Take Private Transactions: Possible New Pitfalls For Private Equity
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.
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.
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.
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.
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.
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 favour 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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