Schemes of Arrangement – CSR’s Demerger Effort Thwarted by Objections Regarding Its Pote
What a great legal term of art – "scheme of arrangement." The term has multiple but related nuanced meanings and applications because "schemes" are essentially corporate law opportunities to end or alter the business life or structure of a corporation. Depending on the nation and the particular use, schemes may have varying outcomes when used in the diverse ways that are possible in the various nations that arise from the former British Empire.
This post focuses on an attempted "scheme" under Australian corporate law. In this instance, the scheme consists of the efforts of a public company, CSR, to move forward with a "demerger" (a "spin-off" in the US) that would split one public company into two "more focused" public companies. Only one of the emerging companies would, they hope, be liable for asbestos bodily injury or property damage claims that will or may arise from past ownership of a crocidolite mine and sales of various asbestos-containing products. Thus, by dividing the company into two pieces. the proposed demerger would reduce the amount of corporate assets available to pay the current and potential future asbestos claims that arise from past business operations. The opinion explains the numbers as follows: "In its financial statements for the half year ended 30 September 2009 CSR has recognised a provision of A$446.8 million for current and future asbestos liabilities. This comprises 10% of CSR’s total assets as at 30 September 2009 but, based on the pro forma balance sheet produced by CSR as at 30 September 2009, would comprise 18% of New CSR’s assets at that date."
To date, the scheme has not succeeded because the trial judge hearing the petition agreed with objections involving the ability to pay future asbestos claim expenses. Who were the objectors ? According to the opinion, " The proposed capital reduction has prompted considerable interest in, and opposition to, the Scheme. This was evidenced by the Australian Securities and Investments Commission (ASIC) and a number of objectors seeking, and being given, leave to intervene in the proceeding when it first came before the Court on 17 December 2009. The matter was then adjourned to allow the objectors and ASIC time to obtain expert assistance in reviewing the Scheme. The objectors were [underlying case co-defendants ] James Hardie Industries NV and James Hardie 117 Pty Limited (together "James Hardie"), the Asbestos Injuries Compensation Fund Limited (under NSW administered winding up), AMACA Pty Limited (under NSW administered winding up) and AMABA Pty Limited (under NSW administered winding up) (together "AICF") and the Attorney-General for the State of New South Wales (NSW). The objectors all opposed the Scheme and argued against the Court making the orders sought by CSR. …ASIC and the objectors were concerned only with potential prejudice to asbestos claimants, that is persons who now have, or in the future may have, a claim for compensation from CSR for injury sustained from exposure to asbestos." The trial court opinion rejecting the scheme certainly was less enjoyable for management than a successful 2003 scheme, The CSR scheme is interesting on a comparative law basis and a social basis. Thus, in the US, companies have often enough spun off liability-laden entities without the SEC and other entities seeking to block the spin-off, and instead simply reacting later, as was done with Tronox. In contrast, the objections here were a subject of popular media coverage as to objections of the Australian Securities and Investment Commission, regional Australian governments, and the various James Hardie interests that arise from James Hardie entities being co-defendants in underlying asbestos cases. The objections by co-defendant Hardie entities also are noteworthy in view of Hardie previously undertaking to create a foundation to manage and pay for its own asbestos litigation and then moving from Australia to the Netherlands as part of it’s own asbestos-related scheme, a move more recently followed by Hardie moving from the Netherlands to tax-haven Ireland. Moreover, some of Hardie’s officers and directors recently were convicted of criminal securities law violations arising from public statements on estimates of future asbestos expenses (this prior post links to the opinion/judgment) because the trial judge appears not to have believed the testimony of the directors. And as described yesterday, Hardie and CSR apparently now are quarreling over their respective obligations in particular asbestos cases.
Another noteworthy part of the opinion revolves around certainty. Thus, the opinion refers to a suggestion that the 2d demerger entity provide a guarantee for the entity holding the asbestos liabilities. See paragraphs 37-38. That suggestion was rejected, and thus the trial judge wrote: " I understand that CSR did not regard the suggestion as attractive. Its submissions in reply noted that the proposal "would significantly alter the commercial characteristics of the proposed demerger". In particular it was said that the proposal would subject Sucrogen "to a contingent liability over which it had no effective control, which had no correlation to its business revenue and which offered no commercial return or benefit". Thus, CSR’s response seems to illustrate a reality I mentioned yesterday in the context of entities emerging from bankruptcy : bankers and investors will always want and seek a predictable free cash flow to sell at a multiple.
The other side of that coin, however, is that the court was unwilling to give the business entities the certainty they want. Why? Because past conduct created enormous uncertainties for exposed persons, and unless science can change the outcomes, thousands of the currently uncertain individuals will in the future suffer painful deaths from mesothelioma, a point raised explicitly by counsel for the New South Wales region. Thus, the trial judge explained:
"There is one last issue to be addressed, namely the submissions made for NSW. Mr Oakes SC who appeared for NSW stated that from his client’s point of view the central issue is: [W]ho in the future should bear the risks if asbestos claims projections are too low, or that actual cash flow is too low because of the inherent uncertainties in long-term earnings and cash flow forecasts … ? So the question is: should the risks be borne by the businesses that currently comprise the CSR group and, thus, indirectly by the CSR shareholders, or should the risks be borne by the current and future asbestos claimants? Our submission is the risks shouldn’t be borne by the current and future asbestos claimants …
A final point. The opinion is frustrating because it alludes to various expert future expense predictions submitted by the parties, but does not go into detail, deeming the information confidential. As a lawyer for corporations, I understand the desires and arguments for secrecy. That said, the law develops through precedent, and it’s much harder to apply and learn from precedent when crucial facts are not on the public record and are not explicitly addressed in the opinion. Courts and companies face difficult issues ahead in trying to balance the competing considerations as to secrecy. Set out below are the statements the court did put on the record regarding the predictions of future expenses.
"Analyses of expert reports 31. It is not possible to give detailed analysis of the confidential reports, however, the flavour of the debate is reflected in submissions made on behalf of those commissioning the various reports. For example, the written submissions for ASIC contain 12 pages of detailed analysis of the actuarial material concerning asbestos liabilities and financial stress testing. The submissions analyse the CSR actuarial material including the expert reports and advice provided by Taylor Fry and Navigant, the expert reviews of that material by KPMG and Ernst & Young as well as the response of the CSR advisers. The submissions set out ASIC’s conclusions in relation to the actuarial material as follows: First it is self evident that there is considerable uncertainty surrounding any process of actuarially assessing future asbestos liabilities. Notwithstanding that CSR ceased involvement in asbestos related activities in 1977 both [Taylor Fry] and Navigant have continually being [sic] revising their central estimates upwards from 2004 based on new information that emerges. Second, as described above, there are limitations on the scope of the actuarial assessments which have the potential to under estimate the overall valuations. Third, within the actuarial assessments there are significant matters of judgement over which reasonable minds may differ and which have considerable potential to adversely and materially affect the valuations. This is exemplified by the differences in professional opinion between KPMG and Taylor Fry in relation to both the central estimate and the 95th percentile estimate of the Australian liabilities. Fourth, ASIC submits that in determining this application the Court need not embark upon the task of determining which expert is "correct" or to be preferred. Instead it should note the differences of professional opinion but, in the context of determining the application based on the approach outlined above, it should afford significant weight to the views expressed by KPMG at least so far as they affect the 95th percentile estimate provided by [Taylor Fry]. KPMG have significant expertise in the area and they have provided a detailed rationale for their opinion on these issues. Their views at least so far as they affect the 95th percentile estimates are supported by [Ernst & Young] and, in some limited respects, by Finity. 32. The submissions also analyse the financial stress testing that CSR had undertaken and the Ernst & Young review of this stress testing. The conclusion is stated as follows:
A review of the material concerning the financial analysis and stress testing undertaken by and on behalf of CSR reveals that there are a number of aspects of uncertainty surrounding such an exercise mainly: (i) The obvious uncertainties that arise from any exercise of financial modelling the future performance of any business especially in the context of measuring its ability to meet long tail liabilities such as those that arise from asbestos use; (ii) The limited external scrutiny of the assumptions and workings of the 5 year and 20 year financial models prepared by CSR management, the inputs to which most always primarily originate from CSR’s management; (iii) The judgements involved in identifying the various risks to the business, the relevant parameters for the "shock testing" and the exclusion of other forms of risk …; and (iv) The absence of any testing of the combination of a prolonged downturn and the high case estimates and the related questions of judgement as to whether it would be feasible for New CSR to respond to the various risks to the business under the shock scenarios that were stress tested. 33. CSR’s submissions in reply make the following comments about the submissions made by ASIC: In its written and oral submissions, ASIC … sought to stress the uncertainties and limitations inherent in actuarial analyses of future events. Such a submission should not be taken too far. By definition, any assessment of possible future events involves uncertainty and any attempt to actuarially assess such events will be subject to limitations. As the Court noted in argument, such uncertainties and limitations are equally applicable to CSR in its current structure as they are to CSR post-demerger. Provided that the advice provided to the CSR Board has been shown to be reasonable, the fact that the advice is subject to uncertainties does not warrant a conclusion that the advice should be rejected or lacks persuasive force. Further, … the doubts and uncertainties and the differences between the actuarial experts are of no relevance in circumstances where CSR’s analysis has taken account of the full range of actuarial opinion. Cash outflows associated with the asbestos-related claims have been projected having regard to all "reasonable hypotheses". Further, no party has sought to demonstrate a flaw in the other principal aspects of that analysis, namely the projection and "stress testing" of future cash inflows from CSR’s de-merged business operations. That aspect of the analysis has been reviewed by PWC. It has also been reviewed on behalf of ASIC by [Ernst & Young] without unfavourable comment. In the light of the above, and as there is no correlation between risks attending the projected business cash inflows and the risks of under-estimation of the asbestos related cash outflows, the analysis provides a very high level of comfort that asbestos claims will be met. ASIC’s submissions should be read with this in mind. Its submissions are open to the criticisms that: • they fail to reflect the conclusions of their own expert; • they place undue focus on limitations and uncertainties that no actuary (including KPMG) can avoid without regard to the conclusions ultimately stated by the experts; • they overstate the significance of the limitations and uncertainties … 34. In addition to these criticisms CSR made detailed submissions in tabular form responding to the submissions made by AICF. Those submissions confirm that there is a genuine dispute between the experts as to the appropriate way to assess New CSR’s ability to meet future asbestos claims. The submissions made on behalf of James Hardie echoed the submissions of ASIC and AICF as well as making some additional criticisms of the provision made for New CSR to meet future asbestos claims. 35. In summary, the expert evidence presented by CSR, ASIC, and the other intervening parties brings into sharp relief the inherent uncertainty involved in any actuarial estimate of future asbestos-related claims and in particular the limitations and qualifications expressed in the actuarial reports relied on by CSR. In addition, specific issues raised by the experts retained by ASIC and AICF point to particular limitations in the material supplied by CSR’s experts in relation to future asbestos claims that cannot be reliably estimated at this time. The starting point in considering whether these flaws should lead to my not being satisfied that the provisions made in respect of asbestos-related claims following demerger are consistent with public policy or commercial morality must be: (a) that New CSR will be the repository of all CSR’s liabilities in respect of asbestos-related claims both present and future; and (b) that it will suffer a significant reduction in the capital available to meet such claims. 36. The significance of those two factors increases with the uncertainty of the actuarial estimates and other expert opinion and is such that I cannot be satisfied that the provisions made are consistent with commercial morality or that the Scheme, if given effect, would not involve an unfair or oppressive result. Moreover, these same issues lead me to conclude that the material in the explanatory statement cannot provide adequate disclosure to CSR shareholders of New CSR’s ability to meet these future liabilities. For both these reasons I have concluded that I should decline to make the orders for convening the Scheme meeting. In the circumstances, it is not necessary that I should consider the aspects of the Scheme that might otherwise be addressed at the first hearing."