The following chapter of Gilbert + Tobin’s  2022 Takeovers and Schemes Review focuses on the acquisition of Afterpay.

On 2 August 2021, Afterpay announced that it had entered into a scheme implementation deed with NYSE-listed Block, Inc. (formerly known as Square, Inc.) under which Block would acquire all of the issued shares in Afterpay by way of a scheme of arrangement. The scheme was implemented on 1 February 2022.

This transaction was the largest successful public M+A deal in Australia’s history, and the biggest cross-border fintech deal globally. Gilbert + Tobin advised Afterpay on this transaction.

Set out below is an overview of key aspects of the transaction.

All-scrip consideration

The scheme of arrangement involved all-scrip consideration at a fixed exchange ratio of 0.375 Block Class A shares for each Afterpay share (Scheme Consideration). The Scheme Consideration was received in the form of:

• ASX-listed Block CHESS depositary interests (Block CDIs) representing the Block Class A shares for all Afterpay shareholders with a registered address in Australia and New Zealand; and
• NYSE-listed Block Class A shares for all other eligible shareholders,

with an ability for all shareholders to elect to receive the alternative to their default. Each Block CDI represented a beneficial interest in one Class A share.

Block shareholder approval

Block was required under the NYSE listing rules to obtain approval from its own shareholders in order to issue the Scheme Consideration.

In connection with this, Block was required to despatch a proxy statement to its shareholders. Proxy statements differ from the requirements and market practice relevant to Australian disclosure documents in a number of respects, including:

• the requirement to include detailed background information in relation to all discussions between the parties prior to entry into definitive documentation, including details of negotiations around price and terms;
• the inclusion of financial forecast information for the merged group prepared by Block and for which Afterpay took no responsibility; and
• a written opinion from Block’s financial adviser as to the fairness of the Scheme Consideration to Block shareholders.

Block’s dual class structure

Block has a dual class stock structure, comprising Class A shares and Class B shares. Class B shares, which are held by certain of Block’s executive officers and directors and their respective affiliates, have ten votes per share, while Class A shares have one vote per share.

The ten-to-one voting ratio between Class B and Class A shares meant that the holders of the Class B shares collectively controlled more than a majority of the combined voting power of Block’s common stock. This had the effect that the Class B shareholders could control the outcome of matters put to a Block shareholder vote including the vote relating to the issue of the Scheme Consideration.

Fixed exchange ratio

The Scheme Consideration was agreed at a fixed ratio, meaning that the number of Block securities received by Afterpay shareholders was not impacted by movements in either the Afterpay or Block share price. However, any movement in the share price of either company would necessarily have an impact on the value of the Scheme Consideration.

This was a point of significant interest throughout the period between announcement and implementation of the scheme of arrangement, as both companies experienced significant share price volatility due to increased US regulatory focus on the buy now, pay later sector as well as rising interest rates and broader market uncertainty due to COVID-19 impacts. On the trading day prior to announcement of the scheme, Afterpay shares and Block shares closed at A$96.66 and US$247.26, respectively, and closed at A$66.47 and US$122.29, respectively, prior to implementation.

From a valuation perspective, there were a number of challenges presented by share price and general market volatility in the context of an all-scrip deal. This resulted in a heightened focus on the independent expert’s report, required for an Australian scheme, including if the share market volatility would result in any change in the expert’s opinion throughout the transaction.

Afterpay ultimately sought a reconfirmation from the independent expert in the week prior to the scheme meeting that it continued to consider that the scheme was fair and reasonable and in the best interests of Afterpay shareholders. This reconfirmation was done through the issue of a supplementary letter. The Australian Securities and Investments Commission (ASIC) questioned whether such a reconfirmation was appropriate unless the valuation was effectively re-calculated using the full range of methodologies and procedures assessed in the original independent expert’s report. The court, in considering ASIC’s concerns, noted that ASIC’s approach would give rise to real practical difficulty in scrip transactions in periods of market volatility. This is because it was entirely possible that by the time the full reassessment had been completed, market conditions would have changed again, reducing the utility of completing the full reassessment in the first place.

Condition precedent to condition subsequent

The scheme of arrangement was subject to a number of regulatory conditions precedent, including approval from the Bank of Spain in connection with the change of control. When it became clear that the Bank of Spain approval would not be received prior to the scheme meeting scheduled for 6 December 2021, Afterpay announced that:

• it intended to postpone its scheme meeting; and
• Afterpay and Block were considering options to proceed with a scheme meeting in December 2021, notwithstanding the fact that the Bank of Spain approval was not expected to be received until mid-January 2022.

Afterpay then applied to the court for orders in connection with dispatching further materials to its shareholders to advise them that Afterpay and Block had agreed to convert the Bank of Spain approval from a condition precedent to a condition subsequent to the scheme of arrangement becoming effective. From a practical perspective, this had the effect of Afterpay being able to take all steps required for the scheme to become effective (including to obtain the approval of both the Afterpay shareholders and the court for the scheme) prior to receipt of the Bank of Spain approval. Receipt of such approval satisfied the condition subsequent and locked in a timetable to implement the scheme.

The benefit of this structure was that the scheme was only conditional on the Bank of Spain approval after the effective date of 17 December 2021. From that time, it was no longer subject to other conditions precedent including a material adverse change condition precedent. This significantly reduced the deal execution risk of the transaction.

The potential risk with shifting a condition precedent to a condition subsequent in this manner is that, had the Bank of Spain approval not been received, the scheme would have automatically failed.

Such a structure has only been employed in a handful of previous schemes, primarily in similar circumstances where a regulatory approval is delayed. Courts in Australia have been willing to approve schemes that are subject to a condition subsequent where the outcome of satisfaction or failure of that condition subsequent is binary and requires no further decision-making or discretion on the part of the target company, where the “status quo” for the target company can largely be restored should the condition subsequent fail and where the relevant subsequent regulatory approval is to be determined within a specified timeframe.

Impact on SGX convertible notes

The conversion of the Bank of Spain approval into a condition subsequent had a significant impact on the $1.5 billion zero-coupon SGX-listed convertible notes issued by Afterpay in March 2021 (SGX Notes). The terms of the SGX Notes included a change of control provision triggered by receipt of Afterpay shareholder approval. Under the terms, a change of control of Afterpay entitled the holders of the SGX Notes to, among other things, elect within 60 days to have their SGX Notes redeemed for their full A$1.5 billion face value in cash (the payment of which was due a further 10 business days following the 60 day redemption period).

As such, in order to convert the condition precedent to a condition subsequent, the Afterpay board had to be willing and able to fund the redemption of all or a portion of the outstanding SGX Notes at their face value in circumstances where the scheme did not proceed. While Afterpay secured funding to address this risk, ultimately the Bank of Spain approval was received and the scheme was implemented well in advance of the redemption date.

Convertible instruments are becoming increasingly popular as a means for companies to access capital and they can provide a board with more strategic options from a funding perspective. When issuing a convertible instrument, companies should give consideration to conversion right triggers, how the conversion price is calculated, how the exercise of the conversion right may fit into a broader regulated deal timetable and to what extent and circumstances the convertible instruments could survive a change of control transaction. While it is typical in the scheme context for the shareholder vote or effective date to trigger the change of control provisions of convertible instruments, it may be preferable to have the change of control triggered once the scheme is no longer subject to any conditionality instead.