Guidance

Introduction

1. An upstream acquisition is a transaction (whether in New Zealand or overseas) that may indirectly affect control of a Code company.^[1]  Where an upstream company (an Upstream Company) holds or controls voting rights in a Code company (a Downstream Code Company), an acquisition of effective control of that Upstream Company may be restricted by rule 6 of the Code.
2. This Guidance Note outlines the Panel’s approach to the application of the Code in the context of upstream acquisitions. Specifically, this Guidance Note addresses when an upstream acquisition may have Code implications, how acquirers can comply with the Code and the exemptive relief the Panel may consider when compliance is impractical or impossible. 
3. This Guidance Note also includes the following appendices:
   1. Appendix A: a flow chart illustrating the Panel’s upstream exemption policy.
   2. Appendix B: a series of case studies and examples illustrating the Panel’s approach to prior upstream acquisitions and exemptions.
4. Parties contemplating any of the transaction structures discussed in this Guidance Note are encouraged to consult the Panel executive in advance. 

Application of the Code

Introduction

1. The Code was drafted on the premise that parties should not be able to use upstream transactions to achieve outcomes that could not be achieved through transactions which directly involve voting securities of the Code company. In other words, the Code is drafted so that the fundamental rule cannot be avoided merely because voting control in a Code company is acquired indirectly. Accordingly, the Code will apply to certain upstream transactions.
2. However, not all increases in control in an Upstream Company will have Code implications. Principally, upstream acquisitions have Code implications where the Upstream Company holds or controls more than 20% of the total voting rights in a Downstream Code Company (the Downstream Voting Rights).^[2] While the application of the Code to the upstream transaction will be fact-specific, the Code will generally apply where an upstream person (the Upstream Acquirer) obtains effective control of the Upstream Company.^[3] Where this occurs, the Upstream Acquirer must comply with the Code whether or not the acquisition was undertaken for the purpose of obtaining control of the Downstream Voting Rights. 
3. Market participants are encouraged to read this Guidance Note in conjunction with the Panel’s Guidance Note on Control and Association, and Codeword 7, which provide examples of some upstream acquisition scenarios. The Panel’s Guidance Note on Exemptions may also be of assistance.

   How the Code may apply

4. Where control of an Upstream Company is acquired by an Upstream Acquirer (for example, on completion of the upstream transaction) then the Upstream Acquirer may become the effective controller of the Downstream Voting Rights. 
5. Whether an upstream acquisition results in an Upstream Acquirer becoming the effective controller of the Downstream Voting Rights depends on a number of factors:
   1. There are clear cases where effective control of the Downstream Voting Rights will be achieved – for example, where the upstream transaction (e.g., a takeover of the Upstream Company) results in the Upstream Acquirer holding or controlling 100% of the voting rights in the Upstream Company.
   2. An acquisition which results in the Upstream Acquirer holding or controlling more than 50% of the voting rights of an Upstream Company will likely result in the Upstream Acquirer obtaining effective control of the Downstream Voting Rights. However, it is possible that, in some circumstances, this may not be the case.
   3. It is also possible, that in some circumstances, an Upstream Acquirer becoming the holder or controller of 50% or less of the voting rights of an Upstream Company will result in the Upstream Acquirer obtaining effective control of the Downstream Voting Rights. 
6. In any event, the key question is whether effective control was acquired. Relevant factors to determining whether control was acquired may include voting agreements, shareholders’ agreements and the Upstream Company’s constitution. Such arrangements may limit or increase the Upstream Acquirer’s ability to exercise control over the Downstream Voting Rights. 
7. Where the Upstream Acquirer becomes the controller of sufficient voting rights to control, in practice, the composition of the board of the Upstream Company, this will likely be treated as effective control of the Downstream Voting Rights. 
8. Other less obvious circumstances where the Code may apply include:
   1. Changes in joint venture interests: If an incorporated joint venture controls the Downstream Voting Rights, a change in participating interests, such as admitting a new joint venture party or one party acquiring part or all of another’s interest, may have Code implications as a result of the operation of rule 6(2)(b) of the Code.
   2. Further acquisitions by an existing controller: Where an Upstream Acquirer already has effective (but not full) control of the Upstream Company and acquires a further interest, the deeming provisions in rule 6(2)(c) of the Code may result in the Code applying. 
9. The examples set out above are not exhaustive. Parties considering transactions of this nature are encouraged to contact the Panel executive to discuss how the Code may apply in their specific circumstances. 
   

   Prior shareholder approval or downstream takeover

10. Absent an exemption, in order to comply with the Code, before the Upstream Acquirer gains control of the Upstream Company (and therefore of the Downstream Voting Rights), the acquirer must have either:
    1. obtained approval from the Downstream Code Company’s shareholders by way of an ordinary resolution under rule 7(c) of the Code.; or
    2. become the holder or controller of the Downstream Voting Rights directly (in a Code compliant method, e.g., through a takeover) such that the Upstream Company no longer holds or controls the Downstream Voting Rights.
11. Under option (a), the rule 7(c) approval by the Downstream Code Company’s shareholders would need to have been obtained before the upstream acquisition is completed (or any earlier acquisition of control of the Downstream Voting Rights occurs).
12. Under option (b), acquisition of the Downstream Voting Rights would need to be contemporaneous with, or in advance of, the acquisition of control of the Upstream Company. This would likely involve the Upstream Company having sold the securities to which the Downstream Voting Rights are attached (the Downstream Voting Securities) to the Upstream Acquirer under a full takeover of the Downstream Code Company under rule 7(a) of the Code, a scheme of arrangement or other Code compliant method.  Expressed differently, the Upstream Company would have to have ceased to hold or control the Downstream Voting Rights before (or at the same time as) the Upstream Acquirer obtains control of the Upstream Company. 
13. However, the Panel recognises that both compliance options may be impractical, if not impossible, in some circumstances. In these situations, the alternative to complying with the Code’s requirements is to obtain an exemption from those requirements. 

Application for exemption

1. This section outlines how the Panel is likely to exercise its discretion to grant exemptions. A flow chart illustrating this policy is set out in Appendix A of this Guidance Note.
2. Where appropriate, the Panel may keep an exemption confidential on the grounds of commercial confidentiality. Generally, the confidentiality would only last as long as appropriate and necessary for the purposes of the transaction. 
   

   Unconditional exemption

3. The Panel will normally grant an unconditional exemption from rule 6(1) of the Code for an Upstream Company, where the upstream acquisition would result in the Upstream Acquirer becoming the controller of more than 20% of the total voting rights in a Downstream Code Company, if acquiring control of the Downstream Voting Rights would not reasonably be regarded as a significant purpose of the upstream acquisition (the No Downstream Purpose Test).
4. There are two key enquiries in relation to the No Downstream Purpose Test:
   1. First, whether the value of the Downstream Voting Securities^[4] is less than 25% of the enterprise value of the Upstream Company (or such other valuation methodology that the Panel considers may be appropriate in the circumstances (the Value Test)).^[5]
   2. As a secondary question, whether the Upstream Company is listed on a “recognised exchange” as described below (the Listing Standard).
5. If the Value Test and the Listing Standard are met, then the No Downstream Purpose Test will be prima facie satisfied. However:
   1. The Value Test and the Listing Standard are only proxies for purpose.
   2. If the Panel considers that a significant purpose of the upstream acquisition is to acquire control of the Downstream Voting Rights, the meeting of the Value Test and/or the Listing Standard will likely be disregarded.^[6]
   3. If the Value Test is met but the Listing Standard is not, the Panel may still consider that the No Downstream Purpose Test is satisfied. However, this may affect the conditions that may attach to an exemption.
6. Where the value of the Downstream Voting Securities is more than 25% of the enterprise value of the Upstream Company, it is possible that the failure to meet the Value Test may be disregarded if the Panel is satisfied that it is not a significant purpose of the acquisition to acquire control of the Downstream Voting Rights.
7. “Recognised exchanges” include the New Zealand Exchange Limited and foreign exchanges in jurisdictions with a comparable level of investor protection to New Zealand. The Panel has identified the following foreign exchanges to be “recognised exchanges”: the Australian Securities Exchange, Deutsche Börse AG, Euronext Amsterdam NV, Euronext Paris SA, Borsa Italiana S.p.A, JSE Limited, Bursa Malaysia Berhad, London Stock Exchange plc, The NASDAQ Stock Market Inc, New York Stock Exchange Inc, Singapore Exchange Limited, The Stock Exchange of Hong Kong Limited, SIX Swiss Exchange, Tokyo Stock Exchange and The Toronto Stock Exchange Inc. 
8. If the No Downstream Purpose Test is satisfied, the Panel is likely to grant an exemption which is subject to no (or very limited) conditions. Specifically:
   1. Where both aspects of the No Downstream Purpose Test are met, the exemption will likely be unconditional.
   2. Where the Listing Standard is not met, but the No Downstream Purpose Test is nonetheless satisfied, the exemption will likely include a condition that the material terms of the upstream acquisition are disclosed to shareholders of the Downstream Code Company on or before the date on which the Upstream Acquirer obtains control of the Downstream Voting Rights. 

   Conditional exemption

9. If the No Downstream Purpose Test is not satisfied, the Panel is unlikely to grant an unconditional exemption. However, the Panel will normally grant a conditional exemption in these circumstances. The exemption would likely be subject to the condition that the Upstream Acquirer elects, and undertakes, one of the following options (each a Compliance Option), being to either: 
   1. decrease the Upstream Company’s holding or control of securities carrying voting rights in the Downstream Code Company to 20% or less by no later than 12 months after the upstream acquisition becomes unconditional, and ensure that, pending the decrease occurring, the Upstream Company does not exercise any more than 20% of the total voting rights (the Control Reduction Option);^[7] or
   2. make a full Code offer for the voting securities in the Downstream Code Company not already held or controlled by the Upstream Acquirer or the Upstream Company within 40 working days after the upstream acquisition becomes unconditional (the Follow-on Offer Option).
10. It will generally be a requirement that the election of the Compliance Option be notified to the Panel and to the Downstream Code Company (and the registered exchange, if either of the Upstream Company or the Downstream Code Company has equity securities quoted on a New Zealand registered exchange) on or before the later of: 
    
    1. 10 working days after the follow-on offer price is determined (see below for details about the determination of the follow-on offer price); or
    2. the working day after the upstream acquisition becomes unconditional.
11. This timing allows the election of the Compliance Option to be made after the follow-on offer price is determined. However, the election of a Compliance Option could be made at any time in advance of the follow-on offer price being determined.
    

    Requirements of the Control Reduction Option

12. If the Control Reduction Option is elected, the Upstream Acquirer must undertake to the Panel that it will procure the Upstream Company to decrease its holding so that the Upstream Acquirer (and its associates) would hold or control no more than 20% of the total voting rights in the Downstream Code Company after the decrease. This must normally be achieved no later than 12 months after the upstream acquisition becomes unconditional. The Upstream Acquirer will likely also have to undertake to the Panel that, pending the decrease occurring, it will ensure that it, the Upstream Company and any associate of either of them, will not exercise any voting rights in the Downstream Code Company above the permitted 20% level.
13. If the Downstream Voting Securities are divested, any acquirer(s) of the Downstream Voting Securities must also comply with the Code. For example, under rule 6(1)(a), if the Downstream Voting Securities conferred a control percentage of 25%, they could not be sold to an associate of the Upstream Acquirer unless the associate obtained the approval of the Downstream Code Company’s shareholders in accordance with rule 7(c) of the Code. 
    

    Requirements of the Follow-on Offer Option

14. The Panel will typically require that the consideration for the follow-on offer must be cash (or include a cash alternative) and must be determined as follows:
    1. If the Panel is satisfied that the price effectively being offered to the Upstream Company’s shareholders for the Upstream Company’s Downstream Voting Securities can be clearly and accurately determined from the upstream offer consideration (the See-through Price), the follow-on offer consideration will not be less than the See-through Price. Only in rare cases will the See-through Price be able to be clearly and accurately determined, for example, where the only assets of the Upstream Company were the Downstream Voting Securities.
    2. Where the See-through Price cannot be accurately determined, the follow-on offer consideration will be not less than the fair and reasonable value of each Downstream Voting Security, as determined by an independent expert that is appointed by the Panel.
    3. The Panel expects that, where there is only one class of Downstream Voting Securities, the fair and reasonable value per Downstream Voting Security will be calculated by:^[8]  
       1. first assessing the value of all the Downstream Voting Securities; and
       2. then allocating that value pro rata among all Downstream Voting Securities.
15. In relation to the Follow-on Offer Option, the following additional conditions of an exemption would likely apply:
    1. The offeror must pay the reasonable fees, costs and expenses of the independent expert in relation to its determination of the follow-on offer price, provide the expert with any requested information and agree to any of the expert’s usual terms and conditions.
    2. The offeror must include with the offer document that is sent to shareholders for the follow-on offer a copy of the independent expert’s valuation and an explanation of how the follow-on offer price was derived.
    3. Any other terms and conditions of the follow-on offer, included by the offeror in the offer document, must be in a form approved by the Panel.
16. The other terms and conditions of the follow-on offer (referred to in paragraph 3.15(c)) that the Panel may approve could include:
    1. the usual conditions of takeover offers that are made pursuant to the Code (the Panel would need to have approved the wording of these and all other conditions); and
    2. that the requisite regulatory approvals (such as from the Overseas Investment Office or Commerce Commission) are obtained, and that the Upstream Acquirer will use its best endeavours in good faith to obtain all such approvals.
17. However, the Panel is unlikely to agree to any minimum acceptance condition being included in the follow-on offer, other than that required by rule 23 of the Code.
18. Also applicable to the follow-on offer conditions are rules 25(1) and 25(1A) of the Code, together with the Panel’s guidance on restrictive conditions, set out in the Guidance Note on Offer Documents.
19. The Panel is unlikely to impose a condition to an exemption that the follow-on offer succeeds.
    

    Appointment of an independent expert

20. The independent expert would likely be appointed by the Panel as follows:
    1. The Upstream Acquirer would request that the Panel appoints an independent expert.
    2. The request should include a list of the advisers from whom the upstream acquirer has already received advice in relation to the upstream acquisition and the resulting downstream acquisition. The Upstream Acquirer should not make any suggestions as to who it thinks would be appropriate for appointment by the Panel. However, the Upstream Acquirer should also advise the Panel of any firms that it considers might be conflicted, and why it considers they may be conflicted.
    3. The Panel would then undertake a closed tender process inviting applications from experts that it considers suitable. The Panel would approach those experts on a confidential basis. The independent expert would be selected on the basis of independence and appropriate qualifications and experience (as to these matters, see the Guidance Note on Independent Advisers). The Panel would also take each expert's quoted fees into account when selecting the expert for appointment.
    4. Once the Panel has selected an independent expert, the Upstream Acquirer would be required to engage the expert on the basis of the conditionality described at paragraph 3.15(a) above. 
21. At least 10 working days should be allowed for the appointment process and 20 working days for the valuation to be undertaken by the appointed expert. The expert will undertake a valuation on the basis of all available information at the time of the valuation and assess the valuation at (or as close as possible to) the date on which the follow-on offer is to be made. 
22. A follow-on offer would likely need to be made within 40 working days after the upstream acquisition becomes unconditional. Accordingly, it would be advisable for the Upstream Acquirer to approach the Panel for an exemption as early as possible. 
23. To ensure compliance timeframes are met, if the Panel grants a conditional exemption to the Upstream Acquirer requiring that they elect a Compliance Option, it may be pragmatic to request that the Panel appoints an independent expert at that time. 
    

    Market disclosure

24. To ensure the market for shares in the Downstream Code Company is adequately informed, the Upstream Acquirer will generally be required to notify the Panel and the Downstream Code Company (and, if either the Upstream Company or the Downstream Code Company has its ordinary shares quoted on a New Zealand registered exchange, that registered exchange) which Compliance Option it elects, no later than either:
    1. 10 working days after the follow-on offer price is determined; or
    2. the working day after the upstream acquisition becomes unconditional.
25. If the Follow-on Offer Option is elected, the notification must include full details of both the upstream and downstream acquisitions, including the timing and consideration for the acquisitions (the consideration for the downstream acquisition must be disclosed only if that consideration has been determined at the time of the announcement). 

Rule 64 of the Code – prohibition on misleading or deceptive conduct 

1. Rule 64 of the Code prohibits misleading or deceptive conduct in relation to Code-regulated transactions or events.^[9]

2. Any statements, actions or other conduct by any person in relation to the Downstream Code Company (and potentially the upstream acquisition) would be subject to the rule 64 prohibition.
3. Particular care should be taken over "last and final statements". For example, if the Upstream Acquirer was to state that it was going to elect the Control Reduction Option, that would constitute a last and final statement that is subject to rule 64. The Panel would likely find that rule 64 had been breached if the Upstream Acquirer did not then elect the Control Reduction Option.
4. Likewise, other persons including shareholders and directors are subject to the rule 64 prohibition against misleading or deceptive conduct.
5. The Panel’s policy on last and final statements is set out in the Guidance Note on Misleading or Deceptive Conduct.