Take Private Transactions: Possible New Pitfalls for Private Equity
November 13, 2007
By Timothy Loh and Howard Burchfield III
Proposals by the Securities and Futures Commission in Hong Kong to harmonize the regulatory treatment of asset purchases with the regulatory treatment of share purchases and schemes of arrangement will give minority shareholders greater veto power over acquisitions of Hong Kong public companies by asset purchase. As a result, private equity firms who wish to take such companies private will face an increasingly difficult environment.
TIMOTHY LOH | Financial Services & Law Review
Vol. 1 (2007) at p. 39
In our June 11, 2007 issue ("Take Private Transactions: The
Emergence of a New Approach") we wrote about a possible shift in
practice in take private transactions towards asset purchases to exploit lower
regulatory hurdles for asset purchases compared with share purchases and
schemes of arrangement. The
Securities and Futures Commission ("SFC")
has recently proposed increasing regulatory hurdles for asset purchases with a
view to harmonizing the minority shareholder position for all 3 methods of
effecting a take private transaction.
BACKGROUND
Share purchases and schemes of arrangement are
governed by the Code on Takeovers and Mergers ("Takeovers
Code"). Under the
Takeovers Code, minority shareholders of companies ("target companies") which are the subject of a
take private transaction enjoy certain veto rights designed to prevent them
from being squeezed out without fair compensation.
Share Purchase
To effect a take private transaction by share
purchase, the Takeovers Code requires that the offeror must make an offer to
acquire 90 per cent. of the shares of the target company which he does not
already own to compulsorily acquire the remaining shares not tendered in such
offer.
If the offeror wishes to delist the shares of the
target company without taking 100 per cent. control, 75 per cent. of
disinterested shareholders must approve the delisting and no more than 10 per
cent. of disinterested shareholders may vote against the delisting.
Scheme of Arrangement
To effect a take private transaction by scheme of
arrangement, the Takeovers Code requires that 75 per cent. of disinterested
shareholders approve of the scheme and that no more than 10 per cent. of
disinterested shareholders vote against the delisting. These requirements are on top of any
other requirements stipulated under the company law governing the target
company.
ADVANTAGES OF ASSET PURCHASES
Whilst individual circumstances invariably dictate
the form of a take private transaction, asset purchases offer certain
advantages over share purchases and schemes of arrangement.
Lower Approval Requirements
Asset purchases are primarily governed by The Rules
Governing the Listing of Securities on the Stock Exchange of Hong Kong Ltd. ("Listing Rules"), which
impose lower shareholder approval thresholds than those imposed by the
Takeovers Code on both share purchases and schemes of arrangement.
Under the Listing Rules, a simple majority of
independent shareholders may approve a disposal of assets by the target
company. For this purpose,
majority shareholders may vote so long as their interest in the disposal
coincides with other shareholders.
No Veto Rights for Minority Shareholders
Furthermore, under the Listing Rules, asset
purchases, unlike share purchases and schemes of arrangement, are not subject
to "veto" by 10 per cent. of disinterested shareholders. Veto rights only arise in respect of a
proposal to delist. Where the assets
of the company have already been sold through an asset purchase, there is
limited commercial benefit for minority shareholders to object to a delisting,
particularly where a distribution of the target company's cash hinges on
approval of delisting.
Others
Finally, asset purchases offer financial advantages
to the offeror in that they may be leveraged by security interests in the
assets themselves.
In 2006, these advantages allowed PCCW Ltd. to do
via asset purchase what it had twice failed to do by share purchase or scheme
of arrangement: acquire and privatize Sunday Communications Ltd.
THE SFC TAKES NOTICE
These advantages of the asset purchase as a take
private mechanism have not gone unnoticed by the SFC. In September 2007, it issued a consultation paper proposing,
among other things, to amend the Takeovers Code to address what it
characterized as "inconsistencies" for asset purchases on one hand and share
purchases and schemes of arrangements on the other.
SFC Proposal
Under the SFC's proposed amendments to the
Takeovers Code, asset purchases will be brought under the Takeovers Code and be
treated in the same manner as schemes of arrangement. Thus, in addition to the current requirement under the
Listing Rules for shareholder approval by simple majority of independent
shareholders, a transaction involving significant asset disposals by the target
company coupled with a proposal for or requirement for delisting will be subject
to approval by 75 per cent. of the disinterested shares. At the same time, the transaction may
be blocked by 10 per cent. of the disinterested shares.
Initial Market Response
The consultation period for the proposed amendments
ended on November 9, 2007. Initial
indications are that a number of market participants favor harmonization of
regulatory treatment of asset purchases, schemes of arrangements and share
purchases but prefer regulatory amendments to be made under the Listing Rules
rather than under the Takeovers Code.
TAKING STOCK OF THE CHANGES
There is merit to the SFC's goal to harmonize the
position of minority shareholders in asset purchases with their position in
share purchases and schemes of arrangement. At the same time, there is a concern that the position of
minority shareholders is unfairly elevated to the detriment of majority
shareholders.
Minority Shareholder Justice
From the minority shareholder perspective, the
SFC's proposed amendments may appear to be a matter of simple justice. Without these amendments, minority
shareholders of the target company may be forced to accept less than fair
consideration for the sale of the
company.
No Expropriation to Justify Minority Shareholder
Protection
On the other hand, the SFC amendments ignore
certain fundamental differences between the 3 types of transactions, chief
among which is the fact that both share purchases and schemes of arrangement
concern the expropriation of private property (i.e.
shares in the target company) at times over and against the wishes of its
owners (i.e. the
target company's shareholders). It
would appear to be a valid policy interest to protect minority shareholders'
ability to decide whether or not to dispose of their own property.
In asset purchases, however, it is not the
proprietary interest of the minority shareholder that is directly at stake, but
rather the economic value of that interest. If all shareholders, majority and minority, bear the
economic consequences of an asset disposal equally, it is not clear why a
minority of shareholders should be positioned to block the transaction.
Majority Shareholders Lose Control
Furthermore, asset purchases differ from share
purchases and schemes of arrangement in that in the latter, a minority
shareholder is deciding on how to dispose of his or her own property whereas in
the former, a minority shareholder is deciding on how the target company is to
be managed.
Whilst it is not objectionable for significant
disposals by a target company of its assets to be subject to shareholder
approval, it does not necessarily follow that minority shareholders should
exercise a right to veto such transactions. As before, where all shareholders, majority and minority,
bear the economic consequences of an asset disposal equally, it is not clear
why the majority shareholders should not be in a position to control the
destiny of the target company.
The SFC's proposed amendments clearly favor the
interests of minority shareholders over the discretion of a company's directors
to act in what they perceive to be the company's best interests and the
erstwhile presumed right of a majority of shareholders to exercise
control. The end result may be an
appealing harmonization of the Takeovers Code provisions governing take private
transactions, achieved by the slow and steady erosion of market freedom.
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