise any discretion in respect of the allocation of shortfall shares in a manner that might exacerbate a potentially unacceptable control effect, except to the extent required to prevent breaches of the Corporations Act or the ASX Listing Rules.
The problem with a shortfall facility is that there is no exception to the 20% Rule for acquisitions made under the facility. This means participation in a shortfall facility might inequitably advantage smaller shareholders who can take up additional shares, over major shareholders who may be prevented from participating by the 20% Rule. This has led to some rights issues being structured to place a cap on participation in the shortfall facility for smaller shareholders, with major shareholders effectively participating in additional entitlements through underwriting arrangements.
The Panel has considered these types of arrangements in the past. In Dromana Estate Ltd 01 and 01R  ATP 8, the Panel found that a discretion to refuse applications under the shortfall facility and a cap imposed in individual shareholders was likely to interfere inappropriately with the acquisition of the control of shares in an efficient and informed market. The issue of capping participation for smaller shareholders was also considered in Virgin Australia Holdings Limited  ATP 15. However, the Panel did not find the arrangements unacceptable in this case, as the capping on shortfall participation "would maintain the relative positions of each of the three largest shareholders and would not disadvantage retail shareholders on a proportionate basis".
The decision in the Virgin case reflects a pragmatic approach by the Panel and may warrant some attention in the submissions made to the Panel on the revised draft of GN17.