Contents

Introduction

Scrip offers

Unmarketable parcels
Overseas shareholders

Schemes of arrangement - policy on exemptions

Applications for exemption likely to be declined
Circumstances where exemption may be approved

Facilitating market activity

PPCS / Richmond - class exemption
Cedenco / SK Foods - compulsory acquisition exemption
TrustPower - buyback exemption
Dominion Retail / Tri City - misleading offer document

GPG / Tower - underwriters class exemption

Policy of the exemption

Association and Associates

Designer Textiles / Gould Holdings
Designer Textiles / Rutherford Family

Defensive tactics - Tranz Rail Holdings Limited

How the Code applies to lock-up agreements

Pre bid lock-ups
Intra-bid lock-ups

Conclusion

Introduction

The past year has been an interesting one for the Panel as aspects of the Code, previously untested, have come under scrutiny. At times the Panel has intervened with enforcement actions, and has granted, and also declined, a range of exemptions from the Code.

Today I would like to tell you about some of the events that have occurred that reveal both how the Code works and what the Panel's thinking has been in certain situations.

Scrip offers

Scrip offers can provide difficulties for a bidder in two areas. First, small shareholders may receive unmarketable parcels of scrip. Second, overseas shareholders may necessitate compliance with the requirements of overseas jurisdictions. The Panel has considered both issues.

Unmarketable parcels - class exemption
Rule 20 of the Takeovers Code requires an offer to be made on the same terms and provide the same consideration for all securities of the same class. The effect is that an offeror who makes a takeover offer with consideration that includes securities listed on a stock exchange may be obliged to provide some smaller security holders with an unmarketable parcel of securities. Unmarketable parcels of securities may be difficult for security holders to deal with and are expensive for companies to administer.

Consequently the Takeovers Panel has granted a class exemption to allow offerors to limit the consideration offered to small security holders to cash.

The expression "small security holder" referred to in the exemption is defined as a person who would, if that person was offered, and accepted, consideration securities under a scrip offer, receive an unmarketable parcel of consideration securities. The other key definition is the "unmarketable parcel" which is defined as a number of consideration securities that is less than the minimum holding of consideration securities specified by the stock exchange.

This class exemption obviates the need for specific exemptions in cases where scrip consideration may result in the issue of unmarketable parcels of shares.

The exemption specifies the way in which the cash consideration which is to replace the scrip consideration is to be calculated. It provides:

• if the offer does not include a cash alternative, the cash consideration is an amount equal to the value of the shares, plus any additional cash under the offer; and
• if the offer does include a cash alternative, the cash consideration is the greater of-
  • the amount of the cash alternative; and
  • an amount equivalent to the value of the shares, plus any additional cash under the offer.

The "value of the shares" offered as scrip is defined as the weighted average of the closing prices of the shares on the exchange over a period of five trading days immediately preceding a date which is five days before the first date when consideration is sent to any offeree who has accepted the offer.

Overseas shareholders
Bidders wishing to offer scrip under a takeover offer will need to ensure that the offer complies with securities laws in every country where target company security holders reside.

The Panel is aware that compliance with securities law requirements in overseas jurisdictions can be expensive and time consuming for bidders. Most jurisdictions have rules or regulations governing the offer of scrip under a takeover offer and many jurisdictions impose prospectus-type requirements in respect of such offers. Compliance with such overseas requirements as well as New Zealand securities law requirements increases the cost and complexity of making a scrip offer for a New Zealand code company.

Since the introduction of the Code the Panel has granted two individual exemptions from rule 20 to address difficulties created by the offer of scrip to overseas shareholders. Each exemption in effect allowed the bidder to offer cash rather than scrip to certain overseas shareholders. The exemptions were granted in respect of:

• Normandy NFM Limited's offer for Otter Gold Mines Limited. Normandy proposed to offer scrip as consideration for the Otter shares. The vast majority of its shareholders lived in New Zealand and Australia, and Normandy could offer scrip to those shareholders using the New Zealand takeover documentation and its Australian prospectus. However, shareholders in other jurisdictions held approximately 1.22% of the shares in Otter;

• Independent Newspapers Limited's offer for all of the shares in Sky Network Television Limited. The consideration offered had both a scrip and a cash component. INL's offer could be made in New Zealand, Australia, the United Kingdom and the United States using the New Zealand offer documents. However, approximately 25 Sky shareholders, together holding less than 1% of the shares in Sky, were resident in other jurisdictions.

In both cases the bidders intended to offer scrip in jurisdictions in which New Zealand disclosure documents could be used. However, the bidders stated that because of the small number of shareholders resident in other jurisdictions it was not practical or cost effective to ensure that the scrip offer complied with securities laws in those other jurisdictions. Both bidders proposed to use a nominee arrangement to convert the scrip into cash which would be passed on to the overseas shareholders and sought an exemption from rule 20 to allow them to offer this alternative consideration.

The policy of rule 20 is to ensure that there is equal treatment of all security holders of a code company and the Panel is reluctant to grant exemptions which would allow offers to be made to certain shareholders on different terms. However, the Panel recognises that it is important that the making of scrip offers be a real and practical option available to bidders under the Code. In addition a proper relationship needs to be maintained between the cost of compliance with the Code and the benefits resulting from it.

The Panel granted exemptions from rule 20 to Normandy and INL which in effect allowed cash to be offered to certain overseas shareholders because in both cases the Panel was satisfied that the number of shares held by shareholders in the relevant jurisdictions was of such a low level that compliance with the securities law requirements in those jurisdictions would have been impractical and unreasonably expensive in the context of the offer.

In addition the Panel was satisfied that the alternative consideration to be offered to overseas shareholders was appropriate. Overseas shareholders were offered the equivalent market value (less reasonable expenses) of the scrip offered to remaining shareholders. This was intended to put the overseas shareholders in the same position as shareholders who receive and immediately sell the scrip offered by the bidder. The market value of the scrip offered by Normandy and INL was relatively easy to establish as in each case it was listed on a recognised exchange.

The Panel recognises that the type of difficulties faced by INL and Normandy may arise in respect of future scrip takeover offers. Most code companies of any size will have shareholders resident overseas. Accordingly, the Panel considers that it is appropriate to indicate when it would be likely to grant specific exemptions from rule 20 to allow cash to be offered to certain overseas shareholders. In general the Panel will grant such an exemption if it is satisfied that, in respect of each jurisdiction in respect of which an exemption is sought:

• the number of target company securities held by shareholders in that jurisdiction is a small percentage of the total issued securities;
• the scrip offer cannot be made using the New Zealand takeover offer, investment statement and/or prospectus; and
• compliance with securities laws in that jurisdiction would be impractical or unreasonably expensive in the context of the offer.

In addition, the Panel would only be likely to grant an exemption from rule 20 if it considers that the alternative consideration to be offered to overseas shareholders is appropriate. The alternative consideration offered should be cash equal to the value of the scrip. As previously noted, this is easier to establish when the scrip is listed on a recognised exchange. If the scrip is unlisted, and a market value is not available, an independent valuation of the scrip offered may be required. Each case will be treated on its merits.

Bidders intending to make scrip offers who wish to apply for an exemption from rule 20 to allow cash to be offered to overseas shareholders should provide evidence that the above criteria is satisfied in respect of each jurisdiction in which code company shareholders are resident and for which exemption is sought. This will require a bidder to make inquiries in each such jurisdiction.

A number of jurisdictions recognise the difficulties facing bidders offering scrip in other jurisdictions. Consequently, in the interests of shareholders resident within their jurisdictions, they have established practical and cost effective procedures to enable scrip offers to be extended to those shareholders.

There is a perception that obtaining advice in respect of the requirements of overseas jurisdictions is prohibitively expensive. This is not always the case. Seeking information regarding overseas requirements does not always require the bidder to instruct overseas advisers. Information can sometimes be obtained from overseas regulators at little or no cost. However, the Panel does recognise that differences in language and culture may make it difficult to obtain the relevant information. In such cases, if the applicant is able to demonstrate such difficulties, the number of shareholders resident in that jurisdiction is extremely small and the relevant jurisdiction is not one of those in which it is common for shareholders in New Zealand code companies to reside, the Panel may be willing to consider an application without evidence of the cost of compliance with the requirements in that jurisdiction.

Schemes of arrangement - policy on exemptions
Last year the Panel published a policy on exemptions for schemes of arrangement effected under the Companies Act 1993. The policy explains the circumstances in which applications for exemption for these schemes are likely to be declined and circumstances where the Panel may grant an exemption.

Applications for exemption likely to be declined
If an exemption application relates to a scheme of arrangement that is for all intents and purposes a takeover, particularly if it involves expulsion of minorities, the Panel will treat the transaction as a takeover when it considers the application. The Panel is likely to decline such an application so that target company shareholders are not denied the benefit of the full protections of the Code.

Circumstances where exemption may be approved
An exemption to facilitate the use of a scheme of arrangement may be appropriate where there are clear and compelling reasons why the proposed transaction should not be structured as a takeover, or completed using one of the mechanisms permitted under the Code.

Applicants for an exemption must provide strong arguments as to why it is proposed to use a scheme of arrangement rather than using the Code. There must be genuine reasons for using a scheme for the Panel to favourably consider granting an exemption. The Panel needs to be satisfied that the scheme is not being promoted in order to avoid the disciplines and protections of the Code.

Any exemption granted by the Panel would be framed so as to preserve as far as possible the objectives of the Code and the disciplines of a Code offer.

The Panel may require as a condition of exemption certain voting thresholds for shareholder approval of the proposed scheme. Generally the following voting thresholds applied as conditions of exemption would be:

• 75% of votes cast by those entitled to vote and who vote at the meeting, including by proxy, and being more than 50% of the total voting rights of the target company; and
• 50% by number of shareholders who are entitled to vote, and who vote at the meeting, including by proxy.

However there may be circumstances where the Panel imposes different, more appropriate, voting thresholds.

The Panel will be concerned to ensure that shareholders are given adequate information about the proposed transaction. It will require, at least, that:

• information provided to shareholders should be equivalent to that which would have been provided under a Code offer; and
• an independent adviser approved by the Panel should report on the merits of the scheme of arrangement to shareholders of the scheme company who are entitled to vote on the proposal.

Applicants for exemption should indicate their intentions in respect of the proposed transaction to the Panel early in the planning process. The exemption application should be sent to the Panel for consideration well before the application to approve the scheme is made to the Court.

Facilitating market activity
One of the main tasks of the Panel is to ensure compliance with the requirements of the Code. However, it is important that this is done constructively and in a manner which facilitates rather than inhibits the operation of the takeovers market. The following four cases illustrate this approach.

PPCS / Richmond - class exemption
This exemption arose as a result of orders made by the High Court in respect of proceedings brought against PPCS Limited concerning two parcels of Richmond Limited shares held by PPCS.

The High Court in November 2002 had ordered that one of the parcels be forfeited and that the voting rights attaching to the other parcel be suspended until such time as PPCS sold that parcel. The forfeiture and suspension meant that the voting rights attaching to the shares would not be "currently exercisable" and would therefore not constitute voting rights for the purposes of the Code. Accordingly, the percentage of voting rights held by remaining shareholders would increase proportionately when the orders took effect. This could result in the voting rights of a Richmond shareholder, which had legitimately acquired up to 20% of the voting rights in Richmond before the orders came into force, increasing beyond the 20% threshold in breach of rule 6(1) of the Code.

The orders did not have immediate effect because of an appeal to the Court of Appeal. Subsequently, in January 2003 PPCS made a full takeover bid for Richmond.

The High Court's decision created a number of difficulties for the market. First, there was the uncertainty as to whether the forfeiture and suspension would take effect in view of the appeal.

Second, if the forfeiture and suspension did take effect, then the suspension itself created a very unsatisfactory position under the Code. A shareholder holding 20% of the voting rights in Richmond would, as a result of the suspension, suddenly find itself in excess of the 20% threshold with a result that a sell down to 20% would be required. However, the suspension was not permanent and would cease once PPCS sold the parcel of shares in question. Consequently the shareholder which had originally held 20% of the voting rights but had been forced to sell down shares to comply with the Code would, on the cessation of the suspension, find itself below its original holding of 20%.

In view of the uncertainty as to whether the Court's decision would be upheld on appeal, the Panel considered that the status quo should prevail and shareholders should be entitled to buy and sell shares on that basis. Furthermore, shareholders should not be prejudiced by so doing. Consequently, in the event that the High Court's forfeiture and suspension orders took effect and, as a result solely of the Court orders, a shareholder's voting rights were to exceed the 20% threshold contained in the Code, then there should be an exemption from the Code to allow that excess to be retained. Such an exemption was further justified by the fact that the suspension would eventually cease thereby reducing the amount by which the 20% threshold would be exceeded. The parcel of shares subject to the suspension was over twice the size of the parcel subject to forfeiture.

The Court of Appeal ultimately upheld the forfeiture but quashed the suspension. No shareholder exceeded the 20% threshold as a result of the forfeiture and hence the exemption was not in fact needed.

Although the Richmond exemption is unusual arising out of a very complex situation, it is an example of the need for the Panel to be proactive in trying to ensure certainty in the operation of the takeovers market under the Code.

Cedenco / SK Foods - compulsory acquisition exemption
In August 2003 SK Foods International made a takeover offer for all the shares in Cedenco Foods Limited that it did not own. The takeover offer was successful and on 10 September 2003 SK Foods became the dominant owner of Cedenco.

Under rule 54 a dominant owner must issue an acquisition notice to all outstanding shareholders within 30 days of becoming dominant owner. SK Foods issued its acquisition notice the next day, 11 September 2003, while its takeover offer was still open.

In that notice SK Foods said that it would pay $2.30 for all outstanding shares in Cedenco (the same as its offer price) and informed shareholders that they had no right to object to the compulsory acquisition price.

An issue arose for the Panel because SK Foods was not entitled to assert that outstanding Cedenco shareholders had no right to object to the compulsory acquisition price of $2.30.

SK Foods was relying on rules 56(1) and 56(2) of the Code. These require a person who becomes the dominant owner through acceptances of an offer to pay the same consideration for compulsory acquisition provided it has received acceptances for more than 50% of the shares that were the subject of the offer.

In these circumstances the outstanding shareholders have no right to object to the acquisition price and the offeror has no choice as to the consideration it will pay.

If, however, an offeror achieves dominant ownership otherwise than under an offer, or where it has not received acceptances for more than 50% of the shares that were the subject of an offer, then it must pay consideration that has been certified as fair and reasonable by an independent adviser. In such a case the outstanding shareholders have the right to object to that price. If sufficient shareholders object then the matter must go to expert determination by an expert appointed by the Panel.

SK Foods had 59.1% of the voting rights in Cedenco when it made its offer. This meant that approximately 41% of the voting rights in the company were the subject of the offer.

To be able to rely on, and be bound by, rule 56(2), SK Foods would have had to have received acceptances from holders of approximately 21% of the outstanding shares in Cedenco when it issued its acquisition notice. It had not done so.

Using rule 36 of the Code SK Foods obtained 2.71 million shares, or 17.6% of Cedenco's total voting rights, outside of the offer. The shares it had acquired under the offer amounted to some 2.13 million, or 13.8% of Cedenco's total voting rights.

(Note: Rule 36 enables an offeror, during the course of an offer, where it has made a full offer for cash or including a cash alternative and the offer is unconditional, to obtain shares outside of the offer for cash. Typically these acquisitions will be on-market purchases for cash, but that was not the case with SK Foods which purchased shares by private treaty. If the consideration for any of these purchases is greater than the amount being offered in the offer then this is deemed to be a variation to the offer. While the offeror is able to make such purchases under rule 36, they do not count towards the requirement under rule 56(2) that acceptances be received for more than 50% of the shares the subject of the offer.)

On the Panel's analysis SK Foods was some 1.02 million shares short of the acceptances needed to exceed the 50% acceptance level when it issued its acquisition notice, and was still short of the required number when its offer closed on 15 September 2003.

SK Foods applied to the Panel for a retrospective exemption under section 45 of the Act. The exemption allowed SK Foods' flawed compulsory acquisition procedure to go ahead as planned but provided for the price to go to expert determination if sufficient shareholders objected. The exemption was structured so as to give effect to the requirements of the Code's compulsory acquisition provisions.

Significant features of the exemption granted by the Panel were:

• all shareholders whose acceptances had been received by SK Foods after it had issued its compulsory acquisition notice (because they may have been coerced into accepting the offer by SK Foods' acquisition notice), and all shareholders who had not accepted SK Foods' offer when it closed, could object to the compulsory acquisition price of $2.30 per share;
• if 10% of these shareholders objected to the price then the amount of consideration to be paid would go to expert determination;
• if the expert determined that the consideration should be higher than $2.30 then all shareholders who had accepted the offer and who had objected to the acquisition price, and all shareholders who had not accepted the offer when it had closed, would receive the higher amount;
• if the expert determined that consideration should be less than $2.30 then all those shareholders who had accepted the offer and objected to the price, and all those shareholders who had not accepted the offer when it closed, whether or not they had objected to the price, could have been required to repay any overpayment they had received, to SK Foods. (This is consistent with rule 62(2) of the Code.)

In the event less than 10% of the shareholders objected to the price and the expert determination process was not triggered.

This exemption highlights:

• if offerors wish to use the offer price as the compulsory acquisition price they need to monitor the extent to which they acquire securities outside of the offer during the offer period;
• the effectiveness of the Panel's ability to grant retrospective exemptions. SK Foods was able to validly proceed with its compulsory acquisition while providing rights of objection to shareholders who had not accepted the offer or who may have been influenced by SK Foods' acquisition notice to accept the offer. If the Panel had not been able to grant a retrospective exemption SK Foods' flawed compulsory acquisition process could have become mired in legal challenge.

TrustPower - buyback exemption
In March 2003 TrustPower made a pro-rata buyback offer to purchase 2 shares of every 7 held by each shareholder.

In making this offer TrustPower sought to rely on clause 4 of the Takeovers Code (Class Exemptions) Notice (No 2) 2001 (the buyback exemption). This exemption enables shareholders to retain increases of voting control where a company acquires shares through a buyback that has been approved by the shareholders.

TrustPower planned to:

• distribute the offer document requiring irrevocable responses from all shareholders;
• after the offer closed, prepare a notice of meeting setting out the exact increased control percentages requiring approval of the non-associated shareholders and send it, with an independent adviser's report, to shareholders;
• hold the meeting of the company at which shareholders would vote to approve the increased control percentages arising from the buyback.

The Panel considered that this procedure did not comply with the buyback exemption. The buyback proposal, and the resulting potential increases in control percentage for each major shareholder, should have been put to shareholders with the independent adviser's report at a meeting held before the offer was made.

The procedure followed by TrustPower meant that shareholders were required to irrevocably commit to the buyback offer without having any advice on the merits of the buyback, including its control implications.

The terms of the buyback exemption are designed to ensure that shareholders receive advice on the merits of the buyback, including its control implications, before they are required to decide whether or not to accept the offer.

The Panel convened a meeting under section 32 to determine the application of the buyback exemption. Representatives and counsel for TrustPower's four major shareholders and TrustPower attended the meeting.

The Panel determined that the procedure for the buyback used by TrustPower did not comply with the terms of the buyback exemption. However, the buyback offer was underway and had already been accepted by many shareholders. The Panel said in its determination that it would consider an exemption for TrustPower and the major shareholders intending to increase their voting control in TrustPower.

TrustPower applied, and the Panel granted, an exemption to allow the buyback to proceed but give shareholders who had accepted the buyback the opportunity to withdraw their acceptances.

This ensured that shareholders would have the benefit of the independent adviser's report and the information in the notice of meeting before they made their final decision as to whether to accept the buyback offer.

The exemption from rule 6(1) of the Code in respect of any increase in the voting rights they would hold or control in TrustPower as a result of the buyback was granted to TrustPower's four major shareholders, Alliant International New Zealand Limited, Infratil Limited, The Australian Gaslight Company and the Tauranga Energy Consumer Trust. AGL was included in the exemption even though it transpired that AGL sold out its entire holding in TrustPower as a result of the buyback.

The exemption was subject to conditions which included:

• that shareholders of TrustPower had to approve the potential increase by separate resolution in respect of each of Alliant, Infratil, AGL and TECT;
• that neither the shareholder whose voting control was to increase nor any of its associates could vote in respect of that shareholder's potential increase in voting rights;
• that any shareholder who had accepted TrustPower's buyback offer (other than any of the four beneficiaries of the exemption) would have up until 5 working days after the date of the shareholders' meeting to rescind their acceptances without penalty; and
• that for a short period after the meeting TrustPower would assist any shareholders who had previously rejected the offer to sell their TrustPower shares.

Other conditions related to the contents of the notice of meeting.

This exemption was granted because this was the first time the application of the buyback exemption had come before the Panel and the Panel was satisfied that TrustPower had acted in good faith and on the basis of legal advice in the approach that it had taken.

A further issue arose whether the major shareholders were eligible to vote in favour of the resolutions approving the increases in voting control.

TrustPower's major shareholders at 31 March 2003 were, in round figures:

	Infratil		28%
	Alliant		19%
	TECT		23%
	AGL		20%

Infratil and Alliant were parties to an investment agreement making them "associates" for the purposes of the Code. However the Panel was concerned, on the basis of the evidence, that all four major shareholders may have been associated with each other and with TrustPower in respect of the increased voting control being sought by TECT, Infratil and Alliant.

The four major shareholders offered to give the Panel enforceable undertakings under section 31T of the Act that they would not exercise their voting rights at TrustPower's meeting. The Panel accepted these undertakings as an efficient way to deal with its concerns while allowing the buyback transaction to proceed in accordance with its contractual timetable.

The Panel's determination in this case has settled the procedure for buyback offers involving shareholder approval under the buyback exemption. The shareholder meeting to approve the potential increases in voting control must be held before the buyback offer is made to shareholders. Shareholders who wish to increase their control percentages must disclose their intention before the meeting takes place. This enables the notice of meeting and the independent adviser's report to be prepared on a proper basis.

The need for the type of exemption granted to TrustPower should not arise in the future.

Dominion Retail / Tri-City - misleading offer document
During December 2003 the Panel determined that a mistake in an offer document, which made the statement of the offer price ambiguous, was a breach of the Code. The Panel also determined how this mistake should be remedied in a pragmatic and efficient manner. This was the first occasion on which the Panel had to consider whether offer documents which contain errors or misstatements relating to the terms and conditions of the offer comply with the Code. The matter was determined at a meeting held under section 32 of the Act to consider whether Dominion Retail Property Fund Limited had complied with the Code in relation to its offer for Tri-City Properties Limited.

Dominion Retail made a takeover offer for all of the parcels of shares and mortgage bonds issued by Tri-City on 2 December 2003. The offer stated that it would expire on 31 December 2003. The offer document stated that anyone accepting the offer would receive $4750 for each parcel of shares and bonds plus an "additional cash amount". In relation to the additional cash amount the offer document stated that:

• the additional cash amount would be equal to the amount of interest accrued but unpaid in respect of the bond on the later of 31 December 2003 or the date on which the acceptance was received; and
• for acceptances received on or prior to 31 December the additional cash amount would be $475.

However, these two statements were inconsistent. Under the terms of the mortgage bonds the amount of interest that would have been accrued but unpaid on 31 December 2003 was $118.75 not $475.

On 5 December 2003 Dominion Retail sent a letter to Tri-City security holders advising that the additional cash amount stated in the offer document was incorrect and that the additional cash amount payable in respect of acceptances received on or prior to 31 December 2003 would be $118.75 and not $475.

Following correspondence with Dominion Retail and Tri-City the Panel decided that the mistake in Dominion Retail's offer raised two issues:

• whether the statement of consideration in the offer complied with the requirements of the Code; and
• whether Dominion Retail could correct the mistake in its offer in a way that complied with the Code.

Clause 5 of Schedule 1 to the Code requires that a takeover offer must contain "all the terms and conditions of the offer". As consideration is a fundamental term of any contract, an offer document must state the consideration offered in terms such that offerees can understand the amount that will be paid to them should they decide to accept the offer.

The Panel considered that the inconsistencies between the two statements relating to the additional cash amount created a level of uncertainty such that security holders may not have understood the amount of consideration payable to them should they accept the offer on or prior to 31 December 2003. Although the reference to a payment of $475 for accrued interest to 31 December 2003 was a mistake, it was misleading and confusing. Accordingly, the Panel considered that Dominion Retail's offer document did not correctly state all of the terms and conditions of the offer as required by clause 5 of Schedule 1 to the Code. The Panel determined that Dominion Retail had breached the Code. If a takeover offer does not correctly state all of the terms and conditions of that offer, it does not comply with the Code.

The Panel also determined that although Dominion Retail had attempted to correct the mistake by subsequently writing to security holders, that letter had no status under the Code. The letter did not constitute a variation of the offer and did not correct the defect in the offer document.

In considering what remedy might be appropriate the Panel did not consider that it would be in the interests of Dominion Retail or Tri-City security holders for the offer to be withdrawn and a new offer made. This would have been time consuming and costly.

The Panel considered that the most practical solution would be for the terms of the offer to be clarified and for all security holders who had accepted the offer to be given the right to withdraw their acceptances. This would in effect put shareholders in the same position they would have been in had Dominion Retail's offer contained all of the information required by the Code. In order to give security holders the opportunity to consider the offer as clarified the Panel considered that it would be necessary for the offer to be extended beyond the initial expiry date of 31 December 2003.

The Panel decided that it would accept an undertaking from Dominion Retail under section 31T of the Act, that Dominion Retail would:

• extend the period of its offer to 30 January 2004;
• give all security holders of Tri-City who accepted the offer prior to receipt of notification of the Panel's determination the right to revoke that acceptance at any time up to the closure of Dominion Retail's offer;
• send immediately to all security holders of Tri-City a letter to be approved by the Panel explaining the correct terms of the offer, the rights of security holders to revoke their acceptance, and related matters.

Such an undertaking was provided before the Panel released its determination. A letter clarifying the terms of the offer and advising security holders of their right to withdraw their acceptances was sent to security holders on 19 December 2003. The Panel has been advised that a small number of security holders withdrew their acceptances.

GPG / Tower - underwriters class exemption
In July 2003 Tower Limited, a code company, was undertaking a recapitalisation through making a large pro rata rights offer to existing shareholders. Guinness Peat Group plc, already Tower's largest single shareholder, entered into an agreement with Tower to underwrite the offer. GPG and Tower also agreed, to comply with decisions of the NZX's Market Surveillance Panel, to appoint a panel of subunderwriters.

GPG had the potential, albeit reasonably remote, to obtain in excess of 20% of the voting rights in Tower as a consequence of its underwriting of Tower's rights issue. If this occurred, GPG intended to rely on the class exemption for underwriters set out in clause 19 of the Takeovers Code (Class Exemptions) Notice (No 2) 2001 (the underwriters class exemption). That exemption provides that every person who is, or is an upstream party of, an underwriter is exempted from rule 6(1) of the Code in respect of any increase in the person's voting control.

The exemption is subject to the condition that-

(a)

the increase in the person's voting control results only from the allotment or transfer to the underwriter of voting securities in a code company under a bona fide underwriting or subunderwriting contract entered into in the underwriter's ordinary course of business; and

(b)

the control percentage of the person is decreased within 6 months after the increase in the person's voting control to, or below, either-
(i) the control percentage of the person immediately before the increase in the person's voting control; or
(ii) if-
(A)...; or
(B) the aggregate of the control percentages of the person and the person's associates immediately before the increase was less than 20%, 20% less the aggregate of the control percentages of the person's associates at the time of the decrease; and

(c)

the additional voting rights of the person are not exercised before the decrease.

An underwriter is defined in the exemption as:

a person whose ordinary business includes entering into bona fide underwriting or subunderwriting contracts with respect to offers of securities.

The Panel's preliminary view was that GPG would be unable to rely on the underwriters class exemption because GPG's ordinary business did not include "entering into bona fide underwriting or subunderwriting contracts with respect to offers of equity securities". GPG did not accept that it was unable to rely on the underwriters class exemption.

As an alternative to purporting to rely on the class exemption GPG, at the invitation of the Panel, applied for a specific exemption from the fundamental rule to enable the underwriting agreement to proceed.

The exemption was granted subject to the conditions that-

• the aggregate control percentage of GPG and Ithaca (its subsidiary) was decreased to, or below, 20% within the period that ended with the earlier of-
  (i) the day that was 30 days from the date on which GPG and Ithaca increase their voting control under the agreement; and
  (ii) the day that Tower held its next general meeting; and
• the voting rights attached to the voting securities that must be disposed of are not exercised by GPG or Ithaca.

These conditions were tighter than those contained in the underwriters class exemption and were intended to ensure that GPG, which had demonstrated its desire to increase its control in Tower, had a relatively brief period in which to dispose of any shares it obtained above the 20% Code threshold.

GPG notified the NZX that, after having fulfilled its underwriting obligations, it had acquired only 17.1% of the total voting securities of Tower. Consequently the exemption was not required and was revoked. However, GPG made it clear that it did not accept that the underwriters class exemption did not apply to it.

Policy of the exemption
The policy behind the underwriters class exemption was to provide professional underwriters with a reasonably generous period in which to sell down shareholdings in excess of 20% obtained through fulfilment of their underwriting obligations. It was not intended to extend the benefit of the underwriters class exemption to parties who used underwriting arrangements as a means of increasing their control of target companies.

The Panel is reviewing its underwriters class exemption notice to ensure the wording of the exemption reflects the Panel's policy intentions. A draft of a new exemption has been released for public comment.

Association and Associates
Designer Textiles / Gould Holdings
Rule 6(2) has provisions designed to ensure that the fundamental rule is not defeated by the manner in which company shareholdings are structured. It is basically an anti avoidance provision.

Designer Textiles (N.Z.) Limited is a code company. Its major shareholder is Gould Holdings Limited, an investment company controlled by Mr George Gould, with a 24.69% stake.

Mr Gould has had a long association with the Rutherford family. In the latter part of 2002 the members of the Rutherford family sold their investment company, Amuri Securities Limited to GHL in exchange for shares and convertible notes in GHL. After Mr Gould had subscribed some additional capital in GHL the Rutherford family held 21.24% of GHL while Mr Gould, through a separate company Gould Investments Limited, held 78.76%.

The Panel was concerned that the Rutherford family interests may have joined Mr Gould in "holding or controlling" GHL's 24.69% stake in DTL in breach of the Code. The issue was the effect of rule 6(2)(b) which states that if:

(b) a person or persons together hold or control voting rights and another person joins that person or all or any of those persons in the holding or controlling of those voting rights as associates, the other person is deemed to have become the holder or controller of those voting rights.

To come within rule 6(2)(b) the Rutherfords first had to have joined Mr Gould/GIL in the control of GHL and therefore the control of GHL's shareholding in DTL.

The Panel examined the relationship between the Rutherford family and Mr Gould to decide whether the Rutherfords may have joined Mr Gould/GIL in controlling GHL. Of particular note to the Panel were:

• the Rutherfords had no board representation on GHL;

• the Rutherfords acquired their interest in GHL accepting that they had no right to influence Mr Gould's control of that company; and

• there was no shareholder agreement to provide the Rutherfords with any control in the decision-making process of GHL.

The Panel accepted that the Rutherford family had not joined Mr Gould/GIL in the controlling of GHL's 24.69% holding in DTL. The Panel noted that it would be unusual for an investment of 21.24% to be made in a closely-held company on an entirely "sleeping partner" basis with no checks and balances on the conduct of that company. However, in this case the evidence indicated that:

• Mr Gould was intent on retaining control of GHL; and
• the Rutherford family bought their shares in GHL accepting that they had no rights to influence GHL's governance, either in controlling the votes in DTL, or otherwise.

Designer Textiles / Rutherford Family
The question of association between the Rutherford family and Mr Gould did arise in connection with various acquisitions of shares in DTL itself by members of the family.

Several family members had acquired direct investments in DTL and by February 2003 these holdings amounted to some 8.8% of the total voting rights in DTL. They were in addition to the 24.69% held by GHL.

The issue was that if the Rutherford family were associates of Mr Gould or GIL at the time they had acquired these parcels of shares then the acquisitions would have been in breach of the Code.

The Code defines "associate" in rule 4 as follows:

For the purposes of this code, a person is an associate of another person if-

(a)

the persons are acting jointly or in concert; or

(b)

the first person acts, or is accustomed to act, in accordance with the wishes of the other person; or

(c)

the persons are related companies; or

(d)

the persons have a business relationship, personal relationship, or an ownership relationship such that they should, under the circumstances, be regarded as associates; or

(e)

the first person is an associate of a third person who is an associate of the other person (in both cases under any of paragraphs (a) to (d)) and the nature of the relationships between the first person, the third person, and the other person (or any of them) is such that, under the circumstances, the first person should be regarded as an associate of the other person.

The Panel considered a number of factors, including:

• the historical business relationship through companies in which both the Rutherfords and Mr Gould had an involvement;
• the Rutherfords had previously contracted Mr Gould to manage certain investments in ASL on their behalf;
• the Rutherford investment in GHL was very informal with minimum documentation and was characterised by a high degree of trust on the part of the Rutherford family;
• the Rutherford family agreed not to take part in the governance of GHL; and
• the relevant investment monies of the Rutherfords were kept together over many years, and they adopted a common approach to the investment in GHL.

The Panel was satisfied that the strands of all three elements (business, personal and ownership relationships) of the extended definition of "associate" in rule 4(1)(d) satisfied the requirements for association between Mr Gould and the Rutherford family. The rule 4(1)(d) relationships did not need to exhibit any agreement over control or any particular form of undertaking relating to the voting rights attached to shareholdings in the company. In particular, the expression "in the circumstances" enabled all factors to be considered in assessing the relationship, taking into account the importance of the associate status.

The Panel determined that the associate status crystallized on 11 September 2002 and that consequently all acquisitions of DTL securities by Rutherford family members after that date were held to be in breach of rule 6(1)(a). The parties at fault were required to divest those holdings that had been acquired in breach of the Code.

The family members gave enforceable undertakings that the relevant shares would be sold within six months of the Panel's decision and subsequently confirmed that this had been done.

Even small acquisitions of voting rights in a code company can be in breach of the Code if an associate of the person acquiring the voting rights already holds more than 20% of the voting rights in the company. The provision is designed to ensure that controlling shareholders cannot increase their level of control in a code company through associates when they would be unable to acquire the additional voting rights themselves.

Defensive tactics - Tranz Rail Holdings Limited
Two issues that arose last year involved alleged or possible defensive tactics being used by the directors of Tranz Rail Holdings Limited.

The first issue concerned the agreement between the Crown and Toll Group (NZ) Limited/Toll Holdings Limited relating to the sale of the rail network to the Crown once Toll obtained control of Tranz Rail. The Panel received a complaint that this action amounted to a defensive action by the "directors" of Tranz Rail.

The second issue concerned Tranz Rail's wish to sell the Wellington Railway Station to the Crown during the course of Toll's takeover offer for Tranz Rail. Tranz Rail sought the approval of the Panel to the proposed sale.

Rules 38 and 39 of the Code deal with defensive tactics by the directors of a target company. Rule 38 aims to ensure that directors of Code companies do not take action which could, once notice of an offer has been given or an offer is believed to be imminent, effectively frustrate that offer. Rule 39 specifies the circumstances in which the directors of a code company can take defensive actions.

On 7 July 2003 the Crown and Toll entered into an agreement which provided that, if a takeover offer to be made by Toll in July became unconditional:

• Toll would use its best endeavours to procure Tranz Rail to enter an agreement with the Crown under which Tranz Rail would sell its rail network to the Crown;
• the Crown would commit to improving the rail network (an investment of $200 million), and
• Toll would commit to upgrading Tranz Rail's rolling stock (an investment of $100 million).

Under the Toll/Crown agreement neither party could enter into a similar agreement with any other party until Toll's July takeover offer was withdrawn or lapsed.

Infratil Limited was a shareholder of Tranz Rail. Infratil alleged that Toll's entry into the agreement constituted a defensive tactic under rule 38 because:

• the agreement conferred significant economic benefits on Tranz Rail; and
• the exclusive nature of the agreement effectively denied those benefits to any potential rival bidders.

Neither Tranz Rail nor its then current directors were a party to the Toll/Crown agreement. However Infratil argued that Toll could be considered to be acting as the directors of Tranz Rail for the purposes of the Code because the directors of Tranz Rail may be required to act in accordance with Toll's directions or instructions.

The Panel held a meeting under s32 of the Act to consider the issue. The Panel did not agree with the interpretation of the term "director" put forward by Infratil. For the Toll/Crown agreement to have constituted defensive tactics under rule 38, it must have been shown that the agreement was the result of action taken or permitted by the directors of Tranz Rail.

The Panel did not accept that "directors" for the purposes of rule 38 can include persons in accordance with whose instructions the directors of Tranz Rail may have been required to act at some point in the future, particularly if that "requirement" to act could only occur after control had passed.

Rule 38 required the directors of Tranz Rail to take some action in relation to that company's affairs which frustrated an offer or denied its shareholders the opportunity to decide on the merits of an offer. The directors of Tranz Rail did not take any such action.

Later Tranz Rail directors sought the Panel's approval under Rule 39 of the Code of its prospective sale of the Wellington Railway Station to the Crown.

Under Rule 39 there are certain circumstances where apparently defensive tactics by a code company during the course of a takeover can still proceed. These circumstances are:

• if the action has been approved by an ordinary resolution of the code company; or
• the action is taken or permitted under a contractual obligation entered into by the code company, or in the implementation of proposals approved by the directors of the code company, and the obligations were entered into, or the proposals were approved, before the code company received the takeover proposal or became aware that the offer was imminent; or
• if the action is taken or permitted for reasons unrelated to the offer with the prior approval of the Panel.

The issue with the sale of the station was that Toll's offer for Tranz Rail included a condition that:

Neither Tranz Rail or any of its subsidiaries enters into any agreement or incurs any commitment or liability in connection with the business of Tranz Rail or its subsidiaries having a value or involving an amount, or providing for payments over its term, which are in excess of $5,000,000.

Tranz Rail told the Panel that:

• the sale price of the station exceeded that $5m level and that it needed to complete the transaction within a short period; and
• that Toll would not consent to waive its condition to allow the transaction to proceed without jeopardising the offer.

The Panel sought the views of Toll on Tranz Rail's request. It also told both parties it would make the request public and seek the views of Tranz Rail's shareholders on how it should deal with the request.

In the end the Panel did not need to decide the matter because Toll withdrew its opposition to the sale.

This situation enabled the Panel to make the following points:

• the Code does not prescribe the approach that the Panel should take when considering an application for approval under rule 39;
• competitors may try to use takeovers to frustrate the legitimate commercial aspirations of target companies, potentially for lengthy periods;
• the Panel will generally seek the views of the offeror and the target company shareholders before approving an application under rule 39; and
• in considering an application under rule 39 the Panel will take into account whether the transaction is being undertaken in the normal course of the target company's business and the application has been necessitated by a particularly restrictive condition in the offer.

How the Code applies to lock-up agreements
Lock-up agreements are permitted by the Code and the policies that underpin it. These include lock-up agreements which occur before a bid is made (pre-bid lock-ups) and agreements made during the offer process (intra-bid lock-ups).

Pre-bid lock-ups
A pre-bid lock-up agreement is an agreement between a shareholder and a potential bidder that if the bidder makes a takeover offer for the company on agreed terms then the shareholder will accept that bid.

There is no doubt that such an agreement is permitted by the Code. The fundamental rule contained in rule 6(1) deals with increases in the holding or controlling of voting rights in a code company. Consequently, if the pre-bid agreement does not have the effect that the potential bidder becomes the holder or controller of the voting rights attaching to the shares then no breach will occur.

Clause 8 of Schedule 1 of the Code recognises this position. Under this clause all that is required is that in the offer the bidder must give details of any party that has agreed conditionally or unconditionally to accept the offer and the material terms of the agreement.

Acceptance of the legality of pre-bid agreements is not an oversight in the Code but flows directly from the way the Code has been constructed. The key provisions controlling the content of pre-bid contracts are the fundamental rule as mentioned above, and also rule 20 which requires that an offer must be made on the same terms and provide the same consideration for all securities of the same class. The same rule has the effect also of preventing collateral arrangements which are intended to enhance the effective price received by a shareholder.

It has been suggested that a loophole exists because a party can obtain a number of pre-bid agreements and hence at the time the offer is made the bidder may be in a strong position to achieve a successful outcome. In addition of course, the bidder can acquire outright up to 20% of the voting rights of the target company before a bid is made.

The Code deals with this situation in a number of ways. First, the potential bidder may not actually acquire and control more than 20% of the voting rights in the target company. Second, rule 23 of the Code requires that the bid be conditional upon the bidder obtaining control over more than 50% of the voting rights in the target company. Third, as mentioned above, under rule 20 the offer must be made on the same terms and conditions to all holders of securities of the same class. Furthermore, it can be expected that parties to pre-bid agreements will want to achieve the best possible price for their shares.

If the bid proceeds and is successful the Code will have achieved the desired outcome. The process will be conducted in accordance with the provisions of the Code, including the obligation to provide independent advice, so that all shareholders will be fully informed. Pre-bid agreements may have contributed to the success of the bid, but is this a criticism?

In formulating the Code, the Panel was required by the terms of the Takeovers Act 1993 to consider a number of objectives. These objectives include: encouraging the efficient allocation of resources; encouraging competition for control of companies; and assisting in ensuring the fair treatment of shareholders.

Fair treatment of shareholders, which the Panel has equated with equal treatment of shareholders, is a fundamental objective of the Code. This objective is always satisfied in the case of a pre-bid lock-up agreement because other shareholders must be offered the same price as that provided for in the lock-up agreement. The only issue which needs to be addressed is whether the potential for pre-bid contracts to limit the development of an auction between competing bidders is desirable.

There are good reasons for the Code's approach in allowing pre-bid agreements. This is the subject of considerable discussion in Australia as it considers whether it should move from its present takeovers code to a mandatory bid code, more in line with the City of London code.

The Australian code focuses much more directly on the auction principle. In broad terms, pre-bid agreements are not permitted as they may inhibit the auction between competing bidders. However, this does have important consequences in the operation of the takeovers market.

An example of the flexibility that exists under the New Zealand Code was the sale by the controlling shareholder of its stake in United Networks to Vector. In effect, the seller and the company in conjunction with their financial advisers undertook a competitive process to achieve the best price for the controlling shareholder. This was possible because under the New Zealand Code the preferred bidder had the certainty through a pre-bid agreement with the seller that when the formal bid was ultimately made to all shareholders the controlling shareholder would sell into that bid. Equal treatment was achieved in that all shareholders received that same price. It is argued by many in the commercial world that the ability to undertake a commercial auction in this manner is efficient and also achieves the best outcome.

It is the inability under the Australian code to undertake the same process that has led to pressure to adopt the mandatory bid system. Under this system there would be no constraints whatsoever in undertaking the commercial auction to find the highest bidder for the controlling shareholder's stake in the target company. In fact, a pre-bid agreement is not necessary as there is no restriction on a sale contract being entered into and completed. All that is necessary is for the bidder to subsequently make an offer to all remaining shareholders on the same terms and conditions. This is why the mandatory bid system is often referred to as being based on an exit principle whereby shareholders must be given the opportunity to exit the company, once the threshold has been passed, on terms no less favourable than those enjoyed by the initial sellers.

It can be seen from the above that strict adherence to the auction principle can inhibit commercial transactions which many would regard as efficient business practice. The approach to the New Zealand Code was to try to restrict as far as possible regulation inhibiting normal commercial activity except where this was necessary to ensure that the fundamental policy objectives of the Code were fulfilled. The United Networks takeover is a good example of the flexibility of the New Zealand Code and the balance achieved between its various objectives.

Intra-bid lock-ups
The issue has also arisen recently as to whether during a bid a lock-up agreement can be entered into whereby a shareholder agrees that it will accept the offer as soon as the price has been increased to an agreed figure. Such an agreement is permitted by the Code subject to similar constraints that apply to pre-bid agreements. Just as the original bid must first be made before it can be accepted, so with a variation the variation must first take place in accordance with the provisions of the Code before the offer as varied can be accepted. Rule 20 requiring equal treatment ensures that all shareholders will receive the same price. It is not possible for the "pre-variation" agreement to actually effect a variation as this will result in the bid being varied in a manner which does not comply with the Code. This was the issue that arose in the Otago Power case. The only exception is where the purchase complies with the requirements of rule 36 which is most likely to arise when an offer has become unconditional. Rule 37 then deals with the variation of the offer that flows from any such acquisition at a price in excess of the price contained in the offer.

The important point with lock-up agreements is that the terms must be constrained to ensure that they do not breach the fundamental rule contained in rule 6(1) of the Code or rule 20 requiring equal treatment of all shareholders.

Conclusion
The discussion on lock-up agreements has been included in this paper as a result of some public comment on the Code's approach to such arrangements.

Apart from that issue, the remainder of the paper has dealt with the Panel's activities shows the wide range of issues that the Panel has been required to consider.

I remind you that the Panel maintains an extensive website and also publishes comment from time to time in Code Word. I encourage those active in the market and their advisers to make use of the website and Code Word.

Finally, I refer to the Panel's public consultation document on proposed changes to the Code. These changes do not affect the Code's policy. They are technical adjustments, the desirability of which has become apparent since the Code became operative. The Panel's recommendation are with the Minister of Commerce and we hope that they will be implemented in the not too distant future.

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