Darvallised A-REITs: the takeover implications of redeeming units

A recent revolutionary decision of the NSW Supreme Court will have significant implications for control transactions involving responsible entities of A-Reits and their associates.

Back in the dark ages, before smart phones, way back in 1986, in North Sydney Brick & Tile Co Ltd v Darvall (1986) 5 NSWLR 681 (Darvall’s Case) the NSW Court of Appeal reached the revolutionary conclusion that pre-emptive rights in the constitution1 of a company gave each shareholder control, in a negative sense, over the disposal of all of the shares in the company. This meant that on the facts in Darvall’s Case each shareholder had a “relevant interest” in all of the shares in the target company2 and could, subject to the terms of the pre-emptive rights, buy more shares without making a formal takeover bid.

The RCU Case

Now in a no less revolutionary decision, Re Real Estate Capital Partners Managed Investments Limited as the responsible entity of the Real Estate Capital Partners USA Property Trust [2012] NSWSC 190 unreported 6 March 2013 (RCU Case), White J has found that a provision in the constitution of an A-REIT3 allowing the responsible entity (RE) to redeem the units4 of a unitholder upon request by the unitholder gave the RE a relevant interest in all of the issued units in the A-REIT.5

The RCU Case will have significant consequences on how section 606(1) of the Corporations Act 2001 (Cth)6 (20% Takeover Rule) applies to an A-REIT if its constitution includes a discretionary unit redemption power.7 These consequences include that:

  • An RE of an A-REIT need not make a takeover bid in order to acquire more than 20% of the units in the A-REIT
    Applying the RCU Case, if the A-REIT’s constitution includes a discretionary unit redemption power, the RE will have a relevant interest in all of the units in the A-REIT. Accordingly, the RE would already have a relevant interest in any unit it purchased and so the purchase of the unit would not increase the RE’s voting power and would not breach the 20% Takeover Rule.

  • A person acquiring a relevant interest in more than 20% of the voting shares in8, or control of9, an RE would breach the 20% Takeover Rule
    The person by acquiring such a relevant interest in, or control of, an RE of an A-REIT would be deemed to have the same relevant interests as the RE and so the person’s voting power in the A-REIT would increase from 0% to 100%.10

Further, applying a parity of reasoning, if a constitution of a company includes a provision that a company must consider a request for a buyback from a shareholder, subject to complying with the buyback restrictions in Division 2 of Chapter 2J of the Corporations Act, the concentration of voting power consequent upon the buyback is not prohibited by the 20% Takeover Rule.11 Interesting conclusions?12 Read on.

Background

The fact pattern in the RCU Case was unusual.

The short version of the story is that following the sale of the main undertaking13 of Real Estate Capital Partners USA Property Trust (ASX Code: RCU), a 34% unitholder (Major Unitholder) sought a change of RE and a new investment mandate for RCU. Some institutional unitholders with a combined unitholding of around 20% requested that the RE of RCU, Real Estate Capital Partners Managed Investments Limited (RMIL), redeem their units in RCU (RCU Units) based on net asset value.14

The institutions relied upon clause 7.11 of the constitution of RCU (RCU Constitution) which provided that:

Subject to the Corporations Act and the Listing Rules,15 if the [RE] is not obliged to give effect to a redemption request, it may redeem or repurchase some or all of the Units which are the subject of the request. If the Trust is a Registered Scheme the discretion conferred on the [RE] by this clause may only be exercised while the Trust is Liquid.

RMIL applied to the NSW Supreme Court seeking judicial advice that it would be justified in:

  • inviting all RCU unitholders (RCU Unitholders) to request redemption of their RCU Units (Redemption Invitation)
  • redeeming RCU Units (Redemption Units) the subject of redemption requests received by RMIL (Redemption Requests).

The Major Unitholder opposed the redemptions. Its position was that the capital of RCU should be kept intact and redeployed and that liquidity was provided to RCU Unitholders through the ASX listing of RCU and the ability to trade RCU Units on-market.

Before White J, the Major Unitholder submitted that redeeming the Redemption Units would breach the 20% Takeover Rule as it would result in RMIL acquiring a relevant interest in the Redemption Units and then redeeming them. The relevant interest would arise from RMIL as RE having power to dispose of, or to control the exercise of a power to dispose of, the Redemption Units - the disposal being the buy-back or redemption of the Redemption Units by RMIL or the disposal of the Redemption Units by the RCU Unitholder16. The redemption would increase the concentration of the Major Unitholder’s holding of RCU Units (already over 20%) and therefore increase its voting power.17

White J rejected the submission and found that RMIL, as RE of RCU, already had a relevant interest in all of the RCU Units and therefore voting power of 100% in RCU. Accordingly, no breach of the 20% Takeover Rule would occur if the Redemption Units were redeemed because after the redemption RMIL’s voting power would remain at 100% of the then issued RCU Units.

White J’s judgment in the RCU Case on the takeover’s issues

White J gave two reasons for his decision that the redemption of RCU Units pursuant to the Redemption Invitation was not prohibited by the Corporations Act:

1. The 20% Takeover Rule does not apply to the redemption of units
In his Honour’s view, the takeover provisions only apply with respect to an A-REIT as if it were a notional company. He held that those provisions do not regulate the redemption of units because, unlike an A-REIT, a company could not redeem its shares without complying with the capital reduction provisions.

2. RMIL already had 100% voting power in RCU arising from the discretionary unit redemption power in RCU’s constitution
In his Honour’s view, section 608(8) accelerated the time at which RMIL acquired a relevant interest in the Redemption Units to the time the units were issued pursuant to the constitution. His Honour reasoned that:

  • each unitholder has a relevant interest in the units issued to that holder
  • that person has been given an enforceable right by another person, namely, RMIL in relation to the securities (being the right to have RMIL give due consideration to a redemption request)
    the right to have a redemption request considered is a right “in relation to” the units sought to be redeemed
  • if the unitholder obliges RMIL to give due consideration to the request, RMIL would acquire a relevant interest in the units because it would then be within its power to dispose of the units by agreeing to the request and effecting the redemption
  • accordingly, all of the conditions of s 608(8) would be satisfied from the time the units were issued pursuant to the Constitution. RMIL would have a relevant interest in all of the units. It would not acquire a relevant interest on receipt of the redemption requests.18

It  may be that the facts in the RCU Case are unlikely to be repeated. Nevertheless, the novel conclusions that can be reached applying the reasoning in the case may cause some interesting ripples.

Henry Davis York acted for the Major Unitholder in the RCU Case.

1  In fact, it being the dark ages, the pre-emptive provisions were included in the articles of association of the company.
2  The result of Darvall’s Case was subsequently reversed through law reform. See section 609(8) of the Corporations Act 2001 (Cth).
3  An Australian Real Estate Investment Trust, being a managed investment scheme admitted to the Official List of ASX Limited (ASX).
4  References in this article to units in an A-REIT are references to voting interests (as defined in the Corporations Act 2001 (Cth)) in the A-REIT.
5  In the RCU Case White J also made important findings as to the requirements that a constitution of a registered managed investment scheme contain “adequate procedures” for any withdrawal rights.
6  References in this article to sections are references to sections of the Corporations Act 2001 (Cth).
7  This is the case, as it was in the RCU Case, even if that discretionary redemption power is conditional on the AREIT being liquid for the purposes of section 601KA and on the relevant unitholder requesting the redemption.
8  See section 608(3)(a).
9  See section 608(3)(b).
10  This follows from White J’s conclusion in the RCU Case that the RE has 100% voting power in the A-REIT arising from a discretionary unit redemption power. Note though that although on the change of an RE the incoming RE’s relevant interest in units in, and voting power in, the A-REIT would increase from 0% to 100% on its appointment, there would not be a breach of the 20% Takeover Rule as the acquisition of the relevant interest would not be “through a transaction in relation to securities” (see section 606(1)(b)).
11  Which would mean the operation of the exemption in item 19 of section 611 for buy-backs by companies is limited to situations in which no such right is included in the target company’s constitution.
12  Applying White J’s reasoning there is also doubt over whether the substantial holder provisions would apply given that the obligation applies to an A-REIT if the relevant substantial holder “begins to have” a substantial holding (see section 671B(1)). Based on White J’s reasoning the RE would have 100% voting power before the managed investment scheme was registered and became an A-REIT to which the substantial holder provisions apply.
13  RCU received cash on the completion of the sale of illiquid property assets. Accordingly RCU was “Liquid” for the purposes of clause 7.11 of RCU’s constitution and section 601KA.
14  The institutions’ alternative exit from their investment in RCU would have been to attempt to sell their RCU Units on the ASX on which RCU Units were trading at a significant discount to net asset value and on low trading volumes.
15  ASX did not object to the proposed redemption of RCU Units (see Condition 5, Listing Rule 1.1, which clause 7.11 of the RCU Constitution, in part, tracked).
16  If RMIL redeemed the Redemption Units obviously the RCU Unitholder would be unable to sell them and so, in a negative sense RMIL could control the exercise of a power to dispose of them.
17  It was unusual for a major unitholder to argue that the RE should not take steps which would have the effect of increasing the major unitholder’s voting power in the A-REIT without unitholder approval, the making of a takeover bid or another specific exception to the 20% Takeover Rule applying.
18  According to White J, the RE would automatically acquire a relevant interest in any new units in the A-REIT upon issue but would not breach the 20% Takeover Rule because before and after the issue the RE’s voting power in the A-REIT would be 100%.