The PCCW Privatization: A Guide to the Applicable Law for Schemes of Arrangement
March 2, 2009
By Timothy Loh, Gavin Cumming and Henri Arslanian
Allegations of share splitting in the proposed privatization of PCCW have raised an important question as to how the statutory majority to approve a scheme of arrangement should be determined. This question is significant both in the short-term for investors trading PCCW and in the long-term in the context of future schemes of arrangement. In this article, we examine the applicable laws and regulations with a view to providing hedge funds and other investors with guidance.
TIMOTHY LOH | Financial Services & Law Review
Vol. 3 (2009) at p. 9
The proposed privatization of PCCW Ltd. ("PCCW") by Starvest Ltd. and
China Netcom Corporation (BVI) Ltd.
(together "Joint Offerors")
announced on November 4, 2008 has been the subject of much discussion since
allegations were made that a number of persons had received one lot of shares
of PCCW in return for signing a proxy form enabling the shares received by them
to be voted in favour of the scheme of arrangement to effect the proposal.
On February 24, 2009, the court granted leave for
the Securities and Futures Commission ("SFC"),
which is investigating the allegations, to intervene in the proceedings. The
court is scheduled to hear the petition to sanction the scheme on April 1 and
2, 2009.
The allegations and the decision of the court to
grant leave for the SFC to intervene have generated much discussion, with
market participants no longer sure whether the privatization will conclude
successfully.
BACKGROUND
PCCW is a Hong Kong company listed on the Stock
Exchange of Hong Kong. As a
result, a privatization of PCCW by scheme of arrangement is governed both by
the Companies Ordinance ("CO")
and the Code on Takeovers and Mergers ("Takeovers
Code").
Companies Ordinance
Under the CO, a company may propose a scheme of
arrangement by applying to court for an order to convene a meeting of members (i.e. shareholders) or any
class of them in such manner as the court directs. If a majority in number representing three-fourths in value
of members or a class of members, as the case may be, present and voting either
in person or by proxy at the meeting agree to the arrangement, the arrangement
shall, if sanctioned by the court, be binding on all the members.
Takeovers Code
Under the Takeovers Code, a scheme of arrangement
to privatize a company may, except with the consent of the Takeovers Executive,
only be implemented if, in addition to satisfying any voting requirements
imposed by law:
- the scheme is approved by at least 75 per cent. of
the votes attaching to the disinterested shares that are cast either in person
or by proxy at a duly convened meeting of the holders of the disinterested
shares; and
- the number of votes cast against the resolution to
approve the scheme or the capital reorganization at such meeting is not more
than 10 per cent. of the votes attaching to all disinterested shares.
For these purposes, "disinterested shares" means
shares in the company other than those which are owned by the offeror or
persons acting in concert with it.
POSSIBLE SCENARIOS
The allegations raise at least 2 possible scenarios
of concern. In one scenario, the
Joint Offerors or persons acting in concert with them have split their
shareholdings to support the scheme and in the second scenario, disinterested
members of PCCW have done so.
In the former scenario, the splitting of
shareholdings increases the probability that a "majority in number" of the
members will support the scheme.
At the same time, to the extent that the shares split out appear to be
disinterested shares but may not in fact be so, the splitting of shareholdings
decreases the risk that the scheme will be blocked by members holding
disinterested shares.
In the latter scenario, the splitting of
shareholdings again increases the probability that a "majority in number" of
members will support the scheme but has no impact on compliance with the
Takeovers Code.
COURT SANCTION OF SCHEME
Once the shareholder meeting has approved the
scheme, the sanction of the court must be sought. The sanction of the court is
not a formality. The court has an unfettered discretion as to whether or not to
sanction the scheme, but it is likely to do so, as long as the following
conditions are satisfied:
- the provisions of the CO have been complied with,
- the statutory majority were acting bona fide and were not
coercing the minority in order to promote interests adverse to those of the
class; and
- the scheme is such as an intelligent and honest
person, being a member of the class concerned, and acting in respect of his
interest, might reasonably approve.
As to whether the provisions of the CO have been
complied with, the task of the court is to determine whether the class of
members was properly constituted, the meeting was convened in compliance with
the court's directions, a proper explanation of the effects of the scheme has
been given to the members and a simple majority in number representing
three-fourths in value of the members present and voting at the meeting have
agreed to the scheme.
However, the court is unlikely to sanction a scheme
if it appears that the majority of members of a class had regard to their own
special interests when casting their votes, rather than the interests of the
class as a whole to which they belong.
The requirement for a majority in number thus ensures that members who
hold a large percentage of the issued share capital do not oppress members
holding a small percentage of the issued share capital. This is important given that the sanction
of the court operates, in this context, to expropriate property (i.e. shares of dissenting
members).
Effect of CCASS
The majority of shares are held by investors
through intermediaries who, in turn, hold through the Central Clearing and
Settlement System ("CCASS"). Shares held through CCASS are
registered in the name of HKSCC Nominees Ltd. ("HKSCC"). As a result, such shares are, for the
purposes of the CO, held by a single member even though they may represent the
beneficial interests of many investors.
In the case of meetings in Hong Kong, CCASS
Operational Procedures permit CCASS participants (e.g. brokers and custodians) to appoint their
own corporate representatives to attend and vote at a meeting in respect of
shares held for their account so long as the listed company's constitutive
documents and applicable law so permit.
In the case of PCCW, both its articles of association and the CO permit
CCASS to appoint multiple corporate representatives.
However, CCASS Operational Procedures do not appear
to permit CCASS participants to appoint multiple corporate representatives in
respect of persons on whose behalf they hold shares. Thus, in practice, investors holding shares through CCASS
are unable to count towards the number of members voting for or against a
scheme.
In any event, on a strict reading of the CO, it is
doubtful whether a CCASS participant who appoints a corporate representative to
attend a meeting of members may be counted as a member for the purpose of
determining whether a majority in number have voted for a scheme. Ultimately, no matter how many
corporate representatives are appointed, the shares being voted are being voted
on behalf of a single member, namely HKSCC.
Whilst it may be suggested that such a conclusion
runs counter to a policy objective of seeking the consensus of investors:
- it would be abusive to permit a single investor to
obtain a majority in number to support a scheme simply by appointing multiple
corporate representatives; and
- it is likely to be too difficult to ascertain how
many investors underlying CCASS in fact voted for or against a scheme, there being too great of a risk of
manipulation if each investor could itself declare how many underlying persons
on whose behalf it was holding shares for the purpose of determining how many
investors voted in favour of the scheme.
Effect of Share Splitting
Generally, transfers of shares by a person holding
a large block of shares are unlikely to cause a court concern. This is so even though the transfers
increase the number of members who may attend the meeting (and may thus affect
whether a majority in number vote in favour of the scheme) and even if the
share recipients are known to be inclined to vote the shares in favour of the
scheme.
However, where a person transfers shares for no
financial consideration but on the basis that the recipient of such shares must
hold the shares until the record date and sign a proxy form in favour of a
person nominated by the transferor, two possible concerns arise. First, as set above, a role of the
court is to see whether the majority were acting bona
fide and were not coercing the minority in order to promote
interests adverse to those of the class.
Where persons receive shares on the basis that they sign a proxy form,
there is a real concern that shares voted through these proxies are not bona fide and do not
fairly represent the interests of the members as a whole.
Secondly, the court may fairly take into account
the requirements of the Takeovers Code in exercising its discretion. Indeed, the court has in the past
referred to such requirements in determining petitions to sanction
schemes. To the extent that
interested shares are transferred to persons who appear to be disinterested, on
the basis that such persons sign proxy forms in favour of the person holding
the interested shares, the shares may nevertheless remain interested shares
rather than disinterested shares.
Whilst the factual context is unclear and in
particular, the allegations of share splitting as yet inconclusive, in light of
the foregoing, it is suggested that it if the SFC presents evidence not only of
share splitting but of a quid
pro quo (i.e.
a requirement for shares to be held to record date and proxy forms to be signed
as part of the share splitting), the court may refuse to sanction the scheme.
Whether the court will refuse to sanction the scheme
will likely depend in part on whether the number of shares voted in favour of
the scheme as a result of the quid
pro quo is material, the strength of the evidence presented by the
SFC and the evidence presented by PCCW or others to rebut the allegations of
share splitting or suggestions as to a quid
pro quo.
SFC INVESTIGATION PROCESS
In general, the SFC investigation process is slow,
taking months if not years to complete.
However, in this case, the court gave the SFC only 21 days to bring its
investigation to a point where it could present evidence.
The SFC's powers in a formal investigation are
broad. Its investigators may
require any person believed to have relevant information (i) to produce, within
the time and at the place reasonably required by the investigator, any record
or document specified by the investigator, (ii) to attend before an
investigator at a time and place reasonably required by the investigator to
answer any question, and (iii) to give an investigator all assistance in connection
with the investigation which the person is reasonably able to give.
It is likely to be difficult for the SFC to collect
evidence to establish a forceful and comprehensive case within the limited time
given to it by the court. Legal
concerns may limit the speed at which the SFC may interview persons who may
have received shares as part of a share splitting to determine how they came to
receive the shares and in particular, whether there was any quid pro quo or other
evidence that such persons would not have fairly had the interests of
disinterested members as a whole in mind when voting. For example, a person who receives a request for an SFC
interview may seek to re-schedule on the basis of the need to seek and consult
with legal counsel.
In light of the above, it is likely that the SFC
will be able to do no more than to present a sampling of cases, requiring some
extrapolation or estimation to determine the true extent, if any, of share
splitting with quid pro quo.
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