Such sweet sorrow

At face value the reasoning behind Justice Margaret Stone's decision to reject CSR's application to the Federal Court for an order convening a shareholders' meeting to approve its proposed demerger is inarguable. However, on practical terms it is nonsensical and has disturbing implications for the broader corporate sector.

Justice Stone made the obvious observation that if the demerger of CSR's sugar division went ahead CSR would be less likely to be able to meet its future asbestos liabilities.

A smaller CSR, after spinning off businesses with an enterprise value of around $1.5 billion, would clearly have less capacity to meet those future liabilities – although it doesn't necessarily follow that it wouldn't have more than sufficient capacity. The court's ruling is about relative, rather than absolute, capacity.

There are two problems with the decision. One is that, while the judgment, if left to stand, would prevent CSR from proceeding with the demerger, it doesn't require court or shareholder approval to simply sell the businesses and return the proceeds to shareholders.

If CSR sold the sugar division and then distributed the proceeds to its shareholders, the financial impact – the downsizing of its balance sheet and capacity to fund the asbestos liabilities – would be roughly the same as if it executed the demerger.

China's Bright Food Group, whose belated attempt to acquire the businesses was rejected by CSR, would be delighted by the judgment, which might well deliver it an outcome the CSR board wouldn't entertain.

On second thoughts, CSR probably wouldn't be able to get away with a sale and distribution of the proceeds. The NSW Government, or the compensation fund, or ASIC, or a victim would probably rush to the courts to prevent any distribution of any sale proceeds and the court would presumably hold the same view then as it did today.

Thus it is conceivable that if CSR sold the sugar business for $1.5 billion, it would have to hold that cash and excess capital for the next several decades just in case it transpired that in 20 or 30 year's time it didn't have sufficient funds to cover the liabilities that had emerged at that point. If the judgement holds, it would appear that CSR has been frozen in time.

CSR, of course, would point to actuarial assessments, which were reviewed by actuaries engaged by the Australian Securities and Investment Commission, to argue that a demerged CSR would have more than sufficient capacity to meet even the worst-case assumptions about the liabilities and its own performance. It has previously rejected a NSW government proposal that the demerged business, which was to be renamed Sucrogen, should be required to co-guarantee the liabilities.

The second issue raised by the judgement is that, in their efforts to ensure that there cannot be a repeat of the James Hardie case, the NSW government, ASIC, the Asbestos Injuries Compensation Fund, and ultimately the court have developed a new principle that, if applied more generally, would stifle corporate activity.

If companies were prohibited from taking any actions that might potentially reduce their ability to meet future liabilities, there would be no demergers, corporate reconstructions, capital management or any other actions that weakened, however slightly, balance sheets. CSR probably shouldn't be carrying any debt, or paying dividends, because that might also reduce its capacity to support the liabilities.

The Hardie case was quite different to CSR's because Hardie wanted to deliberately and permanently distance itself from its asbestos liabilities and impose a ceiling on its liabilities that proved to be – and which some within Hardie may have suspected would be -- inadequate.

CSR would continue to have a very substantial suite of businesses, assets and earnings to meet the liabilities as they emerge. It hasn't attempted – and the demerger wouldn't have achieved – any truncation or capping of its prospective liabilities or any distancing of them from its primary businesses and cash flows.

Past demergers and sales of businesses that were part of a once-sprawling conglomerate – Rinker comes to mind – weren't opposed and haven't impacted its ability to meet its obligations.

After the torrid debates and negotiations that ultimately forced Hardie to share its cash flows with its victims, all concerned recognised that the best chance of ensuring there were sufficient funds was if Hardie remained profitable and behaved commercially.

Having courts, regulators and state governments second-guessing and regulating the commercial judgment of CSR's directors and managers about the best interests of the company, its shareholders and all of its creditors and prospective creditors isn't the way to ensure CSR will adapt and prosper and meet those liabilities in future.

The eventual size of CSR's future asbestos liabilities and its future capacity to meet them is unknowable. Those can only be guesstimates, albeit ones calculated on the basis of external actuarial assessments of worst-case scenarios that were in turn tested by other independent experts, with everyone very, very conscious of the Hardie experience.

If the court's logic were to prevail and the underlying principle that CSR should not do anything that might diminish, even at the margin, its capacity to meet its future obligations applied more broadly, the group would have limited if any financial and commercial flexibility for the next 30 or 40 years, if not longer.