Relationship between the Code and reconstructions under the Companies Act - Effect of ability to choose different mechanisms for effecting a merger with or acquisition of a code company

Under the current provisions of the Code and the Companies Act, parties can in some circumstances choose to effect a merger or acquisition of a code company by utilising either code mechanisms or the reconstruction provisions of the Companies Act, or a combination of those mechanisms.

The Panel considers that it can be appropriate for there to be different mechanisms for effecting mergers or restructuring code companies. Each mechanism has its own advantages and disadvantages⁶ . In different situations alternative mechanisms will be more appropriate.

Parties may be able to choose to comply with the provisions of both the Code and the Companies Act in respect of an amalgamation or scheme of arrangement. This will probably mean that shareholders will have two votes on the same transaction. In respect of a merger of a code company with a company which is not a code company, the voting thresholds and resolutions for each set of shareholders may be different.

An amalgamation or scheme structured in a manner which avoids the Code may achieve the same outcome, i.e. the merger or acquisition of a code company, as a code transaction. However shareholders of the relevant code company will have different rights and protections than if the transaction was undertaken within the jurisdiction of the Code.

Most amalgamations and schemes of arrangement involve what is in effect a compulsory acquisition. The shares held by shareholders in a company are all cancelled in exchange for consideration, either in the form of cash or securities issued by another entity. However, this form of compulsory acquisition can occur with a significantly lower level of shareholder support than a compulsory acquisition following a code transaction.

In order for a person to compulsorily acquire shares under the Code that person has to become the holder or controller of 90% or more of the total issued voting rights in the code company. As discussed above, an amalgamation proposal requires the approval of 75% of shareholders entitled to vote and voting at a meeting. Schemes of arrangement usually have the same approval threshold.

Even if an amalgamation or scheme is not characterised as a compulsory acquisition, the threshold for approval of the transaction is very different from the threshold for Code acquisitions and allotments and may not offer the same level of protection to minority shareholders.

The resolution required to approve an amalgamation, and in most cases a scheme of arrangement, is a resolution representing 75% of the voting rights of shareholders who cast a vote at a meeting of shareholders (although a separate approval from an interest group may be required). No shareholders are excluded from voting on the resolution. Accordingly a major shareholder of the code company may be able to pass a resolution approving an amalgamation or scheme with little or no support from other shareholders, depending on the number of shareholders who exercise their votes on such a transaction.

An amalgamation or a scheme of arrangement would also differ from a code transaction in respect of the information provided to shareholders in respect of the proposed transaction. In respect of a code transaction the shareholders of the code company will receive a document which contains information required by the Code on the merits of the transaction. An important part of such information is the report from an independent adviser approved by the Panel. These documents, in particular the independent adviser's report, are prepared from the perspective of shareholders of the code company. In respect of a scheme or amalgamation outside of the Code, shareholders receive a document prepared for all of the merging entities and not tailored specifically to code company shareholders. It may contain an independent appraisal report if required by the listing rules but the Panel would have no involvement in the appointment of this adviser or its report.

Market comment

The issue on which the Panel wants to receive feedback from market participants is - whether it is appropriate that mechanisms for changes of control which achieve the same result and have the same effect on shareholders of code companies should provide shareholders with comparable rights and protections?

The Panel received some comments from market participants on this issue in response to its recent consultation paper on its proposed policy on exemptions for schemes of arrangement⁷. Some market participants also made comments to the Panel concerning the recent amalgamation of Waste Management New Zealand Limited, a code company, with Transpacific Industries Group Limited.

Some market participants advised the Panel that in their view the legislature intended that schemes and amalgamations be completely separate mechanisms from code transactions and that the Code is not intended to apply in respect of these mechanisms. In their view Part XIII and Part XV provide protections for shareholders, in the form of minority buy-out rights and Court approval, and the legislature intended that these protections on their own are sufficient in respect of reconstructions under the Companies Act. Market participants expressing this view consider that if the legislature had intended that Code principles should be taken into account by the Court in considering schemes of arrangement then Part XV would have been amended to require this when the Code was introduced.

However, a number of other market participants, including brokers and shareholders, have said that they cannot understand why a transaction which looks like a takeover and has the same effect as a takeover can be carried out under the amalgamation or scheme provisions under the Companies Act. These market participants referred to the recent amalgamation proposal involving Waste Management, and expressed the view that under that transaction Waste Management shares were in effect being compulsorily acquired for cash consideration by Transpacific on the basis of a special resolution of Waste Management shareholders. They noted that Transpacific was not required to first become the holder or controller of 90% of the voting rights in Waste Management before compulsory acquisition applied.

Some media commentators and market participants have suggested that the Code is weak if it can be avoided easily by structuring a transaction as an amalgamation or a scheme. They have also suggested that in the future more parties wishing to acquire control of code companies would seek to utilise schemes or amalgamations and thus avoid the provisions of the Code.

It has been suggested that the ability to use an amalgamation or a scheme to avoid the Code is a loophole in the Code and if this loophole is not addressed the integrity of the New Zealand market and the confidence of the investors, both domestic and international, in that market will suffer.

While most submissions recognised the need for an alternative transaction structure to a code offer to be available in some circumstances, a number of submissions expressed the view that all structures achieving the same type of result for the shareholders of code companies should be subject to the same threshold requirements and have the same protections for minority shareholders. The majority of market participants who have contacted the Panel in respect of the use of amalgamations and schemes desire consistency as to the rights and protections shareholders have in respect of any change of control regardless of the mechanism utilised by the companies concerned.

Panel comment

The Panel has been considering these comments. The Panel has similar concerns to those of many market participants.

We note that when the Takeovers Act was introduced the legislature decided that in respect of a certain class of companies, code companies, there should be certain restrictions on the mechanisms for changes of control in order to ensure all shareholders have an opportunity to participate in such changes of control in a consistent and fair manner.

The Panel believes that the Code is intended to apply in respect of all code companies and provide protection to all code company shareholders in respect of certain transactions involving changes of control. This intention is demonstrated by rule 5 of the Code which states that parties cannot contract out of the Code and because there were no statutory exceptions from the Code for schemes of arrangement and amalgamations.

The Panel considers that the policy and purpose of the Code is undermined if persons wishing to effect a change of control of a code company can avoid the disciplines of the Code entirely by choosing an alternative transaction structure not subject to those disciplines.

It was not the intention of the drafters of the Code to leave the rights and protections which shareholders of code companies have in relation to a change of control to be determined by the form of the transaction structure utilised by parties wishing to change control of a code company. This can be seen from rule 6 which is based on the outcome of transactions irrespective of their nature. For example involuntary increases of control resulting from share cancellation or buy-back transactions are caught by the Code.

However, the current relationship between the Code and the reconstruction provisions of the Companies Act means that, in the context of a change of control, the rights and protections available to code company shareholders are determined by the form of a transaction rather than its substance.

The Panel does not believe that all changes of control of code companies must utilise one of the code mechanisms.

The Panel considers that it would be inappropriate to limit the ability of parties to choose and utilise different reconstruction mechanisms or to require that changes of control of code companies be effected by the use of a code mechanism only. The Panel recognises that there are a number of legitimate reasons why parties may choose to structure a transaction as a scheme or amalgamation rather than as a takeover.

Nonetheless, the Panel's preliminary view is that all reconstruction mechanisms which effect a change in control (whether by way of a merger with or acquisition of a code company), should provide shareholders with comparable rights and protections in respect of each such transaction.

We note that in the last two years two companies have utilised the device of cancelling voting rights under a scheme in order to effect a merger transaction and avoid the application of the Code. There has been at least one amalgamation of a code company outside of the jurisdiction of the Code.

The Panel has taken some initial steps to protect the interests of shareholders and the market.

In respect of future proposed schemes of arrangement the Panel has stated that it will seek to make submissions to the High Court regarding the principles of the Code and the rights and protection which shareholders of the relevant code company would have if a scheme was not structured in a manner that avoided the jurisdiction of the Code.

However, this may not be an effective solution to the problems which some market participants have urged the Panel to address.

The Panel has no formal standing in respect of applications to the Court regarding schemes of arrangement and the Court has no statutory direction regarding its treatment of such submissions. The Panel has not yet made any submissions to the Court regarding proposed schemes of arrangement. It is uncertain what weight the Courts will give to such submissions or indeed if they will hear the Panel.

In addition, the Panel has no ability to influence the process surrounding amalgamations involving code companies which are framed in such a way that they are outside the jurisdiction of the Code.

Under the current legislative framework of the Code and the reconstruction provisions of the Companies Act, the Panel can take no other action in respect of amalgamations or schemes of arrangement involving code companies which are structured outside of the Code.

If the issues regarding the inconsistencies inherent in the use of amalgamations and schemes of arrangement to effect a merger with, or acquisition of, a code company outside of the jurisdiction of the Code are to be addressed satisfactorily this will require some form of amendment to the Code and the Companies Act.

Subject to the comments received on this paper, the Panel intends to make recommendations to the Government for some form of amendment to the law to address the issue of consistency of shareholder rights and protections in respect of mergers with and acquisitions of code companies.

In considering what may be an appropriate approach regarding these issues it is useful to look to overseas experience. The legal requirements regarding schemes in Australia are especially important to consider in the interests of harmonisation between takeovers code requirements in Australia and New Zealand.

Footnotes

6. There may be different tax and other consequences resulting from the mechanism used
7. Policy on exemptions from the Code for schemes of arrangement effected under the Companies Act 1993, 4 April 2006, available on the Panel's website