STATUS QUO AND PROBLEM

14. At various times over the past several decades in New Zealand concerns have been raised about the use of different procedures that regulate changes in control of companies. Before the Takeovers Code was introduced, there was considerable concern about how this impacted on shareholders' and local and international investors' confidence in the integrity of the New Zealand market.
15. Prior to the introduction of the Code, with some exceptions for listed companies, control of companies could pass, through the sale of the shares of one controlling shareholder to another. This could occur without the knowledge or participation of the minority shareholders.
16. The Takeovers Act was passed in 1993. The provisions of the Code were introduced in 2000 and came into force in July 2001.

Status Quo: The Takeovers Act and Code, and the Companies Act 1993

Takeovers Code

17. Companies that have voting securities listed with a registered exchange, or that have 50 or more shareholders named on their share register, are 'Code companies' which are subject to the specific protections, provisions and procedures of the Takeovers Code. The fundamental rule of the Code (rule 6) prohibits changes in control arising from the increase in the holding or controlling (together with associates) of more than 20% of the voting rights in a Code company.
18. The fundamental rule is subject to a limited number of exceptions set out in rule 7. These exceptions permit changes of control which may arise from the increase in the holding or control of voting rights above the 20% level. These exceptions may take the form of Code compliant offers (which may be partial or full offers), selective acquisitions or allotments.
19. The Code sets out procedural rules for conducting the change of control and prescribes in detail the information that must be provided to shareholders for any of these transactions. This information includes prescribed disclosures by the acquirer, a recommendation by the Board of the target Code company (and prescribed disclosures about the target company's involvement with the acquirer), and a report from an independent adviser on the merits of the transaction for the shareholders. The Takeovers Panel monitors the process and the information, for compliance with the Code, including the approval of the independent adviser.
20. For an acquisition or allotment of a parcel of shares under rule 7(c) of the Code (a purchase of a parcel of shares) or rule 7(d) of the Code (an allotment of shares), the non-acquiring shareholders must approve of the transaction by ordinary resolution, and the acquirer and its associates cannot vote to approve of the transaction. For a takeover offeror to be able to take up any of the shares under a rule 7(a) (full) or (b) (partial) takeover offer, it has to have received sufficient acceptances to take its control position to more than 50% of the target company (or have shareholder approval for a lesser percentage). In order to compulsorily acquire any shares under the Code, the acquirer has to already have obtained 90% or more of the shares in the Code company.

Schemes of arrangement and amalgamations under the Companies Act

21. The reconstruction provisions of the Companies Act (Parts 13 (amalgamations) and 15 (schemes)) also provide mechanisms which can be used to effect a change of control of a company.

Amalgamations under Part 13 of the Companies Act

22. An amalgamation under Part 13 of the Companies Act permits two or more companies to combine to form one company if the proposed amalgamation is approved by the Board of each company and if the amalgamation proposal is also approved at a meeting of shareholders of each amalgamating company. Combining of the companies may effect a simple pro-rata merger of all the shareholding interests. Alternatively, it may be structured to effect a change in the control of the shareholding interests, resulting in a non pro-rata outcome where one or more shareholders increase their control position in the amalgamated company, resulting in the rest having their control positions reduced or even the complete exit of the company by the other shareholders.
23. The amalgamation proposal must be approved by shareholders representing 75% of the shares held by those who vote on the proposal. Section 221 of the Companies Act sets out some particulars of information that must be provided to shareholders, including a copy of the amalgamation proposal, a statement about the "minority buy-out rights" available under section 110 of the Companies Act for shareholders that vote against the proposal, and 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.
24. The Companies Office ensures that all of the procedural requirements of Part 13 are met before registering the amalgamation proposal. However, this is an ex post review, as the amalgamation proposal is only received by the Companies Office after the proposal has been approved by the shareholders of the amalgamating companies. The Companies Office reviews the amalgamation proposal to ensure that it contains the particulars required by section 220 of the Companies Act and that the requisite certificates have been signed by the companies' Boards. However, there is no third-party review of the standard of information provided to shareholders.
25. If a Code company is involved in the amalgamation, the amalgamation may be structured so that the Code company will be removed from the Companies Office Register and the "acquiring" shareholder will continue as the holder of shares in an entity that is not a Code company. Such changes of control do not appear to have consequences under the Code.³ Recent examples of such amalgamations include the amalgamation of Waste Management New Zealand Limited (Waste Management) and Transpacific Industries Group (Transpacific), and the amalgamation of Humanware Limited and Jolimont Capital.

Schemes and amalgamations under Part 15 of the Companies Act

26. An amalgamation, or some other restructuring of a group of companies, can also be undertaken under the "scheme" provisions of Part 15 of the Companies Act. Schemes are supervised by the High Court.
27. There are common law rules on the information that must be provided to shareholders. The Court is able to review the scheme documentation before it is put to shareholders. Usually only the promoters of the scheme appear at the initial hearing where that documentation is put to the Judge for approval. The common law has consistently required that the scheme be approved by shareholders representing 75% of the shares held by those who vote on the proposal.
28. A scheme of arrangement under Part 15 of the Companies Act, as with an amalgamation under Part 13, will only have a Code consequence if it results in a person becoming the holder or controller of more than 20% of the voting rights in a Code company during the reconstruction process or after the scheme has taken effect. If a scheme is structured so that no person becomes the holder or controller of voting rights in the Code company, the Code will not apply. An example of such a scheme was the merger of Independent Newspapers Limited (INL) and Sky Network Television Limited (Sky), through a new company that was formed to effect the scheme, and where the voting rights attached to the shares were suspended under the terms of the scheme in order to avoid the application of the Code. The Code has no anti-avoidance mechanism to address this behaviour.
29. The Panel may grant an exemption from the Code's requirements in relation to the elements of an amalgamation or scheme which may be captured by the Code and in respect of which an exception under rule 7 of the Code is not available. A focus of concern for the Panel in granting such exemptions (which will be reflected in the conditions attached to the granting of the exemption) is to ensure that the information to be provided to shareholders, and the shareholder voting approval thresholds, mirror the requirements of the Code.

Broader regulatory environment

30. An additional layer of regulation is also involved for companies listed on registered exchanges such as New Zealand Exchange Limited (NZX). Listed companies also have to comply with the Securities Markets Act's continuous disclosure requirements and the Securities Act's prospectus and investment statement disclosure requirements for offers of securities.
31. When listed companies are involved in takeovers, schemes or amalgamations, the NZX:
    1. reviews meeting notices for schemes and amalgamations to ensure that shareholders have information in a readable and understandable form;
    2. monitors the disclosures required to be made under the Listing Rules;
    3. approves independent advisers to prepare appraisal reports, if required under the Listing Rules;
    4. suspends trading in the stock five days after a compulsory acquisition notice has been sent to outstanding shareholders; and
    5. deals with applications for waivers and with complaints of breaches of the Listing Rules.
32. In addition, the Securities Commission has an oversight role in respect of offer documents and market practices that might mislead securities markets participants.

Nature of the problem

33. In a change of control involving a Code company the bidder and some shareholders in, and the Board of, the target company can, and sometimes do, structure takeover bids so that the Code does not apply, using provisions in the Companies Act. This creates a situation of regulatory arbitrage, where the promoters of the reconstruction or transaction can pick and choose between the available regulatory regimes to improve their chances of success for the deal. While that appears on its face to be attractive in terms of achieving the efficient allocation of resources, it also creates uncertainty and may result in (or result in perceived) unfairness to investors.
34. There is a concern about how this might affect shareholders and the integrity and competitiveness of the New Zealand capital market.
35. 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 shareholders by ensuring that control of companies cannot change without the appropriate participation of shareholders.
36. 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.
37. 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. ⁴ 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.
38. The reconstruction provisions of the Companies Act were adopted from other jurisdictions' reconstruction statutes and were clearly not drafted with the New Zealand Takeovers Code's objectives in mind.⁵
39. In its 2007 discussion document the Panel defined the problem on the basis that although the outcome of a scheme or amalgamation can be the same as a successful full takeover that goes to compulsory acquisition, the requirements of the Code are expressly designed to be fairer, to provide equality of treatment and to give shareholders in the target company greater protection from the potential adverse consequences of a change in control:
    1. the shareholder approval thresholds for amalgamations and schemes are in effect lower than for Code offers;
    2. shares can be compulsorily acquired at a significantly lower approval threshold under an amalgamation or scheme than is provided in the Code;
    3. shareholders may receive lower quality information in respect of a proposed amalgamation or scheme than they would in respect of a Code offer;
    4. the Code provides for a longer time period to consider an offer, whereas, under an amalgamation or scheme, approval can be attained at a single meeting;
    5. under the Code the consideration and terms of an offer to shareholders must be the same for all shareholders regardless of the size of the shareholding, but there are no such constraints in the case of an amalgamation or a scheme where there is no requirement for equal treatment of shareholders;
    6. the Code provides for a complaints vehicle (the Panel, which can intervene and resolve breaches) at a nil or a relatively low cost to aggrieved parties, whereas under the Companies Act complainants may face delays and significant legal and Court costs.
40. With the benefit of the submissions made on the 2007 discussion paper, and further consideration of the way other jurisdictions regulate schemes and takeovers, the Panel now believes that the problem can be defined a little more narrowly in respect of the fairness and protection concerns. This is because the Panel considers that with relatively minor regulatory change to improve the procedures and information for shareholders, the Court is the appropriate supervisor of schemes. It can ensure that a scheme is reasonable for shareholders to approve and that dissentient shareholders' concerns about a proposed scheme are suitably managed.
41. However, the problem in New Zealand is that the Court only hears from the promoters of a scheme and there is no external expert to assist the Court. Under our adversarial judicial system, the Judge (as in other common law jurisdictions) is only able to base his or her decision to approve the scheme on the information that is put to him or her. No one stands in the shoes of the shareholders who are to be bound by the scheme, to raise any issues of concern, or, conversely, to give assurances that from the shareholders' perspective there are no concerns, for the benefit of the Judge. There is no independent advocate to point out to the Judge whether the promoters of a scheme have different interests than the other shareholders, whether the information for shareholders is balanced or is slanted to promote the scheme, or whether the information fully explains what the value is to the promoters of having the scheme approved.
42. While, theoretically, a shareholder could present these issues to the Court, the reality is that the costs, complexity and technicality of the issues generally preclude all but the largest of shareholders from doing so, and, in fact, shareholders rarely make such appearances. Even when they do, it has usually, perhaps always, been an appearance at the final scheme hearing, after the scheme proposal has been put to shareholders for approval.⁶
43. In respect of Part 13 amalgamations, there is no Court supervision for giving consideration to, or managing, the impact of an amalgamation on the shareholders.
44. However, the use of the reconstruction provisions may create benefits for the offeror and for at least some of the shareholders of the target company:
    1. greater certainty of outcome - one shareholder meeting determines the success or failure of the proposal, unless the proposal is conditional;
    2. potentially greater speed (although there have been instances of lengthy conditionality to proposed amalgamations that could see months pass before the outcome is known).
45. While the Panel accepts that schemes and amalgamations are appropriate and necessary vehicles for carrying out some types of company reconstructions and mergers (with proper safeguards for shareholders), the current situation of regulatory arbitrage and avoidance of the Code through deal structuring, is of concern.⁷
46. The Panel believes that this regulatory arbitrage may result in the following potential costs:
    1. undermining of the integrity of the market, resulting in fewer market participants than otherwise, which can adversely affect allocative efficiency and market liquidity;
    2. raising of the risk premium associated with investing in New Zealand, hence discounting share values;
    3. generating of inefficiencies, as companies spend resources on structuring transactions in such a way as to enable avoidance of the Code, rather than on productive activity;
    4. potentially lowering share prices, as reduced competition in friendly 'takeovers' essentially forecloses other offers;
    5. unequal consideration for some shareholders;
    6. a shortened timeframe for making decisions, or compulsory acquisitions at too low a threshold, so that some shareholders sell (under a compulsory process once the approval threshold is met) at a price that is lower than one at which they would have wished to sell.
47. While efficient economic outcomes for changing control of companies are important, the Panel puts particular emphasis on ensuring procedural fairness. The Panel regards the Code's procedures as prescribing a minimum standard, as is the case in Australia. It is therefore concerned that where alternative procedures are used and the Code's standards are not taken into account, they can give rise to an inferior process with potentially negative effects on shareholders' rights and on the integrity of the market in New Zealand.

Footnotes

3. Such changes of control will only have Code consequences if the amalgamated company becomes a Code company (i.e., it will be listed or will have 50 or more shareholders) and the manner in which the amalgamation is structured results in a person becoming the holder or controller of more than 20% of the voting rights in the amalgamated company.
4. These objectives are set out below in the objectives section of this paper.
5. A concise judicial discussion on the provenance of Parts 13, 14 and 15 of the Companies Act 1993 is found in the recent Court of Appeal decision in Elders New Zealand v PGG Wrightson Limited [2007] NZCA 596 (CA277/06) at paragraphs [18] to [20]:
   "The Part 15 procedure is broadly comparable to that provided under s 205 - 207 of the Companies Act 1955 which in turn can be traced back via the Companies Act 1933 to s 129 of the Companies Act 1929 (UK). That section was construed reasonably narrowly by the House of Lords in Nokes v Doncaster Amalgamated Collieries Ltd [1940] AC 1014; in particular as not permitting a transfer of contractual rights (in that case associated with a contract of employment) which were not otherwise assignable by the parties. Perhaps as a result of Nokes, Canadian legislatures adopted a rather different approach to amalgamations under which the relevant statutes provided that the amalgamating companies continued in the form of the amalgamated company. ... When the Law Commission reported on the reform of New Zealand company law, it proposed what was in effect a Canadian rather than a United Kingdom approach. Its recommendations were for essentially what are now Parts 13 and 14, and contained nothing equivalent to Part 15. That Part was inserted as a result of the recommendations of the Justice and Law Reform Committee's report of 15 December 1992. As a consequence, Parts 13, 14 and 15 provide something of an awkward mix and match rather than a coherent regime."
6. This was the case in Weatherston v Waltus Property Investments Limited [2001] 2 NZLR 103 (CA), one of the few reported cases on a Part 15 scheme.
7. Several of the respondents to the Panel's 2007 discussion paper submitted that the status quo has created a situation of regulatory arbitrage. The NZX made the following comment: "... the reputation of NZ's capital markets, already a marginal investment destination for off shore investors, will be adversely affected if the status quo were to remain. Any regulatory arbitrage in respect of such a key area of capital market regulation is undesirable from an integrity perspective. Liquidity would be impacted and accordingly pricing would also be affected. Where market participants are uncertain as to which particular takeover regime will govern their investment this will attract a risk premium. We believe these issues are significant in a marginal investment destination competing for global funds."