Nature of the problem

The issue

32. In a takeover involving a Code company the bidder and some shareholders in, and the Board of, the target company can, and sometimes do, structure takeover bids to circumvent the Code, using provisions in the Companies Act.
33. There is a concern about how this might affect shareholders and the integrity and competitiveness of the New Zealand capital market.
34. The Panel regards market integrity as a situation where there are clear property rights, clear, fair and consistent rules about the protection and exchange of those rights, enforcement of the rights, predictable outcomes (e.g., in the case of a dispute), and transparency. In the corporate control context integrity is about protecting the legitimate interests of all shareholders by ensuring that control of companies cannot change without the appropriate participation of all shareholders.
35. Competitiveness in this context is the ability to freely change the control of ownership, which is helped by there being potentially many buyers and sellers of shares, cost-effective mechanisms that facilitate the making and considering of offers, and good information available at reasonable cost.
36. When the Panel was formulating the Takeovers Code, it had to strike a balance between the competing objectives set out in section 20 of the Takeovers Act. The rules of the Code provide procedures that regulate for fairness and the autonomy of shareholders' decision making, while also encouraging competition for control and the efficient allocation of resources. The reconstruction provisions of the Companies Act were not drafted with the Takeovers Code's objectives in mind.

Discussion

37. The Panel's concern at the use of the reconstruction provisions to effect changes of control of Code companies has spanned several years. It was heightened by the amalgamation transaction which occurred in 2006 whereby Transpacific effectively took over Waste Management, a New Zealand listed Code company without having to comply with the Code. The reconstruction provisions of the Companies Act were used instead. Shareholders of Waste Management received cash for their shares.
38. The Panel was contacted by many market participants, including shareholders and brokers, about the amalgamation of Waste Management and Transpacific. There was a concern, widely reported in the media, that the integrity of the New Zealand market would suffer if the provisions of the Code could be avoided by adopting a mechanism to acquire a Code company outside the provisions of the Code.
39. After that transaction the Panel became aware of a scheme of arrangement involving the amalgamation of three companies of the Dominion Funds Group, and an amalgamation involving Humanware and Jolimont (an Australian equity fund). Most recently there was the (now aborted) amalgamation proposal involving Auckland International Airport Limited and Dubai Aerospace Enterprise, and the subsequent (and also firstly aborted, but then reactivated) amalgamation proposal involving Auckland International Airport and a Canadian pension scheme.² Cadmus Technology Limited and Provenco Group Limited have also announced an intention to undertake an amalgamation to merge their businesses. They are both Code companies. Media speculation about the future of The Warehouse Group Limited also indicates that a bidder would likely use the Companies Act reconstruction provisions, rather than the Code, to pursue a takeover.
40. When the Code procedures are circumvented, the statutorily mandated Code protections are denied to shareholders (e.g. information, timing, independent advice and participation). In these circumstances, shareholders may see themselves as disadvantaged or may be aggrieved if they had no chance to participate effectively in the decisions about proposals. Potential consequences are that:
    • their shares are being compulsorily acquired at a low level of shareholder approval, and/or at a lower price than they would have been willing to accept
    • they find themselves amalgamated with a new controlling group that was not in place when they bought their shares, where they have no confidence in the new ownership and they cannot sell their shares (e.g., because the market also has no confidence in the new ownership and/or the stock has become illiquid)
    • they find they are not treated equally with all shareholders
    • they lose confidence in the capital markets.

Shareholder support

41. Under the Code a full takeover cannot succeed (that is, no shares can be taken up by the offeror) unless the offeror receives acceptances of its offer that result in the offeror holding or controlling more than 50% of the voting rights in the target company. One consequence of a takeover that achieves more than 50% but less than 90% control is that the original shareholders in the target company may retain a minority (sometimes less than 20%) shareholding.
42. Reconstructions can proceed if approved by 75% of the votes cast by those entitled to vote and who actually vote at a meeting (or by proxy). There are no restrictions on who is eligible to vote nor is there a minimum number who must vote. Accordingly, the level of shareholder support may well be less in terms of total voting rights than under a Code offer, and will almost certainly be less than the 90% required under the Code to proceed to a compulsory acquisition of the shares.³
43. This was the case in respect of the amalgamation of Waste Management and Transpacific referred to above. In that case a special resolution was passed, with around 97% approval. However, the holders of only approximately 47% of the total voting rights in Waste Management exercised their voting rights. Accordingly, the amalgamation proceeded (and all the shares in Waste Management were acquired by Transpacific) with the support of the holders of less than 46% of the total voting rights in the Code company.
44. If a parcel of voting rights of more than 20% is sought under an acquisition or allotment under rule 7(c) or 7(d) of the Takeovers Code, an ordinary resolution of the Code company is required, but interested parties and their associates cannot vote on the resolution. The higher the percentage of control sought the fewer are the number of shareholders who would be eligible to vote to approve it. The effective approval threshold (in relation to a company's total voting rights) therefore can be very high under this Code process.
45. A significant difference between takeovers undertaken under the Code and schemes or amalgamations undertaken under the Companies Act is that, for the latter, approval is attained at a single meeting of shareholders of the target company. This gives a degree of certainty in outcome for the promoters of amalgamations or schemes once the company's meeting has been held.
46. But decisions being made at company meetings occur in a more restrictive time frame than Code takeovers so could be regarded as being more pressured for shareholders. In the case of a Code takeover, shareholders have a minimum of 30 days, and usually a longer period than that, in which to consider what they wish to do with their shares.
47. Under the reconstruction provisions the rights of shareholders are significantly diluted when compared to an analogous Code offer, through lower approval thresholds and a more pressured situation in which to consider proposals. This is inconsistent with the fair treatment and autonomous decision-making objectives of the Code.

Compulsory acquisition

48. Under the Code the compulsory acquisition provisions are triggered when a person becomes the holder or controller of 90% or more of total voting rights in the Code company. The high threshold required for compulsory acquisition reflects the conventional view that a person should not be forced to sell their property except in very limited circumstances and for very good reasons. A 90% compulsory acquisition threshold under the Code is consistent with similar requirements in many other countries.
49. Shareholders are sensitive about having their shares compulsorily acquired. The Panel has received a number of complaints over the years from shareholders whose shares are being compulsorily acquired in the course of various Code takeovers.
50. Under a reconstruction, all shares of one or all of the companies involved will, in effect, be compulsorily acquired. Once the proposal is approved shareholders cannot choose to continue to hold their shares in the amalgamating company. The threshold is approval by a resolution of 75% of voting rights exercised at a meeting of the company. As illustrated above, such a resolution can be passed by the holders of less than half of the company's total voting rights, depending on how many shareholders choose to exercise their voting rights.
51. The Panel has received a number of comments suggesting that it would be impossible to achieve a 90% of voting rights approval at a shareholders meeting because of the combination of timing issues, shareholders who cannot be found, and passive fund investors who cannot vote. The use of the reconstruction provisions may overcome this potential barrier to efficient allocation, and may diminish the opportunities for "greenmail" by holders of parcels of 10% or more of shares, but it comes at a cost of diminished rights of Code company shareholders.
52. In brief, under the reconstruction provisions, the protection against compulsory acquisition is significantly diluted when compared to an analogous Code offer.

Shareholder information

53. The Code prescribes what information must be included in materials for shareholders:
    1. an independent report for shareholders on the merits of the transaction, to be prepared by an independent adviser approved by the Panel
    2. disclosure of key assumptions used in the valuation of any asset or prospective financial information about the target company, and the full valuation report must be made available upon request
    3. disclosure of who has already agreed to accept the offer, the material terms of the agreement, and details of the ownership of equity securities in the target, including shares held or controlled by the offeror
    4. a statement of the general nature of any material changes likely to be made by the offeror to the business activities of the target company and its subsidiaries unless its offer requires 90% acceptance (and that condition is not waiveable).
54. Under an amalgamation the Companies Act prescribes only some of the information that is to be provided, such as the terms of the amalgamation proposal, information about the constitution of the amalgamated company, a description of minority buy-out rights, and the material interests of directors in the proposal. Beyond this, Part 13 requires that shareholders be provided with "such further information and explanation as may be necessary to enable a reasonable shareholder to understand the nature and implications for the company and its shareholders of the proposed amalgamation". What is necessary to enable a reasonable shareholder to understand the proposal is a matter for the directors of the amalgamating companies to decide. There is no regulatory review of the information that is put to shareholders under the proposal.
55. An independent appraisal report may be required by the Listing Rules if any of the amalgamating companies is a party to a listing agreement with the NZX, because the parties are regarded as related.
56. The Companies Act does not specify information to be provided to shareholders in respect of a scheme. However, the standard applied by the Court in approving a scheme proposal is that it gives shareholders all the information reasonably necessary to enable the recipients to judge and vote upon the proposal.
57. Submitters on the Panel's earlier discussion documents relating to the use of schemes and amalgamations emphasised the robustness of the Court process and the breadth of the Court's mandate. The Court must consider the rights of all parties involved in the scheme, not just those of the shareholders. However, 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.
58. The differences in the information that needs to be provided to shareholders when considering an offer under the Code compared with Companies Act reconstructions are significant. While some of this information (such as an appraisal report) may be provided in the case of schemes involving listed companies (because of the NZX's Listing Rules), the absence of prescribed information requirements means that some crucial but sensitive information may be omitted from a scheme proposal. There is no consistency in the scope of disclosures that are required for a scheme or amalgamation, as compared with a Code offer.
59. The inferior information may inhibit shareholders from making well-informed decisions on the merits of a proposed transaction. This conflicts with the Code's objectives that shareholders must ultimately decide the merits of a takeover offer and of encouraging the efficient allocation of resources; the better informed the participants in the market the better the decisions that they will make. 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.

Equal consideration

60. Rule 20 of the Code requires that the consideration offered under a takeover be on the same terms and provide the same consideration to all offerees, regardless of the size of their shareholding. There are no such constraints in the case of an amalgamation or a scheme.
61. The provisions in the Companies Act are somewhat more flexible than the Code when it comes to the types of transaction that can be effected (and the payment of consideration). This was the substantive reason for the inclusion of provision for Court-approved schemes in the Companies Act. Amalgamations also provide greater flexibility when it comes to paying consideration to shareholders.
62. For example, in a transaction under the Code, the consideration must generally be paid no later than 7 days after the offer goes unconditional, or 7 days after the end of the initial offer period. Sometimes takeover transactions involve delays in the payment of consideration to shareholders in a commercial relationship with the target to accommodate earn-out provisions or the achievement of performance targets. Sometimes these are difficult to accommodate in a Code takeover.
63. There are instances where a major shareholder also has a commercial relationship with a target company, such as under a distribution agreement. Sometimes, when a change of control is being sought through a takeover, the bidder will also wish to change these types of arrangements that the target company has in place. This may mean the payment of compensation to a contractual party for termination of existing agreements. Such arrangements will be acceptable to the Panel under a Code offer provided the payments represent fair value and are not simply a means of paying additional consideration to encourage them to sell their shares to the bidder.
64. The Panel has also seen an instance where some shareholders of an amalgamating company were given the opportunity to subscribe for shares in the continuing entity when others were not. It was not clear just how favourable the terms of those reinvestments were, however it could not have occurred under the Code without close scrutiny by the Panel.
65. In brief, while the reconstruction provisions offer more flexibility on control transactions that cannot always be accommodated by Code offers, the Panel is concerned that the use of the reconstruction provisions does not guarantee the offering of equal consideration to shareholders.

Enforcement

66. The Panel monitors all Code transactions and the market generally, and can take action against apparent breaches of the provisions of the Code. The Panel's broad enforcement powers, and willingness to act quickly on apparent breaches, have contributed to a high level of compliance with the provisions of the Code.
67. The Companies Office monitors compliance with the procedural provisions of the Companies Act in relation to amalgamations conducted under Part 13 of the Act (after the proposal has been put to and voted on by shareholders), but not Part 15 schemes. In reconstructions, there is no competitive tension that might ensure proper scrutiny of a proposal (because they always require the cooperation of the boards of the companies involved), although the need for Court approval adds an additional layer of impartial oversight to scheme proposals.
68. Under the reconstruction provisions, aggrieved shareholders can, in certain circumstances:
    1. apply to the High Court under section 226 of the Companies Act if they consider that they would be unfairly prejudiced by an amalgamation proposal
    2. apply to be heard by the High Court when the that Court considers the requirements for a scheme to proceed.
69. These avenues require the shareholder to be aware of the requirements and remedies available under the Companies Act, and to be proactive. Taking action through the Court system can be costly, and will be unaffordable for most shareholders. The remedy under section 226 appears to be used rarely.
70. Relying on private enforcement rights may effectively disempower some shareholders. Recent trends in New Zealand are towards enabling regulatory agencies to act on behalf of the public generally to enforce the law. The Panel and the Securities Commission are two such agencies.
71. It is generally accepted that well-regulated markets engender the confidence of investors and encourage the participation of the widest range of players. The mechanisms currently exist to effectively regulate the takeovers market where Code transactions are used. They exist with a narrow focus in respect of changes of control being carried out as amalgamations under Part 13 of the Companies Act and exist to a lesser extent than under the Code in respect of changes of control carried out through the scheme of arrangement provisions of the Companies Act.
72. In brief, the Code provides for a complaints vehicle at relatively low cost to aggrieved parties, whereas under the Companies Act complainants may face barriers to challenge outcomes, and the light-handed monitoring and enforcement with respect to schemes and amalgamations may undermine the integrity of the market.

Process costs and timeliness