Advisory Board

  • Cai Hongbin
  • Peking University Guanghua School of Management
  • Peter Clarke
  • Barry Diller
  • IAC/InterActiveCorp
  • Fu Chengyu
  • China National Petrochemical Corporation (Sinopec Group)
  • Richard J. Gnodde
  • Goldman Sachs International
  • Lodewijk Hijmans van den Bergh
  • De Brauw Blackstone Westbroek N.V.
  • Jiang Jianqing
  • Industrial and Commercial Bank of China, Ltd. (ICBC)
  • Handel Lee
  • King & Wood Mallesons
  • Richard Li
  • PCCW Limited
  • Pacific Century Group
  • Liew Mun Leong
  • CapitaLand Limited
  • Martin Lipton
  • New York University
  • Wachtell, Lipton, Rosen & Katz
  • Liu Mingkang
  • China Banking Regulatory Commission (CBRC)
  • Dinesh C. Paliwal
  • Harman International Industries
  • Leon Pasternak
  • Bank of America Merrill Lynch
  • Tim Payne
  • Brunswick Group
  • Joseph R. Perella
  • Perella Weinberg Partners
  • Baron David de Rothschild
  • N M Rothschild & Sons Limited
  • Dilhan Pillay Sandrasegara
  • Temasek Holdings
  • Shao Ning
  • State-owned Assets Supervision and Administration Commission of the State Council of China (SASAC)
  • John W. Snow
  • Cerberus Capital Management, L.P.
  • Former U.S. Secretary of Treasury
  • Bharat Vasani
  • Tata Group
  • Wang Junfeng
  • King & Wood Mallesons
  • Wang Kejin
  • China Banking Regulatory Commission (CBRC)
  • Wei Jiafu
  • China Ocean Shipping Group Company (COSCO)
  • Yang Chao
  • China Life Insurance Co. Ltd.
  • Zhu Min
  • International Monetary Fund

Legal Roundtable

  • Dimitry Afanasiev
  • Egorov Puginsky Afanasiev and Partners (Moscow)
  • William T. Allen
  • NYU Stern School of Business
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Johan Aalto
  • Hannes Snellman Attorneys Ltd (Finland)
  • Nigel P. G. Boardman
  • Slaughter and May (London)
  • Willem J.L. Calkoen
  • NautaDutilh N.V. (Rotterdam)
  • Peter Callens
  • Loyens & Loeff (Brussels)
  • Bertrand Cardi
  • Darrois Villey Maillot & Brochier (Paris)
  • Santiago Carregal
  • Marval, O’Farrell & Mairal (Buenos Aires)
  • Martín Carrizosa
  • Philippi Prietocarrizosa & Uría (Bogotá)
  • Carlos G. Cordero G.
  • Aleman, Cordero, Galindo & Lee (Panama)
  • Ewen Crouch
  • Allens (Sydney)
  • Adam O. Emmerich
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Rachel Eng
  • WongPartnership (Singapore)
  • Sergio Erede
  • BonelliErede (Milan)
  • Kenichi Fujinawa
  • Nagashima Ohno & Tsunematsu (Tokyo)
  • Manuel Galicia Romero
  • Galicia Abogados (Mexico City)
  • Danny Gilbert
  • Gilbert + Tobin (Sydney)
  • Vladimíra Glatzová
  • Glatzová & Co. (Prague)
  • Juan Miguel Goenechea
  • Uría Menéndez (Madrid)
  • Andrey A. Goltsblat
  • Goltsblat BLP (Moscow)
  • Juan Francisco Gutiérrez I.
  • Philippi Prietocarrizosa & Uría (Santiago)
  • Fang He
  • Jun He Law Offices (Beijing)
  • Christian Herbst
  • Schönherr (Vienna)
  • Lodewijk Hijmans van den Bergh
  • Royal Ahold (Amsterdam)
  • Hein Hooghoudt
  • NautaDutilh N.V. (Amsterdam)
  • Sameer Huda
  • Hadef & Partners (Dubai)
  • Masakazu Iwakura
  • Nishimura & Asahi (Tokyo)
  • Christof Jäckle
  • Hengeler Mueller (Frankfurt)
  • Michael Mervyn Katz
  • Edward Nathan Sonnenbergs (Johannesburg)
  • Handel Lee
  • King & Wood Mallesons (Beijing)
  • Martin Lipton
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Alain Maillot
  • Darrois Villey Maillot Brochier (Paris)
  • Antônio Corrêa Meyer
  • Machado, Meyer, Sendacz e Opice (São Paulo)
  • Sergio Michelsen Jaramillo
  • Brigard & Urrutia (Bogotá)
  • Zia Mody
  • AZB & Partners (Mumbai)
  • Christopher Murray
  • Osler (Toronto)
  • Francisco Antunes Maciel Müssnich
  • Barbosa, Müssnich & Aragão (Rio de Janeiro)
  • I. Berl Nadler
  • Davies Ward Phillips & Vineberg LLP (Toronto)
  • Umberto Nicodano
  • BonelliErede (Milan)
  • Brian O'Gorman
  • Arthur Cox (Dublin)
  • Robin Panovka
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Sang-Yeol Park
  • Park & Partners (Seoul)
  • José Antonio Payet Puccio
  • Payet Rey Cauvi (Lima)
  • Kees Peijster
  • COFRA Holding AG (Zug)
  • Juan Martín Perrotto
  • Uría & Menéndez (Madrid/Beijing)
  • Philip Podzebenko
  • Herbert Smith Freehills (Sydney)
  • Geert Potjewijd
  • De Brauw Blackstone Westbroek (Amsterdam/Beijing)
  • Qi Adam Li
  • Jun He Law Offices (Shanghai)
  • Biörn Riese
  • Mannheimer Swartling (Stockholm)
  • Mark Rigotti
  • Herbert Smith Freehills (Sydney)
  • Rafael Robles Miaja
  • Robles Miaja (Mexico City)
  • Alberto Saravalle
  • BonelliErede (Milan)
  • Maximilian Schiessl
  • Hengeler Mueller (Düsseldorf)
  • Cyril S. Shroff
  • Cyril Amarchand Mangaldas (Mumbai)
  • Shardul S. Shroff
  • Shardul Amarchand Mangaldas & Co.(New Delhi)
  • Klaus Søgaard
  • Gorrissen Federspiel (Denmark)
  • Ezekiel Solomon
  • Allens (Sydney)
  • Emanuel P. Strehle
  • Hengeler Mueller (Munich)
  • David E. Tadmor
  • Tadmor & Co. (Tel Aviv)
  • Kevin J. Thomson
  • Barrick Gold Corporation (Toronto)
  • Yu Wakae
  • Nagashima Ohno & Tsunematsu (Tokyo)
  • Wang Junfeng
  • King & Wood Mallesons (Beijing)
  • Tomasz Wardynski
  • Wardynski & Partners (Warsaw)
  • Rolf Watter
  • Bär & Karrer AG (Zürich)
  • Xiao Wei
  • Jun He Law Offices (Beijing)
  • Xu Ping
  • King & Wood Mallesons (Beijing)
  • Shuji Yanase
  • OK Corporation (Tokyo)
  • Alvin Yeo
  • WongPartnership LLP (Singapore)

Founding Directors

  • William T. Allen
  • NYU Stern School of Business
  • Wachtell, Lipton, Rosen & Katz
  • Nigel P.G. Boardman
  • Slaughter and May
  • Cai Hongbin
  • Peking University Guanghua School of Management
  • Adam O. Emmerich
  • Wachtell, Lipton, Rosen & Katz
  • Robin Panovka
  • Wachtell, Lipton, Rosen & Katz
  • Peter Williamson
  • Cambridge Judge Business School
  • Franny Yao
  • Ernst & Young

Monthly Archives: October 2011

KOREAN UPDATE – Amendments to the Korean Commercial Code To Have Far-Reaching Implications for Korean M&A and Corporate Governance

Editors’ Note:  Sang-Yeol Park is a partner at Kim & Chang and member of the XBMA Legal Roundtable.  Mr. Park is one of Korea’s leading corporate law practitioners, with broad expertise in mergers and acquisitions and cross-border transactions and extensive experience advising multinational and Korean companies on industrial projects.

Executive Summary/Highlights:

  • The recently amended Korean Commercial Code (“KCC”), which will become effective April 15, 2012, includes an array of provisions that aim for more flexibility and transparency in corporate management, such as by introducing new forms of business entities and diverse types of stock, relaxing restrictions on dividend payments, and prohibiting the appropriation of business opportunities.
  • These new concepts and regulations are expected to bring about fundamental and far-reaching changes in various aspects of business, including incorporation, corporate governance, corporate ownership and control structure, M&A, and corporate finance.

MAIN ARTICLE

On March 11, 2011, the National Assembly passed a highly anticipated bill to amend the Korean Commercial Code (the “KCC”).  These amendments represent the most extensive revisions to the KCC since its inception in 1962 and are the final piece in a series of amendments attempted since 2005.  They were originally prepared and proposed by the Korean government to address industrial developments and to meet changing needs.  The Korean government promulgated the amendments as of April 14, 2011; the amendments will become effective one year after the promulgation date.

Set forth below are the key changes in the amended KCC that affect the practice of M&A inKorea:

1.       Introduction of New Forms of Business Entities (Limited Partnerships and Limited Liability Companies)

The amendments introduce limited partnerships modeled after LPs in theU.S., which consist of general partner(s) and limited partner(s).  The amendments also provide for limited liability companies modeled after LLCs in theU.S., which acknowledge the limited liability of members even while granting them autonomy to establish, manage, and structure the organization of the company.

These new forms of business entities will provide investors with access to a wide range of new investment options and are expected to facilitate investments, especially by providing alternative business structures to private equity funds and start-up companies.

2.     Introduction of Squeeze Outs

The amendments also permit squeeze outs – i.e., the compulsory acquisition by a controlling shareholder (with a stake of 95% or more) of shares held by minority shareholders at fair value.  In exchange, minority shareholders may require a controlling shareholder to purchase their shares at a fair price.

3.     Improvements to Laws Governing Mergers Cash-Out Mergers, Etc.

It has been unclear whether the surviving company in a merger could pay only cash as consideration for the stock of the company being merged.  Under the amendments, however, the surviving company in a merger may pay the shareholders of the company being absorbed in just cash or bonds, without delivering any new shares of the surviving company to such shareholders.

Also, mergers may currently be approved by a resolution of the board of directors (in lieu of obtaining approval at a general meeting of shareholders) if the new shares issued by the surviving company represent 5% or less of the total issued shares of the surviving company.  The amendments increase this small-scale merger threshold, though, from 5% to 10%.

4.     Diverse Stock Types

Prior to the recent amendments, companies could issue shares with no voting rights only if such shares were classified as preferred shares.  However, following the amendments, companies will be able to issue shares with no voting rights or restricted voting rights regardless of whether such shares are common shares or preferred shares (provided that the collective percentage of non-voting shares and shares with restricted voting rights shall not exceed 25% of the total issued and outstanding shares).  Also, conversion rights and redemption rights, which are currently permitted for preferred shares only, will be allowed for all types of shares.  Further, companies (and not just shareholders) will be permitted to exercise such conversion rights and redemption rights.  The added flexibility resulting from these changes will make it easier for companies to raise capital.

In addition, the amendments will allow companies to issue no-par value stock, which is currently prohibited.

5.     Relaxed Restrictions on Acquisition / Disposition of Treasury Stock

The KCC strictly limits the circumstances under which companies may acquire treasury stock, in an effort to regulate companies’ capital adequacy.  However, the amendments will allow companies to acquire treasury shares in an amount up to their distributable profits.  According to the amendments, companies will also be able to freely dispose of their treasury stock after approval of the board of directors, as long as such disposition is not prohibited by the articles of incorporation.

6.     More Flexible Use of Legal Reserves.

The disposition of legal reserves has been strictly restricted by the KCC.  Following the amendments, however, the shareholders of a company can resolve to use the legal reserves exceeding 150% of the company’s capital to pay dividends or for certain other purposes.  This change will allow companies to distribute excess legal reserves to shareholders without having to transfer their reserves to capital or undergo a capital reduction.

7.     More Flexible Dividend Policies

Pursuant to the amendments, dividend payments can be approved by the board of directors of a company in certain cases, instead of always having to be approved at a general meeting of shareholders, which can be an extended process.  The amendments also allow the payment of non-cash dividends in addition to cash dividends.

8.     Improving Regulations on Bond Issuance

Ceilings on the total permitted issuance amount of bonds will be abandoned.  Further, the amended KCC will provide a legal basis for issuing a variety of bonds, including participating bonds.

9.     Prohibition of the Appropriation of Business Opportunities; Expanded Restrictions on Self-Dealing Transactions

A new provision will be added to the KCC that prohibits directors of a company from causing certain of their relatives or other third parties from appropriating business opportunities that would be beneficial to the company, unless it is approved by more than two-thirds of the board members of the company.

Also, following the amendments, restrictions on self-dealing transactions (which currently apply only to directors) will apply to directors and major shareholders, certain relatives of such directors and major shareholders, as well as affiliated companies.  Such self-dealing transactions will have to be approved by more than two-thirds of the board members and must be on an arm’s length basis.

10.  Reduced Liability for Directors

There are currently no provisions in the KCC that provide for a reduction in director liability, except for a provision that allows shareholders to unanimously resolve to exempt a director from liability.  The amendments, however, limit directors’ liability to their most recent annual salary multiplied by six (6) (in the case of outside directors, the multiple is three (3)); provided that this limit will not apply to damages resulting from a director’s willful misconduct or gross negligence.

11.   Elimination of Various Restrictions on Limited Companies

The amendments will eliminate the restriction on the number of members a limited company (yuhanhoesa) may have and will allow the free transfer of membership units to third parties (provided that such transfers may be subject to restrictions set forth in the articles of incorporation).  The amendments will also allow limited companies to convene general meetings of members by providing notice to members through electronic documents, subject to the members’ consent.  Furthermore, limited companies will be permitted to relax the current requirement to obtain approval at a general meeting of members prior to converting the company to a joint stock company (jusikhoesa), by specifying the modified approval requirements in their articles of incorporation.

The views expressed herein are solely those of the author and have not been endorsed, confirmed or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

CHINESE UPDATE – The Most Recent Challenges to the VIE Structure for Foreign Investment in China

Editors’ Note:  Adam Li (Li Qi) is a partner at Jun He and a member of XBMA’s Legal Roundtable.  Mr. Li is a leading expert in international M&A, capital market and international financial transactions involving Chinese companies. He has broad experience with VIEs and other structures for foreign investment in China.  This paper provides a second perspective on the challenge to the VIE structure discussed in Ms. Xu Ping’s recent paper.

Executive Summary/Highlights:

  • Reuters reported on Sept. 18, 2011 that CSRC, the Chinese securities market regulatory watchdog, submitted a report urging the State Council to “clamp down” on  the VIE structures employed in thousands of investments by foreigners into domestic Chinese companies.
  • The VIE structure was adopted to gain access to the sectors where China had not yet opened to foreign investors.
  • If the PRC government decides to take action against the structure, it would be a huge blow to both the overseas IPOs of Chinese companies as well as private investment (both industrial and private equity) by foreign companies into Chinese companies.
  • Since the story on the CSRC Report, many Chinese law firms have become very cautious or even reluctant to issue previously standard opinions on the validity of VIEs.

MAIN ARTICLE

The Challenges

Reuters reported on Sept. 18, 2011 that China Securities Regulatory Commission (“CSRC”), the Chinese securities market regulatory watchdog, submitted a report (“CSRC Report”) to the State Council (the cabinet of Chinese national government), urging the State Council, through the Ministry of Commerce of the PRC (“MofCom”),  to “clamp down” on the VIE structures “used by companies such as Sina (SINA.O) and Baidu (BIDU.O) to list overseas, and employed in thousands of other investments by foreigners into domestic Chinese companies.”[1]  CSRC has not confirmed this report.  MofCom spokesman did report on Sept. 20, 2011 that they are in discussion with other authorities on how to regulate VIE.[2]

This was at least the third incident this year where the VIE structure was questioned.  If the PRC government decides to take action against the structure, it would be a huge blow to both the overseas IPOs of Chinese companies as well as private investment (both industrial and private equity) by foreign companies into Chinese companies.

Concept

VIE, or variable interest entities, is “a term used by the United States Financial Accounting Standards Board in FIN 46 to refer to an entity (the investee) in which the investor holds a controlling interest that is not based on the majority of voting rights.”[3]  It is accomplished, in the context of Chinese regulatory framework, by setting up Chinese domestic companies (“Domestic Companies”) by nominee shareholders controlled by ultimate shareholders.  The nominee shareholders are usually Chinese nationals, and therefore are not subject to the market access restrictions to foreigners.  The ultimate shareholders also set up one or several special purpose entities (“SPV”), often offshore, to own a wholly owned subsidiary in China (a “WFOE”).  The nominee shareholders will borrow from the SPV or the WFOE, and pledge the shares of the Domestic Companies to the SPV or the WFOE.  The WFOE also enters into a series agreement to get all the financial benefit from operations of the Domestic Companies.  As the result, the SPV may consolidate the balance sheet of the Domestic Companies as if they were part of the SPV.  Chinaaccountingblog.com has a very good article explaining how it works. [4]

The VIE structure was adopted to gain access to the sectors where China had not yet opened to foreign investors.  Because the foreign investors contractually control and benefit from operation of the Chinese Domestic Companies, they effectively have bypassed the regulatory hurdles to these restricted markets.  Recently, the structure has been used to bypass the regulatory requirement for foreign investors to acquire Chinese companies.

Incidents

The VIE has always been controversial.  Because the effect has been for the foreign investors to penetrate the Chinese market otherwise inaccessible, the government’s effort to counter the use of VIE structure may be traced back as early as in 2006, when the Ministry of Information Industry (“MII”) requested all the telecommunication companies (the Domestic Companies) to own their own domain name, trademark, and servers etc.  Nevertheless, throughout the years, the VIE structure has become more popular (while more sophisticated), and has applied in more varieties of industry from TMT to education.

The recent incident was Buddha Steel case, reported in April 2011.  It was a typical VIE structure, but used for the first time in the iron and steel industry.  According to the media, Hebei Province (a Northern Province of China) government advised the operating company that the VIE agreements “contravene current Chinese management policies related to foreign-invested enterprises and are against public policy.”  The VIE was unwind.  Buddha Steel requested that its S-1 filing with the SEC be withdrawn.[5]

In May 2011, Jack Ma, the founder of Alibaba, transferred the Alipay (the PayPal equivalent in China) from Alibaba Group, a company whose major shareholders include Yahoo!, Softbank, and Jack Ma, to Zhejiang Alibaba, a company controlled by Jack.  While the details of the transfer still remain as a mystery, according to media, People’s  Bank of China would refuse to grant a third party payment license, which is essential for Alipay to run payment business, to any company contractually controlled by foreigners.[6]

On August 25, MofCom issued the Rules on the Implementation of the National Security Review Mechanisms (the “New SR Implementation Rules”).[7]  Under Art.9 of the New SR Implementation Rules, MofCom, for the first time in its regulatory history, highlights that it would look at the substance through forms for national security review.  For that purpose, MofCom would include contractual control, i.e., VIE etc., as acquisition.

Outlook

There have been standard disclaimers in VIE opinions issued by Chinese law firms.  Basically, the opinion would say that each contract (being part of the VIE structure) is legal and binding to their respective terms, but lawyers do not guarantee the government would not challenge the substance if looking at the structure as a whole.  The disclaimer had been relaxed by many Chinese law firms, until recently.  Since the CSRC Report, yet confirmed, many law firms have become very cautious or even reluctant to issue opinion on this issue.

There has always been risk associated with VIE structures.  However, with the New SR Implementation Rules, it has become relatively clear that there is a national security checkpoint in the regulations concerning buying Chinese interests.  The VIE structure is not likely to pass this checkpoint now, even if it would have in the old days.  Nevertheless, it may be too early to conclude VIE would not work at all for other conventional purposes.

The views expressed herein are solely those of the author and have not been endorsed, confirmed or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

AUSTRALIAN UPDATE – Regulatory Developments, Private Equity Trends and Deal Terms in Australian M&A

Editors’ Note: Ewen Crouch is Chairman of Allens Arthur Robinson and a member of XBMA’s Legal Roundtable. Mr. Crouch brings a rich perspective to this paper, as one of Australia’s leading M&A lawyers with expertise acting in some of Australia’s most significant transactions, including representation of Foster’s Group in the recent SABMiller transaction.

Executive Summary:

  • Public M&A activity in Australia has been patchy during 2011. Notably, the mining sector was more subdued than anticipated, with companies deploying stockpiled cash into growth projects, dividends or share buy-backs.
  • Upon the recommendation of the Foreign Investment Review Board (FIRB), the Federal Treasurer rejected the proposed merger of ASX with Singapore Exchange Limited (SGX). The ASX/SGX merger was rejected as contrary to Australia’s national interest (because of the loss of sovereignty over ASX clearing systems), indicating that in addition to foreign state-owned acquirer and national security considerations, FIRB will likely heavily scrutinise foreign persons’ acquisitions of businesses that, in the Government’s view, provide or perform some function that is critical to the Australian economy.
  • Sponsor to sponsor private equity deals have dominated the private M&A landscape in the first half of this year.

MAIN ARTICLE

1. Overview


This paper will briefly report on the current Australian M&A environment covering:
(a) government regulators;
(b) deal trends and terms; and
(c) private equity activity and news.

2. Regulatory snapshot


2.1 ASIC

The new Australian Securities and Investment Commission (ASIC) chairman Greg Medcraft, a former investment banker appointed in May this year, has signalled that the corporate regulator will have a greater focus on surveillance, industry engagement and self regulation. In particular, ASIC has been driving the theme of clear, concise and effective disclosure. This drive reflects ASIC’s ongoing concern that investors disengage from the information needed to make sound financial decisions when that information is unclear, inaccessible or needlessly detailed. Of note, recent consultation papers from ASIC raise the possibility of restrictions on paid celebrity endorsements and the use of photos and images in disclosure documentation to ensure that consumers are not distracted from key messages and warnings. ASIC has also set a date of 30 June 2012 for Australia’s funds management industry (the fourth largest in the world) to come up with voluntary best practice standards for portfolio disclosure.

2.2 ACCC

In recent years the Australian Competition and Consumer Commission (ACCC) has been more interventionist. Two trends over the past year include increased examination of alternative bidders in counterfactual analysis and increased requirements for pre-merger divestiture.

2.3 FIRB

Upon the recommendation of the Foreign Investment Review Board (FIRB) the Federal Treasurer rejected the proposed merger of ASX with Singapore Exchange Limited (SGX). The ASX/SGX merger was rejected as contrary to Australia’s national interest (because of the loss of sovereignty over ASX clearing systems). Supervisory issues impacting on effective regulation were also cited as a reason for rejection. This decision indicates that in addition to foreign state-owned acquirer and national security considerations, it is expected that FIRB will heavily scrutinise foreign persons’ acquisitions of businesses that, in the Government’s view, provide or perform some function that is critical to the Australian economy.

2.4 ASX

The Australian Securities Commission (ASX) has indicated that it is on the lookout for pre-downgrade volume spikes which are indicative of insider trading and/or a breach of continuous disclosure obligations. Also, the ASX has proposed to list derivative products in response to volatility concerns. The trend towards higher standards of continuous disclosure that emerged during the Global Financial Crisis has continued, whereby an entity must immediately disclose to the ASX any information that it is aware of concerning itself that a reasonable person would expect to have a material effect on the price or value of its securities. This was most recently born out in the Fortescue case, where a listed company was held to be in breach of its continuous disclosure obligations when it failed to immediately correct misleading information disclosed to the ASX.

3. Market trends in M&A transactions


3.1 Public M&A transactions

Public M&A activity has been patchy during the first half of 2011. Notably, the mining sector was more subdued than anticipated, with companies deploying stockpiled cash into growth projects, dividends or share buy-backs. The uncertainty caused by rising operational cost pressures together with the rising Australian dollar and volatile equity markets has put a dampener on M&A activity in the resources sector, although there has been some action such as the $A4.9 billion takeover bid for McArthur Coal by Peabody Energy and Arcelor Mittal. More generally, there was an uptick in activity around the mid-year point with the announcement of SABMiller’s $A9.5 billion takeover attempt of Foster’s (subsequently accepted with an increased offer price, valuing Foster’s at $12.3 billion), and FOXTEL’s $2.5 billion bid for Austar, although the uptick was followed by month-on-month deal values decreasing in both July and August. In the latter half of the year it is expected that public M&A will become more opportunistic and erratic, although the possibility remains that one or two major deals could catalyse a flurry of year-end activity similar to what we saw in 2010.

3.2 Private M&A transactions

Sponsor to sponsor private equity (PE) deals have dominated the private M&A landscape in the first half of this year, including the sale of the Healthecare Group by Champ to Archer Capital, and the sale of ATF from Quadrant to Champ. PE funds remain under pressure to spend funds raised pre-GFC and also sell assets held through the GFC, so the trend of secondary sales looks set to continue.

We have seen the following deal trends in private mergers and acquisitions transactions terms sheets over the past 36 months.

In respect of purchase price mechanisms, so-called “Locked Box” transactions are growing in popularity. Under this mechanism, the purchase price for the target company is based on an historical balance sheet settled between the parties as at an agreed date in advance of signing. The “box” is then “locked” by the vendor, who in turn gives indemnities and undertakings not to extract value from the target or incur additional indebtedness prior to completion. The value of the target is in this way determined prior to the sale, which allows vendors to avoid the uncertainties which completion accounts create. These transactions often allow for adjustments made for working capital expenditure in the lead up to completion.

In respect of warranties, it has become typical for vendors to cap their liability at 100% of the purchase price, although we have seen a handful of deals where purchasers have secured uncapped warranties and, at the other end of the spectrum, warranties capped to as low as 2.5% of the purchase price. The time limits within which purchasers must notify vendors of a breach of warranty are typically set at around 18 months from completion for all warranty claims except tax, and 6 years for tax claims (mirroring the Australian Taxation Office’s 6 year time limit for making retrospective claims). In respect of indemnities, it is very common to see vendors fully indemnify purchasers for all tax liabilities arising pre-completion.

4. Private Equity roundup


4.1 Australia roundup Q1 2011

  • Deal value US$10.1 billion down 75.5% from Q4 2010.
  • Deal count of 84 – ten more that Q1 2010, but 32 less that Q4 2010.

4.2 ‘My Super’ reforms

In recognition of the high proportion of passive super investors, it is anticipated that the government will promulgate new policy to protect consumers, although the proposed changes (known as the “My Super” reforms) are still in the consultation phase. It is likely that “My Super” products will become the government default, and that there may be a statutory obligation to consider fees paid in relation to both super funds and their investments in connection with these products.

While there is some concern in relation to fees associated with PE investments, as compared to other investments, the leader of the government’s consultation process has recently publicly recognised that fees must be considered in light of the net returns of a given type of investment.

4.3 Legal trends in respect of fees

Investors generally are more savvy to the terms on which they invest with PE. With the market slanted towards investors, we have particularly seen more robust clawback terms in respect of PE performance fees. These provisions are operating along two dimensions. First, defining what fees can be clawed back, and under what circumstances, and second, the mechanics to ensure funds will be available if clawback provisions are triggered. In respect of the latter, safeguards have included funds held in escrow and also third party guarantees, typically from the parent company of the PE fund.

4.4 Sectors

In the first quarter of 2011, the two largest PE investments by deal sector were in respect of Consumer Goods and Retail (32% of all deals) and Energy and Environment (25% of all deals).

4.5 Secondary market likely to continue as primary exit route

There have been a number of recent significant secondary deals including the sale of ATF from Quadrant to Champ, Ausfuel from Champ Venture to Archer and the HealtheCare group from Champ to Archer. More secondary deals are likely as internationally sponsors are now actively looking at certain assets help by domestic sponsors, combined with pressure to spend funds raised pre GFC and a continued challenging IPO market.

The views expressed herein are solely those of the author and have not been endorsed, confirmed or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

SOUTH AFRICAN UPDATE – New South African Companies Act Modernizes South African Corporate Law

Editors’ Note: Michael Katz is chairman and senior partner of Edward Nathan Sonnenbergs, with more than 40 years of prominence in takeovers and mergers and competition law, among other areas. He is a member of XBMA’s Legal Roundtable and, as one of South Africa’s leading corporate lawyers, played a role in drafting the new Companies Act. GivenSouth Africa’s growing position as the gateway for international cross-border transactions throughout Africa, the new Companies Act — which modernizes South Africa’s corporate legal regime — could have broad implications.

Executive Summary/Highlights: South Africa and the global environment have changed dramatically since enactment ofSouth Africa’s old Companies Act of 1973. New corporate law concepts have been developed internationally, such as solvency and liquidity, new and higher standards of corporate governance, new standards of accountability, disclosure and transparency, combating of market manipulation, new ideas and approaches to mergers and amalgamations, minority protections including shareholder appraisal rights and corporate rescue. South Africa’s new Companies Act, which brings South African corporate law current with global standards, is not rooted in any particular jurisdiction but rather combines many of the best practices from around the globe with some home-grown innovations.

1. INTRODUCTION

1.1. The Companies Act, 71 of 2008 (the “New Act“) was signed into law on 8 April 2009 and, after amendment in terms of Act 3 of 2011, became effective on 1 May 2011.

1.2. South Africa’s previous companies act being the Companies Act 61 of 1973 (the “Old Act“) had been amended approximately 42 times in the 37 years of its existence. This patchwork and piecemeal reform inevitably resulted in legislation which was not optimal in its clarity and which inevitably contained conflicting policies and objectives.

1.3. In addition, during the 37 years of the existence of the Old Act, both the domestic and global environment have changed dramatically. New corporate law concepts have been developed internationally, such as solvency and liquidity, new and higher standards of corporate governance, new standards of accountability, disclosure and transparency, combating of market manipulation, new ideas and approaches to mergers and amalgamations, minority protections including shareholder appraisal rights and corporate rescue. The response to these issues is that legislation that had outlived its usefulness and that is stifling the development of the economy must be repealed.

1.4. Accordingly, in the New Act many traditional company law doctrines and concepts have been abandoned or substantially modified. The New Act consists of a mere 225 sections and 5 schedules, coupled with 191 regulations and 4 annexures. It is concise and user friendly in its style and draftsman ship To put this in perspective, the recently modernised United Kingdom Companies Act, 2006, which is the longest statute ever passed by the UK parliament, has 1297 sections and over 16 schedules. It should, however, be pointed out that the Liquidation and Winding-up provisions in the Old Act have not been repealed. They will be inserted into a single Bankruptcy Act.

1.5. Obviously, the introduction of such a major update will have an impact and will require changes to certain practices of South African companies and their boards. There will also, of necessity, be some initial uncertainty. This memorandum seeks to provide guidance on the likely various challenges and the appropriate practical responses.

1.6. This memorandum contains a brief high-level summary of some of the key features of the New Act. It is certainly not exhaustive and is intended as a general guide rather than as detailed legal advice.

1.7. As this memorandum is primarily intended for use by boards of directors, the section dealing with duties and liabilities of directors contains more detailed explanations than the remaining sections. The latter are less comprehensive but nonetheless draw attention to significant changes.

2. IMPORTANT NEW DEFINITIONS

2.1. Alterable Provisions

Alterable provisions are those provisions in the New Act in which it is expressly contemplated that the effect of any such provision on a particular company may be negated, restricted, limited, qualified, extended or otherwise altered in substance or effect by that company’s Memorandum of Incorporation.

2.2. Amalgamation Or Merger

An amalgamation or merger is a new mechanism in the New Act for the acquisition by a company of one or more businesses including their assets, liabilities, contracts, litigation and employees.

2.3. Consideration

The definition of consideration, as read with section 40 of the New Act, allows a company to issue shares as fully paid in consideration for cash, assets fairly valued, services to be rendered or an undertaking to provide value in the future. If either of these latter two categories of consideration is used then the shares must be held in trust until the services are actually rendered or the value is actually received.

2.4. Distribution

Distribution is a category of transactions including share buy-backs, share buy-ins and dividends and other distributions to shareholders. These transactions may only be undertaken if immediately on implementation the company will comply with the solvency and liquidity test. This replaces the old capital maintenance rules.

2.5. Memorandum Of Incorporation

Memorandum of Incorporation means the document, as amended from time to time, that sets out rights, duties and responsibilities of shareholders, directors and others within and in relation to a company, and other matters as contemplated in section 15, and by which –
(a) the company was incorporated under the New Act, as contemplated in section 13;
(b) a pre-existing company was structured and governed before the later of the –
(i) effective date; or
(ii) date it was converted to a company in terms of Schedule 2; or
(c) a domesticated company is structured and governed;”

2.6. Prescribed Officer

2.6.1. There is a new concept in the Act of a ‘prescribed officer’. All of the provisions in the New Act relating to the duty of disclosure by directors of interests (section 75), standards of directors conduct (section 76) and liability of directors (section 77) apply equally to prescribed officers. A number of other sections relating to directors again apply equally to prescribed officers, including the issue of securities to directors (section 41), the issue of options to directors (section 42), the granting of financial assistance to directors for the purposes of acquiring securities (section 44) and the general provisions relating to the granting of financial assistance (section 45). In addition, the obligation to disclose on an individual basis in a company’s financial statements remuneration payable by the company applies both in the case of directors and prescribed officers.

2.6.2. In terms of section 66(10) of the New Act the Minister is empowered to make regulations designating as prescribed officers certain people, whether or not they hold office, who perform certain functions. The Minister has issued Regulation 38 designating a person as a prescribed officer if that person:

2.6.2.1. exercises general executive control over and management of the whole, or a significant portion, of the business and activities of the company; or

2.6.2.2. regularly participates to a material degree in the exercise of general executive control over and management of the whole, or a significant portion, of the business and activities of the company.

It will be observed that a functional test is used in designating a person as a prescribed officer.

2.7. Securities

Securities means shares, debentures and other instruments issued or authorised to be issued by a profit company.

2.8. Shares

Shares means one of the units into which the proprietary interest in a profit company is divided. For certain purposes it has an extended meaning which includes any person entitled to vote or receive distributions from the company.

2.9. Unalterable Provisions

Unalterable provisions means a provision of the New Act that does not expressly contemplate that its effect on any particular company may be negated, restricted, limited, qualified, extended or otherwise altered in substance or effect by a company’s Memorandum of Incorporation or rules.

3. IMPORTANT NEW CONCEPTS

3.1. Related Parties

It is also important to draw attention to the concept of related parties since many provisions in the New Act applicable to a company, a director, or a prescribed officer also apply to related parties of such persons. In terms of section 2 of the Act there are three categories of related parties, namely:

“2. Related and inter-related persons, and control
(1) For all purposes of this Act –
(a) an individual is related to another individual if they –
(i) are married, or live together in a relationship similar to a marriage; or
(ii) are separated by no more than two degrees of natural or adopted consanguinity or affinity;
(b) an individual is related to a juristic person if the individual directly or indirectly controls the juristic person, as determined in accordance with subsection (2); and
(c) a juristic person is related to another juristic person if –
(i) either of them directly or indirectly controls the other, or the business of the other, as determined in accordance with subsection (2);
(ii) either is a subsidiary of the other; or
(iii) a person directly or indirectly controls each of them, or the business of each of them, as determined in accordance with subsection (2).”

3.2. Holding And Subsidiary Companies

In terms of section 3 of the New Act a company is the holding company of another if it has the right to exercise more than fifty per cent of the shares in the latter company or to appoint directors who may exercise a majority of votes at board meetings of the latter company. If the holding company satisfies either of the aforegoing criteria it is sufficient even if it is not a shareholder of the subsidiary.

3.3. Solvency And Liquidity Test

In terms of section 4 of the New Act a company :-

3.3.1. is solvent if its assets fairly valued equal or exceed its liabilities fairly valued; and

3.3.2. is liquid if it appears that the company will be able to pay its debts as they become due in the ordinary course of business in the next twelve months.

4. CLASSIFICATION OF COMPANIES

4.1. There are two broad categories of companies being :-

4.1.1. those that are not for profit; and

4.1.2. all other companies, i.e. for profit companies.

4.2. There are four sub-categories of for profit companies :-

4.2.1. State Owned companies;

4.2.2. private companies

4.2.3. personal liability companies; and

4.2.4. public companies, being all for profit companies other than those set out in paragraphs 4.2.1, 4.2.2, and 4.2.3 above.

4.3. There are important consequences arising from the classification as a public company as opposed to a private company, including the following :-

4.3.1. different financial reporting requirements;

4.3.2. an obligation on the part of a public company to have a statutory audit; and

4.3.3. an obligation to have an audit committee.

4.4. Private companies which have a certain public interest score in terms of the relevant regulations must report on the same basis as a public company and have a statutory audit.

4.5. A foreign company is one that is incorporated outside ofSouth Africaand is unregulated in terms of the New Act unless it carries on business in South African within the meaning of section 23 of the New Act. In such event it will be an external company and certain provisions of the New Act will apply to it.

5. ABOLITION OF CONSTRUCTIVE NOTICE

5.1. Previously third parties dealing with a company were deemed to know the contents of the company’s constitutional documents This placed an onus on third parties dealing with a company to check the company’s constitutional documents whenever entering into a transaction with a company or otherwise dealing with it so as to ensure proper authorisation and compliance with the company’s constitution. While there were certain safeguards to protect third parties from this harsh doctrine, it was viewed by the legislators of the New Act that these protections were inadequate.

5.2. Accordingly, save in one particular circumstance, section 19 of the New Act reverses the legal assumption that persons dealing with companies are deemed to know the contents of the company’s constitutional documents.

5.3. This circumstance is legislated for in section 19(5) of the New Act (as read with sections 15(2)(b) and (c) of the New Act) which provide that a person will be regarded as having notice and knowledge of those provisions of a company’s MOI which constitute ‘restrictive conditions’ applicable to the company and which may have any specific requirements for the amendment of any such condition or prohibit the amendment of such conditions. The concept of ‘restrictive conditions’ was contained in the Old Act, but with the abolition of constructive notice, a mechanism was needed to ensure that companies that wished to rely on such ‘restrictive conditions’ in the New Act alert third parties to their existence.

5.4. Accordingly, section 13 of the New Act provides that the notice of incorporation filed by the company must include a prominent statement drawing attention to each such restrictive provision and its location in the MOI and the company’s name must include the element ‘RF’.

5.5. As a separate concept section 20(1) of the New Act makes the doctrine of ultra vires inapplicable as between a company and third parties.

5.6. Practical advice for a board that wishes to restrict certain conduct of the company or its subsidiaries and therefore to ensure that any such restricted conduct is invalid, is to ensure:

5.6.1. that the company incorporate the element ‘RF’ into its name;

5.6.2. that the notice of incorporation alerts parties to exactly where in the MOI the restrictive conditions are contained; and

5.6.3. that the restrictive conditions are drafted in such a manner so as not to breach section 20(1) of the New Act which, as set out above, renders the doctrine of ultra vires inapplicable as between the company and third parties. In this regard it is advisable to draft the restrictions in a manner which requires, for the validity of a transaction, compliance with a specified procedure for the authorisation of the transaction.

5.7. Pre-existing companies (that is, companies in existence before 1 May 2011), that already have restrictive practices drafted in terms of the Old Act should, amend their names to insert the element ‘RF’ as well as to amend their notices of incorporation to alert persons as to exactly where in the MOI those restrictive conditions are contained.

6. MoI AND ALTERABLE AND UNALTERABLE PROVISIONS AND SHAREHOLDER AGREEMENTS

6.1. With effect from 1 May 2011, the existing constitutional documents of a company, namely its memorandum of association and articles of association automatically became its MOI.

6.2. The relationship between a company’s MOI and the provisions of the New Act is governed by the alterable and unalterable provisions. The meanings of these two definitions appear earlier in this memorandum. The alterable provisions create flexibility. Generally a provision is alterable only where it is expressly stated in the New Act that it is alterable. However, in our view, there are a number of other provisions that can also be alterable if they don’t violate any unalterable provision. The New Act therefore introduces a great deal of flexibility into the governance of companies.

6.3. There are a number of transitional provisions contained in Schedule 5 to the New Act that are designed to deal with conduct initiated in terms of the Old Act but not yet completed by 1st May. These transitional provisions are of very limited application.

6.4. In terms of the New Act, quite apart from the aforesaid transitional provisions, if there is a conflict between the New Act and the MOI, the New Act prevails. However, the legislature has appreciated that it may take some time for companies to change their MOIs. Accordingly, there is a statutory moratorium which preserves for two years the validity of an MOI, notwithstanding that it is inconsistent (in other words, in conflict) with the New Act. It is respectfully submitted that this moratorium in effect only refers to the unalterable provisions of the New Act, i.e a conflict with those provisions.

6.5. Section 15(7) of the New Act effectively constitutes a reversal from the position that applied under South African common law where shareholders’ agreements took precedence over the MOI in respect of any conflict between the MOI and the shareholders agreement. The result of this is that companies will need to ensure that their MOIs and shareholders’ agreements do not conflict with the New Act and do not conflict with each other, in which event the shareholders agreement will be void to the extent of the conflict. There is another two year statutory moratorium to afford an opportunity to eliminate any such conflicts.

6.6. Practically, companies should, therefore, as soon as possible, review their MOIs and shareholders’ agreements to ensure that they are in compliance with the New Act. While there has been widespread panic in this regard, from our analyses of the articles of many companies we have found that conflicts between MOIs and the New Act are very limited and where they do exist they are seldom material. The main issues that arise are that there is some uncertainty as to interpretation as many of the articles were designed for the purposes of the Old Act and make specific reference to provisions in the Old Act.

7. SECURITIES, SHARES, BENEFICIAL INTEREST

7.1. There are now extended obligations on shareholders to disclose to companies their beneficial interests in securities and for companies to maintain a register of such disclosures. In this regard a registered holder must disclose in writing to the company the identity of each person with a beneficial interest in the securities held by such person, the number and class of securities held for each such person with a beneficial interest and the extent of each such beneficial interest. This must occur within 5 business days of the end of every month during which a change in that information has taken place or more promptly in certain circumstances. A public company, amongst others, must, in terms of section 56(7), establish and maintain a register of the beneficial shareholder disclosures made as well as publish these in its annual financial statements where a person holds a beneficial interest equal to or in excess of 5% of the total number of securities of that class issued by the company, together with the extent of those beneficial interests.

7.2. Moreover, Part F of the New Act, which relates to governance of companies and includes provisions, amongst others, relating to shareholder meetings and the required notices, now specifically includes in the definition of ‘shareholder’ a reference to those persons who hold the voting rights in securities. Accordingly, under the New Act, companies, when issuing notices and looking at the numbers required for quorums for resolutions will need to include shareholders who hold the voting rights in respect of their securities and not necessarily the registered holders of those securities, as was the case under the Old Act.

8. NO PAR VALUE SHARES

8.1. Under the Old Act, shares of both par value and no par value could be issued by a company subject only to all the shares of a particular class being entirely par or no par. It was far more common for a company to issue par value than no par value shares. Under the New Act, companies are permitted to issue no par value shares only, save in very limited circumstances applicable to companies which existed before the commencement of the New Act. Even those so-called pre-existing companies have severe restrictions on the extent to which they can issue par value shares after 1st May 2011. In this regard:

8.1.1. pre-existing companies are permitted to retain any par value shares which were issued prior to the commencement of the New Act;

8.1.2. pre-existing companies are permitted to issue further par value shares in a class where par value shares were already in issue at the commencement date but only to the extent that those further par value shares were authorised prior to the commencement of the New Act;

8.1.3. a pre-existing company cannot create any new par value shares subsequent to the commencement of the New Act and, therefore, after the par value shares authorised prior to 1 May 2011 have been exhausted, will have to issue no par value shares.

8.2. Accordingly, while there is no requirement on companies to convert their par value shares into no par value shares, the fact that their authorised share capital will eventually invariably prove to be inadequate, will result in many companies being required to convert their par value into no par value shares so as to avoid having two separate share class regimes existing side by side although there is no prohibition in this continuing.

9. CONSIDERATION FOR SHARES AND THE PROHIBITION AGAINST ISSUING PARTLY PAID SHARES

9.1. In terms of section 40 of the New Act a requirement has been included that shares must be issued for adequate consideration as determined by the directors exercising due care and skill. This cannot be challenged otherwise than by the shareholders on the ground of an alleged breach by the directors of their duty of care, skill and diligence.

9.2. In terms of section 92 of the Old Act companies were prohibited from issuing shares unless the full issue price had been paid. This prohibition is carried forward into the New Act in terms of section 40. However, in terms of the New Act the issue price can be paid in cash or by means of assets fairly valued or for services to be rendered or value to be contributed. If shares are issued for services to be rendered or consideration to be given in the future the company can issue the shares immediately but the shares must be transferred to a trust and later transferred to the subscribing party when the services have been rendered or the consideration has been received. While the shares are held in trust, the voting rights and appraisal rights on those shares may not be exercised and distributions made on those shares will be used as a credit against the remaining value at that time of any services still to be performed by the subscribing party save to the extent as otherwise provided. Shares that have been issued but are held in trust may not be transferred by or at the direction of the subscribing party unless the company has expressly consented to the transfer in advance.

10. REGULATION OF FINANCIAL ASSISTANCE

10.1. In terms of section 44 of the New Act the prohibition against the giving of financial assistance for the purposes of the acquisition of securities in the company has been widened as follows :-

10.1.1. the prohibition now applies not only in respect of the acquisition of shares but also in respect of the acquisition of all securities; and

10.1.2. the securities to which the prohibition relates are securities issued by the company or a related or inter-related company;

10.2. Section 45 of the New Act provides that a company may not give financial assistance including lending money, including a loan, or other obligation and including any debt or obligation to a director or prescribed officer (or parties related to them) of the company or companies related to it. The prohibition also includes giving any such financial assistance by a company to any related or inter-related company. The prohibition does not apply if the proposed financial assistance has been authorised by a special resolution passed within the preceding two years. It also does not apply to the lending of money in the ordinary course of business by a company whose primary business is the lending of money.

10.3. Even where financial assistance as contemplated in paragraphs 10.1 and 10.2 is permitted its grant is always subject to compliance with the solvency and liquidity tests.

11. GOVERNANCE

11.1. There are a number of important provisions relating to the governance of companies.

11.2. Allocation Of Powers As Between Directors And Shareholders

An entirely new concept is contained in section 66(1) of the New Act which provides for the allocation of the powers of a company as between the directors and shareholders. Unless otherwise provided in the company’s MOI, the business and affairs of a company must be managed by or under the direction of its board which has the authority to exercise all of the powers and perform any of the functions of the company.

11.3. Audit Committee And Social And Ethics Committee

11.3.1. In terms of section 94 public companies are required to have an audit committee. The audit committee is not a committee of the board but is a statutory committee elected by shareholders. Moreover, an audit committee must have not less than three non-executive directors.

11.3.2. Certain private companies are also required to have an audit committee if they meet certain financial and size thresholds as prescribed in the regulations. Subsidiaries of companies which have an audit committee which performs the same functions for the subsidiary are exempted from this requirement.

11.3.3. In terms of section 72(4) public companies are also required to have a social and ethics committee. Certain categories of private companies as set out in the regulations are also required to have a social and ethics committee but a private company which is a subsidiary of a public company whose social and ethics committee performs functions on behalf of that subsidiary are exempted. A company’s social and ethics committee must comprise not less than three directors or prescribed officers of the company, at least one of whom must be a non-executive director, and must not have been an executive within the previous three financial years. A social and ethics committee has the following functions:

11.3.3.1. to monitor the company’s activities, having regard to any relevant legislation, other legal requirements or prevailing codes of best practice, with regard to matters relating to:

11.3.3.1.1. social and economic development, including the company’s standing in terms of the goals and purposes of:

11.3.3.1.1.1. the ten principles set out in the United Nations Global Compact Principles; and

11.3.3.1.1.2. the OECD recommendations regarding corruption;

11.3.3.1.1.3. the Employment Equity Act; and

11.3.3.1.1.4. the Broad-Based Black Economic Empowerment Act;

11.3.3.1.2. good corporate citizenship, including the company’s:

11.3.3.1.2.1. promotion of equality, prevention of unfair discrimination, and reduction of corruption;

11.3.3.1.2.2. contribution to development of the communities in which its activities are predominantly conducted within which its products or services are predominantly marketed; and

11.3.3.1.2.3. record of sponsorship, donations and charitable giving;

11.3.3.1.3. the environment, health and public safety, including the impact of the company’s activities and of its products or services;

11.3.3.1.4. consumer relationships, including the company’s advertising, public relations and compliance with consumer protection laws; and

11.3.3.1.5. labour and employment including:

11.3.3.1.5.1. the company’s standing in terms of the International Labour Organisation Protocol on decent work and working conditions; and

11.3.3.1.5.2. the company’s employment relationships and its contribution toward the educational development of its employees;

11.3.3.2. to draw matters within its mandate to the attention of the board as occasion requires; and

11.3.3.3. to report, through one of its members, to the shareholders at the company’s annual general meeting on the matters within its mandate.

11.4. Electronic Participation By Shareholders

11.4.1. Section 61(10) of the New Act requires public companies to provide for electronic participation by shareholders in shareholder meetings by allowing shareholders and their proxies to participate by electronic communication in all or part of the shareholder meeting that is being held, so as to ensure that all those persons participating in the meeting are able to communicate concurrently with each other without an intermediary and to participate reasonably effectively in the meeting.

11.4.2. The Old Act did not allow companies to provide notices electronically. The New Act makes express provision for notices to be given electronically. The New Act also, allows company records to be retained in electronic form.

11.5. Round Robin Shareholder Resolutions To Be Passed By Means Of A Majority

11.5.1. The Old Act did not deal with round robin resolutions and this was regulated by companies in their MOIs. Public companies invariably did not provide for this, the result being that all shareholder resolutions of public companies were passed at duly convened meetings.

11.5.2. In terms of section 60 of the New Act, a resolution that could be voted on at a shareholders’ meeting may instead be submitted for consideration to the shareholders to be voted on in writing by the shareholders entitled to exercise voting rights in relation to the resolution.

11.5.3. A resolution so submitted to shareholders will have been adopted if it is supported by persons entitled to exercise sufficient voting rights for it to have been adopted as an ordinary or special resolution, as the case may be, at a properly constituted shareholders’ meeting.

11.5.4. The only exception to this rule is that matters which must be conducted at an annual general meeting cannot be voted on by way of a round robin resolution. This will include, for example, the approval of the audited financials and the appointment of an auditor and the audit committee for the ensuing financial year. Section 60 specifically provides that the election of a director which could be conducted at a shareholders’ meeting may instead be conducted by way of a round robin resolution.

12. DIRECTORS DUTIES

12.1. Fiduciary Duties And Duties Of Care, Skill And Diligence

12.1.1. There is a widespread misconception that directors’ duties have been drastically expanded in terms of the New Act. This is not accurate. In terms of the common law principles applicable inSouth Africarelating to the duties and liabilities of directors there are two main categories:

12.1.1.1. fiduciary duties which in turn include the duty:

12.1.1.1.1. to act honestly and in good faith;

12.1.1.1.2. to act in the best interests of the company;

12.1.1.1.3. to use their powers for a proper purpose;

12.1.1.1.4. to avoid conflicts of interests;

12.1.1.1.5. not to usurp corporate opportunities;

12.1.1.1.6. not to take secret profits;

12.1.1.1.7. to act independently and not fetter their discretion; and

12.1.1.2. the duty of care, skill and diligence which is the care, skill and diligence that may reasonably be expected of a person :-

12.1.1.2.1. carrying out the same functions in relation to the company as those carried out by that director; and

12.1.1.2.2. having the general knowledge, skill and experience of that director.

12.1.2. In terms of the New Act these duties have been partially codified. The concept of codifying directors duties and responsibilities is in accordance with a trend that has been adopted in a number of foreign jurisdictions. The method of codification which has been adopted bySouth Africain the New Act is such that the common law principles as set out above have been retained almost in their totality.

12.1.3. The duties of directors which are contained in sections 76(2) and (3) of the New Act are effectively a précis of the existing common law principles. Sections 76(2) and (3) read as follows :-

“76(2) A director of a company must –
(a) not use the position of director, or any information obtained while acting in the capacity of a director –
(i) to gain an advantage for the director, or for another person other than the company or a wholly-owned subsidiary of the company; or
(ii) to knowingly cause harm to the company or a subsidiary of the company; and
(b) communicate to the board at the earliest practicable opportunity any information that comes to the director’s attention, unless the director –
(i) reasonably believes that the information is –
(aa) immaterial to the company; or
(bb) generally available to the public, or known to the other directors; or
(ii) is bound not to disclose that information by a legal or ethical obligation of confidentiality.
76(3) Subject to subsections (4) and (5), a director of a company, when acting in that capacity, must exercise the powers and perform the functions of director –
(a) in good faith and for a proper purpose;
(b) in the best interests of the company; and
(c) with the degree of care, skill and diligence that may reasonably be expected of a person –
(i) carrying out the same functions in relation to the company as those carried out by that director; and
(ii) having the general knowledge, skill and experience of that director.”

12.1.4. Perhaps the only extension of the common law duty is that a director must not use the position of director or any information, obtained while acting as a director to knowingly cause harm not only to the company but also to a subsidiary.

12.1.5. The objective of retaining the common law principles is reinforced in section 77 which deals with the liability of directors. In this regard there is an express direction to determine liability in accordance with the appropriate common law principles. Section 77(2) reads as follows:-

“77(2) A director of a company may be held liable –
(a) in accordance with the principles of the common law relating to breach of a fiduciary duty, for any loss, damages or costs sustained by the company as a consequence of any breach by the director of a duty contemplated in section 75, 76(2) or 76(3)(a) or (b); or
(b) in accordance with the principles of the common law relating to delict for any loss, damages or costs sustained by the company as a consequence of any breach by the director of –
(i) a duty contemplated I section 76(3)(c);
(ii) any provision of this Act not otherwise mentioned in this section; or
(iii) any provision of the company’s Memorandum of Incorporation.”

12.1.6. In terms of section 77 read together with section 76 there are instances where directors are personally liable for breach of their duties. In a number of these statutory duties directors can avoid personal liability by voting against the relevant resolutions. These resolutions include the following :-

12.1.6.1. the issuing of unauthorised shares;

12.1.6.2. the issuing of authorised shares with knowledge that the issue of those shares was contrary to certain express provisions of the New Act;

12.1.6.3. the granting of options contrary to the provisions of the New Act;

12.1.6.4. the granting of financial assistance contrary to the provisions of the New Act;

12.1.6.5. the making of a distribution contrary to the provisions of the New Act;

12.1.6.6. the reacquisition of shares by the company contrary to the provisions of the New Act;

12.1.6.7. the making of an allotment contrary to the provisions of the New Act.

12.1.7. If a director (even if he may have voted in favour of the resolution) believes that the board has made a decision on any of the above in a manner that contravenes the New Act, that director may bring an application to court for an order setting aside the decision of the board, and in such a case the court may require the company to indemnify any director who has been or may be liable.

12.1.8. In any proceedings against a director, the court may relieve the director, either wholly or partly, from any liability, on any terms the court considers just if it appears to the court that the director has acted honestly and reasonably or it would be fair to excuse the director.

12.1.9. It is noteworthy that the duties of directors, and more particularly the standard of directors conduct, is somewhat ameliorated by the new business judgement test which has been borrowed from certain foreign jurisdictions. Thus, in terms of section 76(4) of the New Act it is specifically provided that :-

 

“76(4) In respect of any particular matter arising in the exercise of the powers or the performance of the functions of director, a particular director of a company –
(a) will have satisfied the obligations of subsection (3)(b) and (c) if –
(i) the director has taken reasonably diligent steps to become informed about the matter;
(ii) either –
(aa) the director had no material personal financial interest in the subject matter of the decision, and had no reasonable basis to know that any related person had a personal financial interest in the matter; or
(bb) the director complied with the requirements of section 75 with respect to any interest contemplated in subparagraph (aa); and
(iii) the director made a decision, or supported the decision of a committee or the board, with regard to that matter, and the director had a rational basis for believing, and did believe, that the decision was in the best interests of the company; and
(b) is entitled to rely on –
(i) the performance by any of the persons –
(aa) referred to in subsection (5); or
(bb) to whom the board may reasonably have delegated, formally or informally by course of conduct, the authority or duty to perform one or more of the board’s functions that are delegable under applicable law; and
(ii) any information, opinions, recommendations, reports or statements, including financial statements and other financial data, prepared or presented by any of the persons specified in subsection (5).”

12.1.10. Practical advice for boards to enable them to demonstrate that they have complied with the business judgment test may be to ensure that they keep detailed records of discussions on particular maters in board minutes as evidence of the rationality of their decision-making process and do not merely record board resolutions.

12.2. Directors’ Personal Financial Interests

12.2.1. The duty to disclose interests in contracts as set out in section 75 of the New Act is significantly more onerous than the position at common law and the Old Act. Sections 75(3), (4), (5), (6), (7) and (8) read as follows :-

“75(3) If a person is the only director of a company, but does not hold all of the beneficial interests of all of the issued securities of the company, that person may not –
(a) approve or enter into any agreement in which the person or a related person has a personal financial interest; or
(b) as a director, determine any other matter in which the person or a related person has a personal financial interest,
unless the agreement or determination is approved by an ordinary resolution of the shareholders after the director has disclosed the nature and extent of that interest to the shareholders.
75(4) At any time, a director may disclose any personal financial interest in advance, by delivering to the board, or shareholders in the case of a company contemplated in subsection (3), a notice in writing setting out the nature and extent of that interest, to be used generally for the purposes of this section until changed or withdrawn by further written notice from that director.
75(5) If a director of a company, other than a company contemplated in subsection (2)(b) or (3), has a personal financial interest in respect of a matter to be considered at a meeting of the board, or knows that a related person has a personal financial interest in the matter, the director –
(a) must disclose the interest and its general nature before the matter is considered at the meeting;
(b) must disclose to the meeting any material information relating to the matter, and known to the director;
(c) may disclose any observations or pertinent insights relating to the matter if requested to do so by the other directors;
(d) if present at the meeting, must leave the meeting immediately after making any disclosure contemplated in paragraph (b) or (c);
(e) must not take part in the consideration of the matter, except to the extent contemplated in paragraphs (b) and (c);
(f) while absent from the meeting in terms of this subsection –
(i) is to be regarded as being present at the meeting for the purpose of determining whether sufficient directors are present to constitute the meeting; and
(ii) is not to be regarded as being present at the meeting for the purpose of determining whether a resolution has sufficient support to be adopted; and
(g) must not execute any document on behalf of the company in relation to the matter unless specifically requested or directed to do so by the board.
75(6) If a director of a company acquires a personal financial interest in an agreement or other matter in which the company has a material interest, or knows that a related person has acquired a personal financial interest in the matter, after the agreement or other matter has been approved by the company, the director must promptly disclose to the board, or to the shareholders in the case of a company contemplated in subsection (3), the nature and extent of that interest, and the material circumstances relating to the director or related person’s acquisition of that interest.
75(7) A decision by the board, or a transaction or agreement approved by the board, or by a company as contemplated in subsection (3), is valid despite any personal financial interest of a director or person related to the director, only if-
(a) it was approved following disclosure of that interest in the manner contemplated in this section; or
(b) despite having been approved without disclosure of that interest, it –
(i) has subsequently been ratified by an ordinary resolution of the shareholders following disclosure of that interest; or
(ii) has been declared to be valid by a court in terms of subsection (8).
75(8) A court, on application by any interested person, may declare valid a transaction or agreement that had been approved by the board, or shareholders, as the case may be, despite the failure of the director to satisfy the disclosure requirements of this section.”

 

12.2.2. Certain of the changes from the common law and the Old Act are as follows :-

12.2.2.1. directors are obliged to disclose not only their own interests but also those of their related parties;

12.2.2.2. whereas at common law if permitted by the company’s constitution a director could disclose that director’s interests in a contract and then participate in the meeting and vote on the resolution, in terms of section 75 of the New Act the director must disclose the interests of that director and related parties and is then permitted to comment on the proposed transaction. The director must then leave the meeting. The director may be counted in determining whether a quorum was present but may not be counted in the voting;

12.2.2.3. a director must not execute any document on behalf of the company in relation to a matter where the director has a conflict unless specifically requested or directed to do so by the board;

12.2.2.4. the validity, or otherwise, of decisions by the board, or a transaction or agreement approved by the board or by a company as contemplated, is now specifically regulated.

12.3. Prohibition Of Reckless Trading

12.3.1. In terms of section 22 of the New Act a company must not carry on its business recklessly with gross negligence with intent to defraud any person or for any fraudulent purpose.

12.3.2. In addition where a company conducts its business and is unable to pay its debts as they become due in the ordinary course there are certain administrative remedies that may be adopted. Also there is a possibility of personal liability in terms of section 77(2).

12.4. Indemnification And Directors’ And Officers’ Insurance

12.4.1. There are three important methods that companies have hitherto relied on in order to limit the extent to which their directors are exposed to personal liability for negligence, breach of fiduciary duties, breach of trust or other default. First, companies have inserted provisions in their constitutions exempting directors from liability. Secondly, indemnities were given to directors that protected them from loss as a result of some default. A third method was to pay for directors’ liability insurance which indemnified a director form liability arising out of his or her service to the company. The extent to which these methods are valid and permissible has a direct effect on the effectiveness of the duties imposed on directors. To curtail abuse and ensure that directors did not with impunity breach their duties, the Old Act declared all such provisions void, whether contained in a contract or in the company’s constitution.

12.4.2. With the more effective enforcement mechanisms, the need for such protective measures for directors and prescribed officers is considered to be greater. The intention appears to be that directors and prescribed officers may now face the real possibility of more derivative actions being instituted against them personally by disgruntled minority shareholders and others, including shareholder activists, which they may now have to defend at their own cost. The New Act contains provisions which will provide a wider scope for the indemnification and insurance of directors and public officers of a company. In terms of section 78 of the New Act the following limitations against indemnification and similar mechanisms exist :-

12.4.2.1. section 78(2) provides as follows :-

“78(2) Subject to subsections (4) to (6), any provision of an agreement, the Memorandum of Incorporation or rules of a company, or a resolution adopted by a company, whether express or implied, is void to the extent that it directly or indirectly purports to :-
(a) relieve a director of –
(i) a duty contemplated in section 75 or 76; or
(ii) liability contemplated in section 77; or
(b) negate, limit or restrict any legal consequences arising from an act or omission that constitutes wilful misconduct or wilful breach of trust on the part of the director.”

12.4.2.2. section 78(3) provides as follows :-

“78(3) Subject to section 3(A), a company may not directly or indirectly pay any fine that may be imposed on a director of the company, or on a director of a related company, as a consequence of that director having been convicted of an offence, unless the conviction was based on strict liability.”

12.5. Delegation

12.5.1. Insofar as concerns the power of directors to delegate, section 72 of the New Act varies the common law position. Whereas at common law a board was only permitted to delegate to committees of the board if expressly permitted to do so in terms of the constitution of the company the New Act itself now permits such delegation. In this regard section 72(1) reads as follows:

“72(1) Except to the extent that the Memorandum of Incorporation of a company provides otherwise, the board of a company may –
(a) appoint any number of committees of directors; and
(b) delegate to any committee any of the authority of the board.”

12.5.2. If a member of a committee of the board is not a director then such person may not vote on a matter to be decided by the committee; however such person has all the duties of a director. This is provided in section 72(2) which reads as follows:

“72(2) Except to the extent that the Memorandum of Incorporation of a company, or a resolution establishing a committee, provides otherwise, the committee –
(a) may include persons who are not directors of the company, but –
(i) any such person must not be ineligible or disqualified to be a director in terms of section 69; and
(ii) no such person has a vote on a matter to be decided by the committee;
(b) may consult with or receive advice from any person, and
(c) Has the full authority of the board in respect of a matter referred to it.”

12.5.3. It is also necessary to point out that the creation of a committee or the delegation of any power to a committee does not in itself constitute compliance by directors with their duties as set out in the Act. This is provided in section 72(3):

“72(3) The creation of a committee, delegation of any power to a committee, or action taken by a committee, does not alone satisfy or constitute compliance by a director with the required duty of a director to the company, as set out in section 76.”

12.5.4. It would seem that if the committee to which the delegation is made consists of appropriately skilled persons and there is a proper charter relating to such committee requiring the necessary report-backs to the board and the board exercises its own judgment in deciding whether to follow the advice of the committee then it is unlikely that the entire board would be liable for the negligence of the committee.

12.6. Derivative Action

12.6.1. A ‘derivative action’ is a statutory exception to the principle that, where a wrong is done to the company the proper plaintiff is the company itself. A ‘derivative action’ is brought by a person on behalf of a company in order to protect the legal interests of the company. The statutory ‘derivative action’ (section 165) is an important minority shareholder protection. It protects the minority shareholders from the effects of corporate personality and majority rule. It enables a minority shareholder who knows of a wrong that is done to the company and not remedied by the directors (often because they are the wrongdoers), to institute proceedings against the wrongdoer on behalf of the company.

12.6.2. The ‘derivative action’ contained in the New Act is much wider than under the old regime and much improved. It is available to a wider class of applicants than simply minority shareholders. For example, it is now extended to trade unions. Moreover, its use is not limited to wrongs that are committed by the management or the controllers of the company – it even extends to wrongs that are committed by third parties or outsiders such that a shareholder can in certain circumstances bring a claim against a third party on behalf of the company where those in control refuse to do so.

13. ACCOUNTABILITY AND TRANSPARENCY

The New Act regulates the appointment of auditors and a secretary.

13.1. Mandatory Appointment Of Company Secretary

13.1.1. A public company or State owned company, in terms of section 86, must appoint a company secretary, and such person must have the requisite knowledge of and experience in, relevant laws and be a permanent resident of the Republic while serving in that capacity.

13.1.2. In certain instances private companies must also appoint a company secretary.

13.1.3. The duties of the company secretary are prescribed in section 88 of the New Act and include :-

13.1.3.1. providing the directors of the company collectively and individually with guidance as to their duties, responsibilities and powers;

13.1.3.2. making the directors aware of any law relevant to or affecting the company;

13.1.3.3. reporting to the company’s board any failure on the part of the company or a director to comply with the Memorandum of Incorporation or rules of the company of this Act;

13.1.3.4. ensuring that minutes of all shareholders meetings, board meetings and the meetings of any committees of the directors, or of the company’s audit committee, are properly recorded in accordance with this Act;

13.1.3.5. certifying in the company’s annual financial statements whether the company has filed required returns and notices in terms of this Act, and whether all such returns and notices appear to be true, correct and up to date;

13.1.3.6. ensuring that a copy of the company’s annual financial statements is sent, in accordance with this Act, to every person who is entitled to it; and

13.1.3.7. carrying out the functions of a person designated in terms of section 33(3).

13.2. Appointment Of Auditor

13.2.1. In terms of section 90 of the New Act a public company and State owned company, and in certain circumstances a private company, must appoint an auditor.

13.2.2. The requirements for the eligibility of auditors are also set out in the New Act.

14. OFFERS OF SECURITIES TO THE PUBLIC

14.1. Chapter 4 of the New Act harmonises the regulation of offers of securities to the public in the primary and secondary market.

14.2. In the case of listed securities :-

14.2.1. where offers to the public are made in the primary market the following applies :-

14.2.1.1. an IPO requires a prospectus;

14.2.1.2. subsequent offers require compliance with the requirements of the relevant stock exchange;

14.2.2. where offers to the public are made in the secondary market such offers require compliance with the requirements of the relevant stock exchange.

14.3. In the case of unlisted securities :-

14.3.1. where offers to the public are made in the primary market the following applies :-

14.3.1.1. an IPO requires a prospectus;

14.3.1.2. subsequent offers require a document similar to a prospectus;

14.3.2. where offers to the public are made in the secondary market such offers require a document similar to a prospectus.

15. FUNDAMENTAL TRANSACTIONS

15.1. Chapter 5 of the New Act regulates fundamental transactions and take-over offers. There are three categories of fundamental transactions :-

15.1.1. the disposal by a company of its major assets (being 50% of gross assets disregarding liabilities) or more than 50% of the value of its entire undertaking, fairly valued (section 112);

15.1.2. a merger or amalgamation, being a statutory transaction pursuant to which one company acquires the business (including its assets and liabilities, its contracts, litigation and employees) or businesses of another company/ies (section 113); and

15.1.3. a scheme of arrangement (section 114).

15.2. These three categories of transactions are essentially subject to the same regulatory matrix which has the following four features :-

15.2.1. the meeting of shareholders at which a resolution is proposed to implement any one of the fundamental transactions must be convened by a notice containing prescribed (section 115) information and generally accompanied by the report of an independent expert;

15.2.2. the proposed transaction requires shareholder approval by means of a special resolution;

15.2.3. there is the potential of court intervention. Thus, if the proposed resolution is opposed by more than 15% of the votes exercisable at the meeting any dissentient shareholder may approach the High Court to set aside the resolution. The jurisdiction of the Court to do so is limited to manifest unfairness or procedural non-compliance. If the resolution is opposed by less than 15% of the votes a dissentient shareholder needs the leave of the Court to apply to the Court to set aside the resolution;

15.2.4. any shareholder who votes against a fundamental transaction has a right to require the company to buy out such shareholder’s shares at fair value. This remedy, the so-called appraisal right, has been borrowed from certain foreign jurisdictions and may be expected to have a significant impact on corporate activities inSouth Africa.

16. REGULATION OF TAKE-OVERS

16.1. The New Act also regulates conventional take-over offers and subjects them to the jurisdiction of the Take-Over Regulation Panel (“TRP”). The jurisdiction of the TRP applies to affected transactions of a regulated company (section 118).

16.2. The following transactions are defined as affected transactions :-

16.2.1. the disposal of major assets;

16.2.2. the statutory merger;

16.2.3. the scheme of arrangement;

16.2.4. the acquisition of more than 5% of a company or multiples thereof;

16.2.5. the announced intention to acquire a beneficial interest in the remaining voting securities of a regulated company not already held by a person or persons acting in concert;

16.2.6. the acquisition by a party, together with concert parties, of at least 35% of the voting securities ;

16.2.7. the expropriation of the remaining securities pursuant to a mandatory offer.

16.3. A regulated company includes :-

16.3.1. a public company;

16.3.2. a State owned company;

16.3.3. a private company if the percentage of the issued securities of that company that have been transferred, other than between or among related persons, within the period of 24 months immediately before the date of a particular affected transaction or offer exceeds 10% of the issued securities of the company, or if that company’s MOI expressly provides that the company is a regulated company.

16.4. Whereas prior to the coming into operation of the New Act part of the regulation of take-overs was contained in the Old Act itself with the balance of the regulation being contained in the Securities Regulation Code, in terms of the new legislation regulation takes place in the statute itself and the balance in regulations promulgated in terms of the statute.

16.5. As was historically the case the two predominant methods that exist to achieve a take-over or merger are the offer in terms of sections 121, 122 and 123 of the New Act, the so-called take-over offer, and the scheme of arrangement in terms of section 114 of the New Act. Since the scheme of arrangement procedure implies the co-operation of the board of directors of the target company, the only route by which a hostile bid can be effected is the take-over offer.

16.6. At one stage, stamp duty considerations and other fiscal issues played an important role in the structuring of such transactions. This is no longer the case. Furthermore, from a regulatory point of view, since the enactment of sections 121 and 122 of the New Act and the establishment of the Take-Over Regulation Panel pursuant thereto, the mechanics, procedures and structures utilised in the formulation and implementation of a transaction are largely neutral.

16.7. The regulatory regime applies to the substance of the transaction and thus the form of the transaction (whether a take-over offer or scheme of arrangement or otherwise), does not really matter. Once a specified “trigger” occurs, certain regulatory principles will be applied. The regulatory regime thus has little impact on the selection by an offeror of the procedure by which to effect a take-over or merger.

17. BUSINESS RESCUE

Chapter 6 of the New Act contains an entirely new mechanism which provides a structured regime for the rescuing of financially distressed companies.

18. MISCELLANEOUS

18.1. Plain Language

The New Act has been drafted in plain language, the intention being to make it more accessible to laymen as opposed to lawyers only. This concept has been extended also to any prospectus, notice, disclosure or document issued in terms of the New Act, it being a requirement that any such prospectus, notice, disclosure or document be in in language such that a person for whom disclosure is intended, with average literacy skills and minimal experience in dealing with company law matters, could be expected to understand the content, significance and import of that prospectus, notice, disclosure or document without undue effort.

18.2. Anti-Avoidance

Section 6(1) of the New Act permits a court, on application by the Commission, the TRP or a stock exchange on which a company’s shares are listed, to declare any agreement, transaction, arrangement, resolution or provision of a company’s MOI or rules –

18.2.1. to be primarily or substantially intended to defeat or reduce the effect of a prohibition or requirement established by or in terms of an unalterable provision of this Act; and

18.2.2. void to the extent that it defeats or reduces the effect of a prohibition or requirement established by or in terms of an unalterable provision of this Act.

18.3. Participation By Employees In The Governance Of Companies

The New Act recognises the participation by employees in the governance of companies in a number of significant respects, including the following :-

18.3.1. in section 20(4) a trade union representing employees of a company have locus standi to apply to the High Court for an appropriate order to restrain the company from doing anything inconsistent with the New Act;

18.3.2. in terms of section 45, if the board of a company adopts a resolution to give financial assistance to related companies or directors (including prescribed officers) of the company or related companies it is necessary to inform shareholders and trade unions representing its employees of that fact within a prescribed period;

18.3.3. in terms of section 66(4) provision is made for the appointment in a company’s MOI of directors being a person ex officio. This could include a representative of a trade union;

18.3.4. in Chapter 6 dealing with business rescue, the three categories of affected persons who play a pivotal role in the entire chapter are shareholders, creditors and a registered trade union representing employees of a company as well as the representatives of employees who are not members of a union;

18.3.5. in terms of section 165(2)(c) a registered trade union or another representative of employees is given locus standi to bring the statutory derivative action on behalf of the company.

The views expressed herein are solely those of the author and have not been endorsed, confirmed or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

FRENCH UPDATE – LVMH’s Stake-Building in Hermès through Undisclosed Cash-Settled Derivatives Prompts French Parliament to Examine Disclosure Rules

Editors’ Note:  Olivier Diaz is the Managing Partner of Darrois Villey Maillot Brochier and a member of XBMA’s Legal Roundtable.  As one of France’s leading M&A lawyers, Mr. Diaz has extensive experience with the French disclosure requirements discussed below.  Mr. Diaz’s paper highlights a trend that is developing across several jurisdictions, including the U.S. and U.K., of modernizing disclosure rules to keep up with the proliferation of derivatives that have enabled acquirors to fly below the radar.  We invite papers from other jurisdictions on this topic.

Executive Summary/Highlights:

  • On October 23, 2010, LVMH announced that it had built up a position of more than 17% in Hermès, mainly through equity swaps which had not been previously disclosed.
  • LVMH’s method of stake-building has prompted the French parliament to consider a change to the French rules regarding the disclosure of interests in public companies to include cash-settled derivatives.
  • The founding Hermès family responded to LVMH’s announcement by contributing a majority of its shares to a family controlled holding company. The AMF, France’s securities regulator, and the Paris Court of Appeals, confirmed that this capital restructuring could be carried out without triggering a mandatory tender offer.

MAIN ARTICLE

1.      Facts

Hermès, the famous luxury-goods manufacturer, was admitted to the Paris stock exchange in 1993 as a “société en commandite par actions” (limited partnership), a rare form for a public company. The founding family owns the general partner and its members collectively own more than 70% of the shares (limited partners’ interests).

LVMH announced on October 23, 2010 that it owned 14% of the shares of Hermès, with the option to acquire a further 3%, and that it had acquired the major part of its shares through cash-settled equity swaps that had been transformed at the last moment into physically settled derivatives. Since then, LVMH has acquired more shares and owns more than 20% of Hermès share capital.

To clarify beyond any doubt that it would remain the company’s controlling and majority shareholder for the long term, the members of the family decided to regroup the majority of their individual holding in a family-owned company (the “Family Holding Company”) that would consequently own more than 50% of the share capital. In addition, the Family Holding Company would have a right of first refusal on the shares owned separately by the family members.

The Hermès family applied to the AMF, France’s securities regulator, for an exemption from the mandatory take-over rule (see §2 hereafter), which was granted on January 7, 2011. Some minority shareholders challenged this exemption. The Paris court of appeals, in a judgment of September 15, 2011, rejected their action and upheld the AMF exemption decision.

2.      Regrouping in a family holding company and mandatory take-over rules

Under French take-over rules, any person coming to hold more than 30% of the shares and voting rights in a French public company must file a tender offer on terms complying with compulsory take-over rules.

However, the AMF can give exemptions in a limited number of cases, among which the regrouping (“reclassement”) in a company to the extent that (i) the persons regrouping their shares can be seen as belonging to a “group” and (ii) the regrouping does not modify the control of the public company.

The notion of “group” in the context of a family is not defined by the AMF regulations.

Both the AMF and the Court of Appeals decided in this case that a group did not exist merely because of family connections.

On the other hand, the AMF and the Court reviewed the situation of the Hermès family members pragmatically, and recognized that they were acting as a “group”, mainly because of their control of the general partner, the public acknowledgement of their control over the company, the stability of their holding over the years and the fact that they generally voted their shares in limited partners’ meeting in the same fashion, even though the family members did not declare themselves historically as acting in concert.

The AMF and the Court also accepted that the restructuring did not alter the public company’s control, since ultimately the shares contributed to the Family Holing Company would be owned –although indirectly- by the same persons.

3.      Projected changes to the disclosure rules

Under French law, a person must disclose its interest in a public company when it  crosses certain thresholds in terms of shares or voting rights. The first of these thresholds is 5%, the other thresholds being 10, 15, 20, 25, 30, 50, 2/3, 90 and 95%. The failure to disclose can entail substantial penalties (up to 10 million euros or ten times the profit realized) as well as the deprivation of the voting rights attached to the shares above the threshold(s) that has failed to be disclosed.

For the computation of the interest of a person in a company, certain rights to shares must be taken into consideration, e.g. shares owned by a third party action in concert with that person or shares which that person may acquire at its discretion. Other types interests, including certain economic interests, are not aggregated but must be separately disclosed when the legal thresholds are otherwise met.

Therefore, cash-settled equity derivatives are unknown to an issuer for as long as a legal threshold is not crossed through the acquisition of shares or other assimilated interests, unless the counterparty to the cash-settled derivative is acting in concert with, or on behalf of, the beneficiary. On the other hand, physically settled equity derivatives (or derivative which the beneficiary can decide to settle in shares) must be assimilated to shares.

This inconsistency was used by LVMH to withhold from the public its economic interest in Hermès, since LVMH had otherwise acquired over the past 10 years a number of shares that was slightly below 5%.

In October 2010, LVMH agreed with the banks to modify the derivatives to provide for physical settlement, and acquired the underlying shares, at which point it disclosed its entire interest, to the surprise of Hermès, the public and the AMF.

The AMF has since then decided to launch an investigation in LVMH’s stake-building.

In the recent past, Wendel (a French financial investment company) had also used cash-settled equity derivatives to facilitate its stake-building in Saint Gobain. The derivatives were not amended to become physically settled derivatives as in the LVMH/Hermès case, but Wendel’s acquisitions of Saint Gobain shares were facilitated by the unwinding of the position of the banks counterparty to the derivatives, when such derivatives were terminated.

In this case, the AMF, in a decision of December 13, 2010[1], considered that Wendel wrongfully withheld from the public the material information that it was preparing to acquire a significant interest in Saint Gobain.

These two cases made it evident that French disclosure requirements were not suited to the modern techniques of stake-building.

This led a member of the French higher parliamentary chamber (the “Sénat”) to propose the introduction of a provision whereby cash settled derivatives should be added to the shares owned by a person in the computation of its disclosure obligations.

This provision is expected to pass but there is still parliamentary debate as to whether the shares underlying such derivatives should be taken into account for the computation of the 30% threshold for the obligation to launch a mandatory tender offer.


[1] This decision is being appealed

The views expressed herein are solely those of the author and have not been endorsed, confirmed or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

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