Rights issues have played an important role in enabling companies to reduce debt given recent global financial instability. However, this dilutes the interests of shareholders who do not take up their right to subscribe for additional shares, with the impact increased where the shares are offered at a significant discount. This is particularly concerning where the rights issue delivers control to a particular shareholder or increases their level of control. The effect on control is likely to be worse in a non-renounceable issue, where shareholders cannot sell their rights and allow other investors to take up the option to purchase the new shares.

Problems also arise where a person who already has a substantial interest in the company or is a related party acts as an underwriter to the rights issue. The Takeovers Panel (Panel) has in recent times relied on dispersion strategies to minimise the risk of the underwriter or others acquiring control. For example, a “shortfall facility” allows members to subscribe for the shares or units not taken up by other members, which is usually done prior to determining the shortfall that is subject to the underwriting agreement. A “back-end bookbuild” can similarly be conducted to disperse the rights not taken up through an offer of securities, with the allotments and issue price determined by bids made by investors.

There is a clear conflict in the application of the fundraising and takeover provisions in the Corporations Act 2001 (Cth) to rights issues. Companies need to be able to raise funds subject to the disclosure requirements in Chapter 6D. Consequently, there are exceptions to the takeover prohibition allowing certain rights issues and underwriting of fundraising in items 10 and 13 of section 611. However, irrespective of whether a rights issue complies with these exceptions, the Panel must decide whether matters brought before it involve unacceptable circumstances based on the purposes of the takeover provisions in Chapter 6. Set out in section 602, these purposes include the underlying policy of ensuring that acquisitions of control take place in an “efficient, competitive and informed market” and that members of the company have a “reasonable and equal opportunity to participate in any benefits” arising from the acquisition of a substantial interest in the company.

Highly dilutive rights issues are particularly problematic as a high ratio of shares is issued compared to the number of existing shares. Shareholders consequently need to purchase a large number of shares relative to their current shareholding in order to maintain their proportionate interest in the company. If they do not take up their entitlement in full, the large number of shares to be issued to other shareholders will magnify the control effect. There have only been a handful of Panel decisions that have been based on a rights issue with a ratio above 1:1 since the Panel became the primary forum for resolving takeover disputes in 2000. This is significant given that ASIC states in Regulatory Guide 159: Takeovers, Compulsory Acquisitions and Substantial Holding Notices that a “high ratio may suggest an abuse of item 10” of section 611.

In the first decision involving a highly dilutive rights issue, the Panel declined to make a declaration of unacceptable circumstances in Anaconda Nickel Limited 02-05 [2003] ATP 4. The rights issue in that case had a 14:1 ratio and a very high discount of nearly 80% to the market value of the shares. It was also renounceable and fully underwritten. Although the Panel considered the dilution and discount to be “most unusual”, it accepted that only alternative seemed to be the company’s failure given its “severe and urgent” need of funds and that the underwritten offer was the only viable source. Significantly, the Panel also referred to the fact that it considered the underwriting arrangements to be a “bona fide financing agreement to ensure the survival of Anaconda, rather than a disguised takeover”.

A rights issue with a massive 178:1 ratio was allowed to proceed in Multiplex Prime Property Fund 03 [2009] ATP 22, with the Review Panel agreeing with the outcome in Multiplex Prime Property Fund 03R [2009] ATP 23. The Multiplex Prime 03 Panel was initially minded to make a declaration of unacceptable circumstances, given the ratio, the lack of a discount, renounceability and dispersion strategies, and the fact that the shortfall would be taken up by an underwriter who was a related party to the responsible entity for the scheme raising the funds. Despite this, the Multiplex Prime 03 Panel reluctantly allowed the rights issue given that the Multiplex scheme had an urgent need for funds and was facing a fixed financial deadline. In contrast, the Multiplex Prime 03R Panel indicated that it might not have needed the fixed financial deadline to find the rights issue acceptable. Notwithstanding the urgent need for funds, the eventual inclusion of a shortfall facility and backend bookbuild was vital to the decision to accept the issue. Both Multiplex Prime Panels emphasised that the decision had resulted in an “open-ended” dispersion strategy. This appears to be referring to a dispersion strategy that is not subject to an inappropriate limitation, such as a cap or discretion that would affect a subscriber’s ability to participate.

In Powerlan Limited [2010] ATP 2, the Panel declined to make a declaration of unacceptable circumstances in relation to a renounceable issue with a ratio of 4:1 and a discount of 40%. The issue was partially underwritten and included a shortfall facility, which was initially subject to a discretion allowing the directors to decide upon the allocation of the shortfall shares. Crucially, the company undertook to remove this discretion so that the shortfall facility distributed shares to applicants on a proportionate basis. The Panel also concluded that the company needed “some, if not all” the funds and accepted that the high issue ratio had resulted from its weak financial position and high gearing. However, the control effect in Powerlan was less significant than in Multiplex Prime 03 and Gladstone Pacific Nickel Limited 02 [2011] ATP 16, with the most extreme scenario in Powerlan involving the largest shareholding increasing from 40.25% to 47.63%.

The most recent decision in Gladstone Pacific 02 presented troubling circumstances for the Panel. A very high issue ratio of 11:1 was accompanied by a large discount (estimated to be in the range of 66% to 90%), but without any renounceability, underwriting or other dispersion strategies. This could have led to a substantial control effect with the interests of related companies potentially increasing from 56.4% to 93.9%. The Panel also did not consider the company’s reasons for the rights issue to be either urgent or compelling. Given the ratio and pricing of the issue, the Gladstone Pacific 02 Panel concluded that the control effects were unlikely to be minimised even if a dispersion strategy were included. Although the rights issue in Gladstone Pacific 02 involved a significantly lower ratio than in Multiplex Prime 03, the transaction in Gladstone Pacific 02 was tainted by concerns held by ASIC and the Panel that that the “ultimate purpose” of the fundraising was to effect a change in control. Despite the seriousness of this case, the Panel did not make a declaration of unacceptable circumstances (or costs orders), due to the withdrawal of the rights issue prospectus.

Changes made to the Panel’s Guidance Note 17: Rights Issues since Multiplex Prime 03 reinforce that the circumstances surrounding each rights issue must be evaluated in light of the factors set out in the Guidance Note. These factors relate to the structure of the rights issue, its effect on control and the company’s situation. This highlights the difficulties involved in attempting to formulate bright-line tests in this area. However, the above decisions and Guidance Note make it clear that it is particularly important to demonstrate a clear need for the funds in the case of large rights issues. Although the Guidance Note no longer refers to the purpose or motive of the issue in determining whether there are unacceptable circumstances, this was still relevant to the decisions in Anaconda 02-05 and Gladstone Pacific 02. Dispersion strategies can also play a vital role in minimising concerns relating to the effect of rights issues on control, except in extreme circumstances such as Gladstone Pacific 02. This is reinforced by the emphasis placed on the introduction of an “open-ended” dispersion strategy in the Multiplex Prime decisions.

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For a detailed discussion of these issues, see Emma Armson, “Testing the limits of highly dilutive rights issues” (2012) 30 Company and Securities Law Journal 405.