25 February 2004
Key Points:
A drafting problem in the Corporations Act may require share sellers and buyers to get ASIC relief for run-of-the-mill transactions.
If you hold 0.1% of a listed company and agree to sell out to the 51% shareholder, you may find that you've accidentally acquired majority voting power in the company. Similarly, if you agree to buy 100 shares from the holder of 1 million shares, you may find yourself deemed to have voting power in the whole 1 million.
These bizarre scenarios are the result of what appears to have been an "accidental" amendment to the Corporations Act. Accidental or not, the ramifications are so serious that ASIC has just issued a public statement about how it proposes to help businesses and shareholders to avoid scenarios such as those outlined above.
Importantly, however, ASIC's current proposal would only give this relief if parties specifically ask for it. There would be no blanket exemptions by way of Class Order. As a result, planning for a large number of run-of-the-mill transactions would have to include the drafting and submission of an exemption application to ASIC.
Clayton Utz has joined other major law firms in suggesting to ASIC that this is not a practical solution: M&A planning is notoriously time-sensitive, and would be significantly disrupted if pre-bid negotiations had to be put on hold while ASIC considered an exemption application. We have submitted to ASIC that what is really required is a Class Order.
Pending ASIC's final decision on this, it's important that M&A advisers are aware of the problem and some of its practical effects.
Background
The associate provisions of the Corporations Act are among the most important takeover provisions.
When calculating whether a shareholder is approaching the magic 20% threshold, one takes into account the relevant interests of that shareholder's "associates". For example, a 2% shareholder whose associates control 19% of the company is effectively deemed to have 21% voting power in the company.
In broad terms, "associates" are shareholders who act together (or plan to act together) to control the company's affairs (s 12). By aggregating associates' voting power, the Corporations Act effectively treats each individual associate as controlling a block of shares made up of all the associates' shares. This prevents a company's falling under the control of a group of likeminded shareholders who, although each owning a small parcel of shares, can together muster enough votes to control the company.
Unfortunately, due to a drafting quirk which even ASIC cannot explain, the "associate" provisions can also catch many totally innocent share transactions.
The Act says that shareholders become associates by agreeing (or planning) to act together in relation to the company's "affairs".
"Affairs" is defined very widely. So widely, in fact, that it covers such matters as "the ownership of shares" and control of the disposal of shares. As a result, an agreement to sell shares may make the buyer and seller associates of each other. The Corporations Act will then effectively add their shareholdings together and treat them as one shareholding.
In many cases, this will not be a significant problem. Most small on-market trades are unlikely to involve sufficient shares to take either the buyer or seller up to the 5% substantial shareholder or 20% takeover thresholds.
However, there are a number of situations in which this will be an important issue.
For example, in the lead-up to a takeover bid, the bidder may acquire a pre-bid stake from a major shareholder (or enter into a pre-bid acceptance agreement). To stay under the 20% threshold, the bidder will often only buy a portion of the major shareholder's holding.
The agreement to buy the pre-bid stake is an agreement about "the ownership of shares". The bidder and the major shareholder are therefore "associates". As a result, the Act aggregates the total shareholding of the bidder and the major shareholder - not just the shares that are changing hands. For example:
A and B may have no intention of acting together in order to control X Ltd, but the Act treats them as having doubled their voting power in the company. A has also, by acquiring the shares from B, committed a contravention of s 606 of the Act (acquiring a relevant interest through a transaction that takes both A and B over the 20% threshold).
ASIC's proposal
Although this problem has been around for a couple of years, it has only recently started to pop up as a live issue.
Although ASIC seems to view the matter as a drafting technicality, it takes the view that, until rectified, it must be regarded as an enforceable part of M&A law. The result has been that ASIC has, on some occasions, been policing the provisions (in relation to substantial shareholding notices, for example) while, at the same time, drafting a policy to overcome the unintended consequences.
Its currently-proposed solution is to grant case-by-case relief. In other words, parties who believe that they've been "wrongly" deemed to be associates could apply for a customised ASIC exemption. This would allow ASIC to scrutinise each application, with the objective of refusing relief to those transactions in which the parties are really making a control play for the company.
In broad terms, relief would be given to "acquisition agreements" where the parties didn't have a "control purpose".
Typical acquisition agreements include:
ASIC would not give relief if it believed that the parties jointly wanted to control or influence the make-up of the company's board or its financial and operating policies.
Ignore at your peril?
ASIC's currently proposed policy is too conservative. As noted above, making parties apply for individual relief and then wait until ASIC assessed the application would be unduly time-consuming.
It has been suggested to ASIC that Class Order relief would be a simpler option. It could easily be drafted to give relief to genuinely "non-control" transactions while filtering out real associate agreements.
ASIC is currently considering its position. In the interim, advisers on all pre-bid negotiations and many day-to-day share sale transactions must ensure that their clients don't accidentally trip up over this issue. The Takeovers Panel is aware of the problem. While the Panel generally takes a robust, business-oriented view of the Corporations Act, it is on record as having a "hair trigger" view of the 20% takeover threshold: "the fact that a contravention may be of a technical nature does not mean that it ought to be excused " (Taipan No 9). It may be reinforced in that strict approach if the parties had deliberately ignored a potential associateship.
_______
The comment period on the proposed policy ended on 6 February 2004
For further information, please contact John Elliott.
