In part one of this series – No shortcuts to control: The Takeovers Panel slams the door on constitutional drag-alongs – we examined the Takeovers Panel’s landmark declaration in Mobile Asset Holdings Ltd, which confirmed that drag-along provisions in a public company constitution give rise to unacceptable circumstances.. That decision raised a broader question: how should shareholders in public and private companies structure their governance arrangements and control transactions to stay on the right side of the Corporations Act 2001 (Cth)?
In part two, we consider whether public companies can have shareholders’ agreements at all, how control transactions should be structured, and the traps that arise for companies seeking to bind members to pre-agreed exit mechanisms.
Need to know:
- Provisions in a shareholders’ agreement for a public company with more than 50 shareholder that give a party the power to control the disposal of shares can create ‘relevant interests’ that breach the prohibition on acquiring control set out in section 606 of the Corporations Act.
- For public companies with more than 50 shareholders, control transactions must be structured as a takeover bid under Chapter 6 or a scheme of arrangement under Part 5.1 — there is no practical shortcut through constitutional or contractual mechanisms.
- For private companies, drag-along and tag-along rights remain effective where shareholders consent to being bound by the constitution on application for shares (addressing section 140(2)) or execute an accession deed to a shareholders’ agreement which contain such provisions.
Following the Mobile Asset Holdings Declaration, market participants have asked whether including drag-along and tag-along rights in a shareholders’ agreement for a public company, rather than embedding them in the company constitution, might avoid the problems identified in that decision. The short answer is that it does not.
A shareholders’ agreement containing drag-along provisions or other mechanisms that give a party the power to control the disposal of another party’s shares will create a ‘relevant interest’ under section 608(1)(c) of the Corporations Act. That section provides that a person has a relevant interest in securities if they have the “power to control the exercise of a power to dispose of” those securities. A drag-along right, by its nature, gives the dragging shareholders precisely this power. Section 608(2) broadens the scope of ‘power or control’ to include agreements (whether or not they are enforceable).
Section 608(8) goes further. If a person already has a relevant interest in shares and enters into an agreement with another person in respect of those shares, and the other person would have a relevant interest if the agreement were performed, then the second person is taken to already have a relevant interest. In practical terms, this means the relevant interest problem arises even before any rights are exercised.
The section 606 problem with shareholders’ agreements
Where a public company has more than 50 members, section 606 prohibits the acquisition of a relevant interest that takes a person’s voting power through the 20% threshold (or from above 20% to a higher point, below 90%) unless an exception applies. A shareholders’ agreement entered into by shareholders collectively holding more than 20% of the company’s shares may, on execution, give rise to relevant interests in each other’s shares by virtue of the power to control disposal. There is an argument that any shareholders’ agreement would result in each of the parties becoming ‘associates’ for the purposes of section 12(2)(c) of the Corporations Act and immediately gaining a relevant interest in each others’ shares. However, the better view is that those provisions must be read subject to the broader purpose of Chapter 6, and accordingly, parties to a shareholders’ agreement would only become associates if the specific provisions confer control. That said, it is uncontroversial that any shareholders’ agreement containing drag-along, tag-along, powers of attorney, buy-out rights or any other provisions that seek directly or indirectly to control the disposal of shares will fall foul of Chapter 6.
Are any exceptions available?
Member approval under item 7 of section 611 faces the same practical difficulties identified in Mobile Asset Holdings Limited. Any shareholder who would acquire voting power under the agreement would be excluded from voting in favour of the resolution (absent ASIC relief), and ASIC’s policy is that it is unlikely to grant such relief where a takeover bid or scheme of arrangement is available as an alternative. In short, while technically available, the exception is unlikely to be practical.
The Takeovers Panel’s approach in Mobile Asset Holdings, while directed at constitutional provisions, is consistent with its broader policy that arrangements having the effect of circumventing Chapter 6 will give rise to unacceptable circumstances – regardless of the legal mechanism employed. A shareholders’ agreement that replicates the effect of a drag-along in a constitution is, in substance, no different. The Panel will look through form to substance.
Structuring control transactions
Given these constraints, how should control transactions be structured in practice? The answer depends on whether the target is a public or private company.
Public companies
For public companies with more than 50 members, the position is clear: a control transaction must follow Chapter 6. In practice, this means either a takeover bid (off-market or on-market) or a scheme of arrangement under Part 5.1 of the Corporations Act. Each mechanism provides the protections that Chapter 6 is designed to ensure – equality of opportunity, adequate disclosure, and fair value for shareholders.
The Mobile Asset Holdings Declaration confirms that there is no alternative path. Attempts to pre-agree exit mechanisms through constitutional provisions or shareholders’ agreements will not withstand scrutiny where they have the effect of circumventing Chapter 6.
Private companies
For proprietary companies, the position is different. Section 606 does not apply to proprietary companies (or unlisted public companies with fewer than 50 shareholders). Drag-along and tag-along rights are commonplace and effective in this context, but the mechanism by which members are bound requires careful attention.
Where drag-along rights are contained in the company’s constitution, section 140(2) of the Corporations Act is the critical provision. It provides that a modification of a company’s constitution imposing or increasing restrictions on the right to transfer shares does not bind a member in relation to shares already held unless the member agrees in writing. Put simply, a constitutional amendment inserting drag-along rights after shares have been issued will not bind existing shareholders without their individual written consent.
The practical solution is to ensure that members consent to be bound at the point of acquiring their shares or at the point where the drag-along rights are included in the constitution (if later). This is typically achieved by including in the share application form an acknowledgement that the applicant has read the constitution and agrees to be bound by its terms, including any restrictions on the right to transfer shares. For existing shareholders at the time of a constitutional amendment, individual written consent must be obtained — a special resolution alone is not enough to bind them in respect of shares already held.
Alternatively, drag-along and tag-along rights can sit in a shareholders’ agreement. The advantage of this approach is that it operates as a contract between the parties, and new shareholders can be bound by executing an accession deed as a condition of the share transfer or issue of shares being registered.
The choice between a constitutional mechanism and a shareholders’ agreement is largely a matter of commercial preference. A constitution binds all members by virtue of section 140(1) (subject to section 140(2)), whereas a shareholders’ agreement only binds its parties. However, a shareholders’ agreement can offer greater flexibility. Regardless of the chosen approach, it is important, particularly for private equity and venture capital investors, to ensure that shareholders are properly bound to drag-along rights, as a failure to do so opens a company up to a real ‘green-mail’ risk.
Additional considerations
Unlisted public companies with more than 50 shareholders present unique challenges. They are subject to Chapter 6 but may lack the liquidity and market mechanisms that facilitate takeover bids for listed companies. A scheme of arrangement may be the more practical path for control transactions involving these companies, as the scheme thresholds are based on shareholders who attend and vote (rather than the fixed 90% threshold for compulsory acquisition under a takeover bid).
For unlisted public companies with a shareholder base slightly above 50, a reduction in the number of shareholders may be worth considering. One of the ways to achieve this is to request that a number of shareholders transfer their shares to a trustee to be held under a bare trust arrangement.
Once the shareholder count is reduced, the company is no longer subject to Chapter 6, and drag-along and tag-along provisions can be implemented through the mechanisms described above.
The position is now clear: for public companies, there is no contractual or constitutional mechanism that can replicate the effect of a control transaction outside Chapter 6. Shareholders’ agreements face the same relevant interest issues as constitutional drag-along rights, and the Takeovers Panel will look through form to substance. For private companies, drag-along rights remain effective and enforceable — provided members are properly bound.
Hamilton Locke’s M&A and Capital Markets teams regularly advise on the structuring of shareholders’ agreements, constitutional provisions and control transactions across public and private companies. We are happy to assist with any questions arising from this article or the Mobile Asset Holdings Declaration discussed in part one of this series.
For more information, please contact Brett Heading, Benny Sham, Peter Williams or Irfaan Rashid.
