Tatts and Tabcorp take on the house

More than four years ago the Victorian Labor government shocked the market – and Tabcorp and Tatts Group – by announcing a new structure for the state's gaming industry that effectively wiped out $1.3 billion of combined value for the two companies. The legality of that move is about to be tested.

Today is the first day of the new regime for the gaming sector in Victoria, with the 18-year Tabcorp and Tatts duopoly making way for a venue-based structure. Tatts, having waited more than four years for the moment, immediately announced it had started legal proceedings against the state seeking compensation for the loss of its licence. Tabcorp will inevitably follow suit.

The actions will be based on the arrangements the companies entered into when they acquired their licences, in Tabcorp's case in 1994 and in Tatts' case 1995. Tatts was actually awarded its licence in 1994 without charge but subsequently negotiated a payment similar to Tabcorp's.

For 14 years the companies, their shareholders and the markets believed that when the licences to operate electronic gaming machines expired this year they would either retain them or be compensated for the loss.

That conviction was based on the agreements they had. When Tabcorp was privatised and floated in 1994 by the Kennett government its prospectus stated that if it didn't retain its licence in 2012 it would either be reimbursed its original licence fee or the price paid by the purchaser of the licence, whichever was the lesser.

That provision for reimbursement was aimed at maximising the value of the Tabcorp float for the debt-laden state by ensuring that Tabcorp didn't have to amortise the value of the licence through its P&L statements, which would have more than halved its reported earnings and reduced the float proceeds from about $675 million to something closer to $300 million.

The Tatts deal was very similar. Together the companies thought that they would either retain their licences or be reimbursed the best part of $1.3 billion.

Instead the former Brumby government came up with a clever/devious plan to create a new structure that didn't involve the licences, with entitlements to operate the machines put up for tender and the industry shifting to none where those entitlements were owned by pubs and clubs as is the case in NSW and Queensland.

The Brumby government's view, and its legal advice, was that because the licences weren't renewed or extended there was no legal obligation to pay Tabcorp and Tatts compensation, despite the clear intent of the original agreements and the reality that Tabcorp and Tatts shareholders had paid for the perceived value of the retention-or-reimbursement provisions in their licence agreements.

Tatts said today it was seeking compensation for the loss of its licence of $598 million or, based on its assessment of the auction of the entitlements, $490.5 million plus amounts paid to the state between the transfer of the entitlements and February next year. Tabcorp would presumably have a very similar claim.

Both companies had said in 2008 that they would challenge the government's interpretation in the courts but they had to wait until the new regime actually commenced before they had the grounds to do so.

The 2008 decision and the use of what could be regarded as a piece of legal trickery to circumvent the original intent of the agreements that Tabcorp and Tatts shareholders had paid for was extremely controversial, given that it was a government that was involved.

The controversies were compounded when the Victorian auditor-general asserted that the auction of the entitlements, which raised $980 million, had sold their value short by $3 billion and possibly more.

If the companies were to win in court it would raise the prospect that licences that the auditor-general assessed as being worth between $3.7 billion and $4.5 billion might, after payment of the compensation, have raised nothing – or even less than nothing if the compensation exceeds the auction proceeds – for the state.