Takeovers Panel

UPSTREAM TAKEOVERS

A CONSULTATION PAPER ISSUED BY THE TAKEOVERS PANEL

April 2009

OPTIONS AND ANALYSIS

77. Set out below are the proposed options. In summary they are:
    1. Option 1: Maintain status quo - comply with Code. Panel will consider all exemptions on a case by case basis.
    2. Option 2a: Class exemption with focus on purpose test¹⁰ and 50% value test¹¹.
    3. Option 2b: Class exemption with focus on purpose test and 25% value test.
    4. Option 2c: Class exemption with focus on purpose test and 50% value test and requirement that upstream transaction occurs in jurisdiction with investor protection comparable to NZ ("reputable jurisdiction requirement").
    5. Option 3: Complete exemption subject to reputable jurisdiction requirement.
    6. Option 4: Complete exemption subject to reputable jurisdiction requirement, unless unacceptable circumstances (mirrors Australian position).

Introduction

78. One of the main reasons for trying to achieve the right level of regulation for upstream acquisitions is to ensure that New Zealand meets its obligations in relation to international comity. Where the purpose of the upstream acquisition is not to avoid the provisions of the New Zealand Takeovers Code, international comity would require that New Zealand legislation not impede a bona fide and otherwise lawful and appropriately regulated takeover offer for an upstream foreign body corporate.
79. International comity requires New Zealand to strive for economic efficiency in international as well as New Zealand capital markets. New Zealand regulatory requirements should not impose excessive costs or obstacles on primarily foreign business transactions unless there is clear need for New Zealand investor protection. International comity requires ensuring that New Zealand takeovers regulation is not used as an improper takeover defence by foreign bodies corporate. International comity also requires that New Zealand takeovers regulation similarly does not inhibit the liquidity and efficiency of foreign securities markets.
80. At present there is nothing in the Code, or in any class exemption from the Code, that addresses or facilitates foreign upstream acquisitions. The specific regulation of upstream acquisitions would make it possible for acquirers to recognise what conditions they have to satisfy to realise a takeover of an upstream target which has control of a significant parcel of shares in a Code company. An established policy would reduce the time and costs of the Panel, and of potential acquirers, compared to the current consideration of upstream takeovers on a case by case basis. However, in considering a policy for upstream acquisitions, the position of shareholders in the downstream Code company is also an important objective that must be weighed up.

Option 1 - status quo: exemptions considered on a case by case basis

81. To keep the status quo would mean that every upstream acquisition must either comply with an exception from the fundamental rule under rule 7 of the Code, meaning the shareholders of the downstream Code company vote on the upstream acquisition (rule 7(c) of the Code) or, alternatively, the acquirer makes a full takeover offer for the downstream Code company (rule 7(a) of the Code)). Alternatively, the acquirer may apply for an exemption from rule 6(1) of the Code. The Panel would continue to consider these applications on a case by case basis probably focusing on the 'purpose test' (that is, that the downstream acquisition was not the purpose of the upstream acquisition).

Analysis of Option 1

82. Option 1 leaves the Panel in control of the extent to which the Code should be complied with in relation to an upstream acquisition. While some may see that outcome as an advantage, others may not. It results in inefficiency, potential non-compliance with international comity and a lack of transparency. The absence of a clear policy for upstream acquisitions results in uncertainty in the market.
83. These disadvantages were evident in the recent BG Group case. It appeared that the proposed acquisition of control of Contact by BG Group, as a result of its proposed takeover of Origin, would fall well within the criteria for what ASIC called unrestricted relief in its RG 71 and would also have fallen within the current Australian regime for a complete exemption, as set out in section 611 Item 14 of the Act. The New Zealand Panel had considered whether the principle of international comity (upon which Item 14 and RG71 are based) could be applied in the BG Group case. However, the Panel was inclined to the view that the principle of international comity is not one on which the Panel should rely. This was because of matters such as the size of the Origin parcel of Contact shares (51%) and the Panel's statutory obligation to grant exemptions that are appropriate and consistent with the objectives of the Code. International comity is not an express objective of the Code. The Panel noted that when the Code was drafted, whilst the downstream consequence of an upstream change of control was expressly recognised, cross-border transactions of the nature under discussion were not expressly borne in mind.
84. When, in the BG Group case, the Panel decided not to follow the Australian model of an unrestricted exemption, it then had to consider whether BG Group should have to sell-down the Contact stake or whether it should be required to make a follow-on offer for Contact. This raised the following problems:
    1. The Panel was concerned about how it could legitimately state that an exemption, subject to conditions such as making a subsequent follow-on offer by BG Group for Contact, or selling down the Contact shares to 20% or less, was appropriate and consistent with the objectives of the Code as required by section 45(4A) of the Takeovers Act.
    2. The Panel also noted that, if a follow-on offer were required to be made, the Panel would need to consider what mechanism could appropriately be used to determine the price at which the follow-on offer should be made.
85. The complete exemptions of Normandy, Canadian National and A.B.C. have been based not only on the internationally used purpose test (which seems sensible) but also on the basis of the downstream acquisition being of a de minimus nature when compared to the value of the upstream acquisition. A problem with this test is that the de minimus test has no policy basis in the Code or in other areas of the Panel's practice. The BG Group upstream acquisition fell outside of the de minimus precedents.

Option 2a - class exemption relating to threshold and purpose test

86. Option 2a proposes a UK approach. This option proposes a class exemption from rule 6(1) of the Code for an upstream acquisition in circumstances where a person acquires control of an upstream company (which need not be a Code company) and thereby acquires or consolidates control of a downstream company (a Code company), unless:
    1. the value of the shares which the upstream company has in the downstream company is significant in relation to the upstream company. In assessing this, the Panel would take into account the assets of the respective companies. Relative values of 50% or more would be regarded as significant; or
    2. one of the main purposes of acquiring control of the upstream company was to secure control of the downstream company.
87. This option does not require that the upstream target be listed in New Zealand or overseas.

Analysis of Option 2a

88. Referring to upstream acquisitions which have been considered by the Panel so far, all cases except the 2004 Origin exemption would have fallen within the ambit of such an exemption. In Canadian National the upstream company had control of 24% of the voting rights in the downstream entity. Despite the fact that in the A.B.C. and BG Group cases the upstream targets controlled more than 50% of the voting rights in the downstream entities, the acquisition of the downstream Code company was not the purpose of the upstream acquisition and the assets of the downstream entities that were held by the upstream entity were not significant in relation to the value of the assets of the upstream entity.
89. In the 2004 Origin case the acquisition of the Contact shares was the purpose of the acquisition of the upstream targets so the 2004 Origin case would have fallen outside of the class exemption. Origin would still have had to apply for an individual exemption to comply with New Zealand takeovers law.
90. Option 2a provides transparency. Acquirers in an upstream acquisition can calculate whether they have to satisfy the Code or have to apply for an exemption from the Code and from the costs involved. In the case of a foreign upstream acquisition, New Zealand would meet its obligations in relation to international comity. The policy would ensure that the law does not impose excessive costs or obstacles on primarily foreign business transactions unless it was clear that the impacted New Zealand Code company shareholders should have the opportunity to participate in the change of control of their company. Moreover, the policy would make upstream acquisitions more efficient.
91. The significant threshold amount of 50% does not seem to be too low to make it unattractive for the acquirer to make an acquisition. By international standards it would also be not so high that the downstream shareholders would not receive adequate consideration. The policy provides an exemption for downstream acquisitions which are incidental to the acquirer's purpose of acquiring the upstream target.
92. The main disadvantage of this option is that it grants an exemption irrespective of where the upstream target is listed or whether it is listed at all. It is not guaranteed that the upstream entity's market is well regulated, which leaves open the opportunity for undesirable behaviours in the securities markets involved.
93. Where the downstream acquisition does not meet the criteria for the proposed class exemption, the acquirer would have to comply with the fundamental rule of the Code or apply to the Panel for an exemption. An exemption granted by the Panel, where the class exemption could not be relied upon, could be conditional on a follow-on offer being made for the downstream company. Where control of the downstream company is one of the main purposes of the upstream acquisition, the offeror will usually be affording a benefit to the upstream shareholders in relation to the shares in the downstream company. This benefit will usually be in the form of a control premium. The Panel would have to consider how to ensure that the shareholders in the downstream company are treated fairly.
94. Although Option 2a appears to meet the objectives of efficiency, international comity and transparency, it could be argued that it sets an improper balance between the costs of the Code and the benefits of the Code's existence by avoiding most of those costs for the acquirer and avoiding the Code's benefits for the Code company shareholders. It could also be argued that it fails to meet the objective of fair treatment of Code company shareholders in that it does not provide for Code company shareholder participation if the purpose and threshold tests of the class exemption were met.

Option 2b - class exemption relating to 25% asset threshold and purpose test

95. Option 2b would be the same as option 2a, focusing on the purpose test, but it would provide a lower threshold for the value of the voting rights of the downstream company. The threshold for what is regarded as a significant relative value of the downstream entity compared to the upstream entity would be reduced to 25%.

Analysis of Option 2b

96. If Option 2b was applied to upstream acquisitions that the Panel has already considered, in each case, except the 2004 Origin case, the parties would have been able to rely on the exemption. This is because, besides the fact that the acquisitions of each of the downstream entities were not the purpose of the upstream acquisitions, none of them constituted more than 25% of the value of the assets of the upstream target.
97. Again, the advantages of efficiency, meeting international comity principles and transparency would be achieved by this option. However, it also shares the same disadvantages as Option 2a relating to no assurances of a reputably regulated upstream transaction, an improper balance between the costs and benefits of the Code (because compliance with the Code by the acquirer was exempted) and fairness to shareholders.

Option 2c - class exemption relating to 50% asset threshold, purpose test, and upstream acquisition in jurisdiction with comparable investor protection

98. Option 2c would be the same as Option 2a (that is, with the purpose test and the 50% asset valuation) but would additionally be dependant on the upstream acquisition being made in a reputable jurisdiction (being one which affords a comparable level of investor protection to that under New Zealand law). The acceptable jurisdictions would be named; quite likely they would be those currently named in the ASIC Class Order 02/259.

Analysis of Option 2c

99. Option 2c is similar to the position under the Australian RG 71. This option would have the advantage that the exemption is only available to be relied upon where it is clear that the upstream acquisition is conducted under appropriate regulatory controls.
100. This option would not unduly inhibit the liquidity and efficiency of foreign securities markets. The acquisition of unlisted upstream entities would not have the benefit of this option, which is appropriate as these transactions are not subject to the regulatory scrutiny of those whose targets are listed on approved exchanges.
101. Compared to the status quo, this option appears to provide an adequate balance between the objectives of efficiency, transparency and complying with international comity compared to the potential disadvantages for shareholders in the downstream entity in not having an opportunity to participate in the change of control.

Footnotes

10. That is, whether the purpose of the upstream takeover is to obtain control of the downstream Code company.
11. That is, the value of the shares held in the downstream Code company by the upstream target is 50% or more of the value of the upstream company's assets.