Corporate Advisory

25 Feb 2008

Last week Simpson Grierson made submissions on the consultation paper issued by the Takeovers Panel Schemes Of Arrangement And Amalgamations Involving Code Companies, 5 December 2007. The broad thrust of our submissions was that the reconstruction mechanisms of schemes and amalgamations should be maintained for Code Companies, essentially in their current form. These mechanisms provide important alternative routes to effect corporate restructuring, including changes of control. They have their own checks and balances which, although different from those provided by the Takeovers Code, are sufficient to prevent the unfair treatment of minority groups. Equally important, these mechanisms enhance the core economic good of allocative efficiency and mitigate against the tyranny of the minority in circumstances where the vast majority of active shareholders and the board supports a particular outcome. 

Our submissions are set out in full below. The Takeovers Panel will now consider the various submissions received before presenting its own recommendations to the Minister of Commerce. Given the tenor of the Panel's call for submissions, as well as prior Panel statements on the same issues, we expect the Panel to continue to call for substantial changes to the law, to limit the availability of amalgamations and schemes for Code Companies. If we are right, those who may need to rely on such mechanisms in the future in order to achieve rational (and fair) outcomes must  stand ready to make their views known to the Minister following the Panel making its recommendations.

We will keep you posted.

The Panel's call for submissions provided a questionnaire.  Our submissions followed the format of that questionnaire. Italicised portions are extracts from that questionnaire.

QUESTIONNAIRE - SCHEMES OF ARRANGEMENT AND AMALGAMATIONS INVOLVING CODE COMPANIES

Problem definition

1. Do you agree that there is a problem? Please explain, considering:
   1. Is the use of the reconstruction provisions to effect changes of control of Code companies likely to become more or less frequent under the current legal situation?
   2. What are the consequences for shareholders and for market integrity, if any, of takeovers or mergers involving Code companies being conducted under the reconstruction provisions, and how significant are these?
   3. Is the information disclosed to shareholders under the Code, amalgamation, or scheme requirements materially different, and if so how might it affect decision-making for shareholders?
   4. Should the rights and protections of the Code apply to all changes of control of Code companies irrespective of the manner in which the change occurs? Why, or why not?

Comment:

1. We do not see a problem with the current reconstruction provisions. Each reconstruction mechanism has appropriate checks and balances to guard against the unfair treatment of minorities. More importantly, the shareholder approval thresholds which apply in the reconstruction provisions represent a fair balancing of the need for the will of the majority to prevail, in order to achieve economic efficiency, with the need to have sufficient minority protection to encourage investment in the first place.

A System of Balance and Integrity

2. The reconstruction provisions are of long standing and are analogous to the provisions in many other jurisdictions, most particularly Canada and the United States of America¹. They allow business combinations to proceed with the approval of a significant majority of active voting power in the subject companies. In so doing, they facilitate the achievement of the value maximisation decisions of the majority, so that economic rationality may prevail, and economic efficiency may be served.
3. Having served this purpose, the reconstruction provisions also recognise that minority protection is desirable; otherwise minority investment will be discouraged. This is achieved in a number of ways:
   1. before any transaction under the reconstruction provisions may proceed, the board of the subject company must approve the transaction under consideration;
   2. as a precondition of any transaction under the reconstruction provisions, an appropriately high majority of voting power in the company must approve it (so the will of the majority is truly tested); and
   3. further layers of protection are added, through the minority buy-out provisions applicable in a Part 13 amalgamation and the oversight of the Court in the case of Part 15 schemes.
4. When looked at this way, the reconstruction provisions can be seen as an attempt to balance the interests of economic efficiency, inherent in the will of the majority, with an appropriate measure of minority protection.

So why does the Code offer more protection?

5. It is important to remember, in analysing the reconstruction provisions, that they were independently developed well before the Takeovers Code (Code), each with its own system of checks and balances to protect against the unfair treatment of minorities. It is also important to remember that the Code provides a mechanism which enables control of a company to pass without the consent and approval of the board of the target or the approval of the Court. Thus, it is appropriate to set the shareholder approval thresholds under the Code at a high level, ultimately at the 90% of all voting power level for full control to pass.

The Paper’s Analysis of the Role of the Board and the Court

6. In a number of instances, we believe that the Takeovers Panel, in seeking to identify the "problem", is discounting the role of the board and the Court in reconstruction processes. In particular we note the following passages:
   1. In paragraph 57 of the Paper it is stated that:
      
      ...although third parties (such as the Panel) may be able to influence the orders made by the Court, the fact is that Court applications are generally made by the promoters of the scheme without any other input. In practice, though, there is no substitute for genuinely competitive advice from a party with a different point of view, representing different interests. That does not happen in most schemes.
      
      These statements appear to ignore the fact that in both Part 13 amalgamations and Part 15 schemes, the board of the company must be convinced that the amalgamation or scheme is appropriate to proceed². The key point here is that it is the board of the subject company which provides the "different point of view". In reality, the board of the subject company is in an extremely strong negotiating position, in seeking a proposal which provides full value to the shareholders.
   2. In paragraph 59 of the Paper it is stated:
      
      The Panel considers that the lack of a requirement under the reconstruction provisions for a report prepared by an independent adviser is a particularly significant issue.
      
      Almost invariably, and particularly in the case of a listed company, a report from an independent adviser is obtained on the merits of the amalgamation or scheme. In the case of a Part 15 scheme, the Court has an express power to require a report to be prepared (section 236(2)(c)) and, in the case of an Part 13 amalgamation, it would be a brave board indeed that proceeded without an adviser’s report to back up the board’s decision.
   3. In terms of equal consideration, in paragraph 65 of the Paper, the Panel expresses the concern "that the use of the reconstruction provisions does not guarantee the offering of equal consideration to shareholders". Again, this ignores the role of the board in a Part 13 amalgamation situation, and the role of the Court in a Part 15 scheme. We are not aware of any case of an amalgamation or scheme in which equal consideration has not been offered among shareholders of the same class, as this would so obviously open an amalgamation or scheme up to challenge under the provisions of the Companies Act dealing with minority oppression (see section 174 of the Companies Act). In addition, in a Part 13 amalgamation, a shareholder aggrieved by unequal treatment might seek to exercise minority buy-out rights, and in a Part 15 scheme, the Court will be careful to ensure that there is fairness between classes. Again we think this is a false concern.
   4. In relation to enforcement, in paragraph 67 of the Paper, the lack of "competitive tension" in scrutinising an amalgamation or scheme is attributed to the cooperation of the boards in each case. This appears to ignore the fact that amalgamations and schemes are negotiated transactions, with terms and conditions of amalgamation (in particular the "ratio") negotiated heavily before the boards grant their "co-operation". It also ignores the ability (and, potentially, the duty) of boards to seek alternative proposals and the fact that schemes and amalgamations are public processes, which will engender an awareness that a company is "in play".
      
      Although there is no case, to our knowledge, specifically adopting it in New Zealand, the directors’ duties expounded in the Delaware case of Revlon Inc v MacAndrews & Forbes Holdings Inc³ might become relevant in a scheme or amalgamation transaction. In that case the Court expressed the view that the board may have regard to various corporate constituencies in discharging its responsibilities, provided that there were related benefits accruing to the shareholders. However, once the sale of the company to the highest bidder is an issue, non-shareholder interest can no longer be taken into account. The Court stated:
      
      …such concern for non-stockholder interest is inappropriate when an action among active bidders is in progress, and the object no longer is to protect or maintain the corporate enterprise, but to sell it to the highest bidder.
      
      This places emphasis on the shareholders of a company when a transaction affecting control is in progress, rather than just the interest of the company as a whole.
      
      In any case, even if the board is not vigilant in seeking alternate offers, minorities still have the buy-out rights that the Companies Act confers in the case of a Part 13 amalgamation, and the protection of the Court, in the case of a Part 15 scheme.
   5. In paragraph 83, the Panel sees the involvement of the board as sometimes being "anti-competitive", and makes reference to the statutory duty to act in the best interests of the company. This appears not to take account of the potential relevance of the Revlon duties, when a company is in play. Also, even if the board is not doing its job properly, buy-out rights and the discretion of the Court add the necessary level of protection for the minority.

Interested Majority

7. A concern might be raised over whether or not the majority seeking to proceed with a scheme or an amalgamation is sufficiently "disinterested". This concern is answered by reference to the "freedom of contract" policy objective discussed below. 
8. Companies that have chosen the governance structure provided by the NZSX and NZDX Listing Rules (Listing Rules) will have the further protections which are provided by the Listing Rules - for example, that an ordinary resolution of disinterested shareholders must approve a Part 13 amalgamation if it is a related party transaction. There is an exemption for Part 15 schemes in the related party transaction provisions of the Listing Rules, but this is predicated upon the role of the Court in ensuring fair outcomes for the minority. 
9. For companies which are not listed, they have a degree of contractual freedom as to the thresholds that they might fix for various corporate events. They operate in a private sphere, where persons purchase their shares on the basis of the constitutional arrangements which are offered to them, and it would be an abrogation of the freedom and sanctity of contract to interfere in those arrangements. In essence, parties buy shares in non-listed companies on the basis of the minority protections which are provided by the Companies Act, which are not insignificant, if it is remembered that there are minority buy-out rights in a Part 13 amalgamation and the supervision of the Court in a Part 15 scheme. Further interference seems unwarranted.

Concluding Comments

10. In summary, we see a real risk that the Panel's policy is being captured by the very minorities which the lower approval thresholds in the Companies Act reconstruction provisions are designed to protect against. By giving these minorities their way, allocative efficiency may be undermined, as minorities may be able to block transactions which would otherwise be effected with the will of the board and a high majority of actively engaged shareholder voting power. 

Policy objectives

2. Are the stated policy objectives appropriate for assessing how alternative solutions for effecting changes of control of Code companies should be measured?

Comment:

11. Yes, but we would add others - see answer C below.

3. Are there other objectives which you think should be included for the assessment referred to in Question B, or should some of the objectives used in this discussion document be excluded? Why?

Comment:

12. There are three other policy objectives which we believe should be included in the assessment of options.

Freedom and Sanctity of Contract

13. Freedom and sanctity of contract are the legal core of a free market economy. If allocative efficiency is to be achieved, parties must be free to contract with whoever they wish on whatever terms they wish, and to have those contracts upheld by the Courts. In the corporate context, this translates into the shareholders of a company being free to agree amongst themselves the constitutional arrangements which will apply to the company, within the ambit of the Companies Act. For Part 13 amalgamations, as with major transactions, the Companies Act requires the approval of a special resolution (section 106), but the shareholders are free to agree a higher than 75% approval threshold for such resolutions if they wish (as per the definition of "special resolution" in section 2). In addition, certain companies might choose to be listed, in which case additional approval thresholds might apply to a Part 13 amalgamation, i.e. the ordinary resolution of disinterested shareholders required by Listing Rule 9.2. Given the importance of freedom of contract, there is a serious question as to whether external parties should interfere with the freedom of shareholders to reach arrangements which are appropriate for their individual companies. This is not an overriding concern, but is a balancing concern to any interference which is proposed.

Integrity of the Company Governance Structure

14. In discounting the role of the board in amalgamations and schemes, the Panel is, in effect, questioning the very foundation of the corporate form, and the governance model it relies upon. Focussing on agency costs in the model (in paragraph 10 of the Paper), the Panel may have lost sight of the fact that the conferral of authority on a democratically elected board is fundamental to the efficient operation of the corporate form, in both a practical and economic sense. If it was necessary to seek the approval of shareholders for each corporate decision, then the activities of a company would grind to a halt. The vesting of business management authority in the board allows efficient decision-making as to the allocation of resources, whilst permitting the spread of ownership and availability of capital that the corporate model facilitates. Recognising that not all decisions should fall to the board, and certain decisions are so significant that the board's authority should be curtailed, the Companies Act refers certain key decisions back to shareholders - for example, major transactions and approval of amalgamations. In doing so, however, it sets an appropriate approval threshold, so that, where the board and an appropriate majority of shareholders is in favour of a course of action, a disgruntled minority cannot stop the action from occurring. If the approval thresholds set by the Companies Act are upset, then this balance of board and shareholder approval is upset, empowering the minority to veto transactions which would otherwise proceed. In developing reform proposals, the Panel should be cognisant of not permitting a "dictatorship of the minority", in place of carefully considered balances of shareholder and board approval.

No Reward for Apathy

15. In fixing approval thresholds, it is important not to give the balance of power to apathetic shareholders. In setting approval thresholds which rely upon a particular majority to turn out and vote, an assumption is being made about the intentions of apathetic shareholders, i.e. that they would have voted against the proposal. It may well be that they are against the proposal, but consider themselves disenfranchised, and are not voting because they have a lack of faith in their ability to influence the outcome. It is equally possible that they fully support the proposal, and have decided not to turn out because they believe it will succeed on its merits. Or they may not care either way. Effectively attributing a particular voting intention to the apathetic minority is not appropriate. That is why the thresholds for passing resolutions are usually determined by reference to the people who are taking an active interest and turn up to vote. The empowerment of an apathetic minority will always favour the status quo, thereby restraining changes in the control of resources which are efficiency enhancing.

4. Are some objectives more important than others? Why?

Comment:

16. Of the objectives identified by the Panel, we believe that allocative efficiency (item 1 in the table on page 23 of the Paper) is the most important. It is a fundamental objective of the corporate model and should also underpin the rules relating to changes of corporate control. In reality, all of the additional policy factors mentioned in C above form part of the overall allocative efficiency policy objective. 
17. The promotion of the international competitiveness of New Zealand's capital markets (item 4) is another key objective. New Zealand simply does not have enough capital to support the business activities required to drive economic growth and increase the wealth of our society. Being able to benchmark ourselves against other capital markets is vital to our access to international capital. In this sense, item 3, the enhancement of fair treatment, is important as a major contributor to item 4, the competitiveness of New Zealand's capital markets.

Options

5. Are there any other options you believe the Panel should consider? What are they and why should they be considered?

Comment:

18. There is another, less intrusive, approach which could be considered. It would seem that many concerns arising out of Part 15 schemes relate to the failure of Courts to consider adequately the measures which should be put in place to protect minority shareholders. We note that there is no empirical evidence that the protections put in place by Courts have been insufficient, other than the vociferous complaints of certain minority shareholders. Having said that, it might be desirable to elaborate upon the Court's jurisdiction under sections 236(2) and 237(1) of the Companies Act, to make it clear that:
    1. approval thresholds may be set which require a certain majority of disinterested shareholders to approve a transaction being promoted by a particular shareholder or group of shareholders or their associates;
    2. in appropriate cases, an approval threshold may be set which requires a particular majority of voting rights in the company to be represented (although, for the reasons set out in the "no reward for apathy" discussion above, we consider these circumstances would be rare); and
    3. confirming that arrangements for persons voting against the scheme may very well include minority buy-out provisions of a nature similar to those available in Part 13 amalgamations.
19. It is submitted this clarification of the jurisdiction is preferable to fixed and inflexible thresholds and controls, as it will enable the Court to tailor the approval requirements to each transaction. After all there is no empirical evidence that the Courts have got it wrong to date.
20. We do not believe further protective mechanisms are necessary or desirable in relation to Part 13 amalgamations. Minority buy-out rights are hard-wired into the mechanism. In addition, the Listing Rules require a related party amalgamation of a NZX-listed company to be approved by a majority of active disinterested voting power, supported by an appraisal report from an independent adviser. Non-listed companies have the freedom to adopt similar rules if they wish. It is submitted these measures provide significant protection to minority shareholders, above and beyond the requirement for board approval and the ability to apply to the Court for relief in the case of unfairly prejudicial proposals.

6. Do you agree with the Panel’s assessment of the impact of the options? If not, what would your assessment be and why?

Comment:

21. Our comments below are structured to reflect the table appearing on page 30 of the Paper. In each case, we reference the options by number, as per the numbering used in the table, and only reference those options where we disagree with the assessment.
    
    Efficient Allocation
    
    1. An improvement in efficient allocation under this option would depend upon the New Zealand Courts taking the same approach as the Australian Courts have taken in this area⁴ where it has been held that Chapter 6 of the Corporations Act (relating to takeovers) does not take automatic precedence over Chapter 5 (relating to schemes), and, just because a deal could have been structured to accord with Chapter 6, the use of a scheme to carry it out is not prohibited. Otherwise, there is a real risk of "minority capture" which could inhibit efficiency creating transactions.
    2. If approval thresholds are set too high, this could undermine allocative efficiency, as it would render certain efficiency creating transactions unachievable. 
    3. The removal of the Part 13 amalgamation option could significantly reduce allocative efficiency. Part 13 provides a business combination mechanism with a lower approval threshold, in exchange for the automatic availability of buy-out rights. It represents a hard-wired balance of interest, the availability of which would be uncertain if application always had to be made under Part 15.

Competition for Control

As a general point here, we note that increased approval thresholds will discourage value enhancing takeover activity which could not otherwise be achieved, leading to an overall reduction in the level of competition in the market for corporate control. 

Fair Treatment

1. The comment here appears to suggest that the Panel considers that the reconstruction provisions automatically lead to greater unfairness. We do not agree, because each of the reconstruction mechanisms contains its own minority protection measures, which are appropriate to the type of reconstruction being undertaken. In the case of a Part 13 amalgamation, this is in the form of minority buy-out rights. In the case of a Part 15 scheme, the Court has a wide discretion to make appropriate arrangements.
2. By prohibiting Part 13 amalgamations for code companies, an option which guarantees a level of protection for minorities (in the form of buy-out rights) would be removed. This will not necessarily lead to an improvement in fair treatment.
3. We take issue with the suggestion that a Code offer will always lead to fairer outcomes. It might be that, with the very high thresholds the Code sets, certain offers or transactions which are of benefit to all shareholders do not proceed at all. Consider the case of a very attractive company which has a 10 percent shareholder who is unwilling to sell. In the absence of a scheme of arrangement or amalgamation proposal, this company may never be in play for a 100 percent purchaser. This seems most unfair to the majority, who might wish to see the transaction proceed. Again, it seems there is so much focus on minority protection, that unfairness to the majority is not factored into the analysis.

International Competitiveness

We have difficulty with the comments in relation to 2, 4 and 5 here. Amalgamations and schemes are clearly recognised on the international stage as appropriate reconstruction mechanisms⁵.

Autonomous Decisions

We consider the analysis here is flawed, because it ignores the desirability of respecting the will of the majority in decision-making. Under the governance model for a corporation, decisions must be made by shareholders of the body, and the will of the majority must usually prevail. In empowering the minority to overcome the will of the majority, the individual autonomous decisions of the majority are overridden. This might sometimes be desirable in the interests of minority protection, so the question is begged as to whether or not appropriate minority protections are available in each case. 

7. (Postscript to options consideration). Please provide comments on the Panel’s question as to whether the Code’s 90% compulsory acquisition threshold should be lowered.  In particular:
   1. does the 90% threshold cause (or significantly contribute to) the utilisation of the Companies Act reconstruction provisions in a manner that avoids the Code?
   2. would reducing the Code’s compulsory acquisition threshold increase the attractiveness of using the Code for takeover transactions?
   3. would reducing the Code’s compulsory acquisition threshold damage the integrity and objectives of the Code?
   4. If the threshold were to be reduced, what would be the appropriate threshold (please explain the reasons for the level you would choose):
      • 85%?
      • 80%?
      • 75%?

Comment:

22. We would not favour any alteration to the 90% compulsory acquisition threshold under the Code. It accords with international standards in this area. It is also appropriate, given that the Code allows a hostile takeover to proceed without the accession of the target board and without any involvement of the Court. Accordingly, a high degree of minority protection is appropriate, and the 90% threshold implicitly guarantees this.

7. Can you provide any cost information to compare the costs of compliance of a Code takeover versus a scheme of arrangement or amalgamation? Please identify any sensitive information for OIA purposes. In particular:
   1. What might be typical legal and other advisers’ fees that are paid by the parties under a Code offer, an amalgamation, or a scheme?
   2. Is there typically a difference in the distribution of the costs between bidders and target company and its shareholders depending on the vehicle chosen?
   3. Do the different vehicles impose differences in staff, management and board time that must be dedicated to preparing and effecting a takeover?

Comment:

23. We prefer not to respond to this question.