The Government has taken up recommendations made by the Law Commission in 2001 to improve the effectiveness of the minority buy-out provisions in the Companies Act 1993 .
On 7 November 2007 the Government introduced the Companies (Minority Buy-out Rights) Amendment Bill 2007 to ensure that the minority buy-out regime "functions efficiently, cost effectively, and appropriately". The bill is a belated response to the Law Commission Report (number 74 Minority Buy-Outs) released in August 2001.
The bill is yet to have its first reading and submissions on the bill have not been called for at this stage, although earlier in the year the Ministry of Economic Development did undertake a limited consultation exercise presumably with a view to confirming that the recommendations made in the Law Commission's 2001 report are still relevant six years on.
New Zealand's minority buy-out regime (set out in sections 110 to 115 of the Companies Act 1993) is loosely based on "appraisal rights" provisions found in some North American jurisdictions. It was included in the 1993 revision of the Companies Act on the recommendation of the Law Commission as a solution to the problem of dissenting shareholders being locked into companies that have made "unanticipated alterations to corporate contracts that change the risk of, or unexpected return from, an investment".
It allows shareholders to require the company buy their shares for a "fair and reasonable" price (provided strict procedures are followed) when the shareholder has unsuccessfully opposed a special resolution that:
alters a company's constitution in a way that imposes or removes a restriction on the company's activities; or
approves a major transaction (under section 129 of the Companies Act); or
To date there has been relatively little use made of the regime and this is thought to be partly a result of the uncertainty surrounding the mechanisms for establishing a "fair and reasonable" price. The first time the minority buy-out provisions came before the court in Natural Gas Corporation Holdings Ltd v Infratil 1998 Ltd1 Justice Doogue noted that, in his opinion, the provisions lacked detail and were "substantially flawed". He called for the provisions to be "urgently reconsidered". It was this judgment which lead to the Law Commission undertaking its review of the minority buy-out regime in 2001.
Establishing a "fair" price
The main focus of the proposed amendments set out in the bill involves providing a statutory framework for calculating a fair price for the dissenting shareholder's shares. The present regime goes out of its way not to provide any basis for determining price other than to stipulate that the price to be paid must be "fair and reasonable", the rationale being that it was desirable to avoid having an overly prescriptive regime. However, in practice this "laissez faire" approach has made it extremely difficult for the company and the stakeholder to reach consensus over what is "fair and reasonable" and there have been calls for greater certainty of the valuation process. The key areas which have been highlighted as requiring some form of statutory guidance include:
fixing a valuation date;
providing guidance on whether the value should take into account the value effect (if any) of the resolution that triggered the buy-out rights; and
The lack of a specified valuation date was one of the criticisms made by Justice Doogue in the Natural Gas Corporation case, noting that:
"it is impossible to see how the company could ever make a truly fair and reasonable assessment of price when there are no indicia within the [Act] as to the date at which the assessment is to be made."
In the bill, the Government has adopted the Law Commission's recommendation by fixing the date at the point the company gives the dissenting shareholder notice under section 111(2)(e) that it will purchase the dissenter's shares (namely, within 20 working days of the company receiving the buy-out notice). This is seen as the most appropriate date given that it is technically the date on which the contract to buy-back the shares comes into existence.
As well as providing for a valuation date, the proposed amendments address the valuation technique to be applied. First, the bill prescribes that the price must be an "honest estimate" in place of the current "fair and reasonable price" wording of the value of the shares. Second, the Government has opted to follow the Law Commission's recommendations and base the valuation on the entire class of shares split pro-rata among the shareholders (after the effect of the triggering event has been accounted for – see below). This approach prevents the application of a minority discount to the dissenting shares and is likely to be the most contentious aspect of the proposed amendments. Indeed, the Law Commission noted in its 2001 Report that this proposal did not command the support of all those consulted on its recommendations.
In our view it is unfortunate that the Government has decided to adopt this approach. There is a strong argument that the value should incorporate any discount that is ordinarily incorporated in the market's valuation of the shareholder's stake. The purpose of the minority buy-out provisions is not to enhance the value of the dissenting shareholder's stake but, rather, to allow the shareholder to exit at a fair price unaffected by the transaction to which the shareholder objects. That should not, therefore, require any enhancement of value above the value for which the shareholder could ordinarily have sold its shares were it not for the transaction that is subject to the resolution. A different test may be appropriate where the transaction in question is in effect a compulsory acquisition of the dissenting shareholder's shares, but where the transaction involves no element of compulsory acquisition then, in our view, the value should reflect the true market value of the particular stake in issue.
Of particular note is the effect the adoption of a pro-rata valuation requirement may have on publicly listed companies in so far as it opens up further possibilities for shareholders of publicly listed companies to take advantage of extraordinary arbitrage opportunities. Even under the existing provisions it has been recognised that the Act creates artificial incentives for shareholders in publicly listed companies to "game" minority buy-out regime by voting against proposals and thereby maintaining the option either to require the company to purchase their shares if the market share price falls or to hold the shares if the price rises. This concern is particularly acute under the New Zealand regime which provides for minority buy-out rights to be triggered by major transactions.
Price to exclude the effect of the "triggering event"
On a less controversial note, the valuation technique proposed also attempts to insulate the dissenting shareholders from the effects of the event giving rise to the minority buy-out being triggered.
Arguably one way of insulating the minority shareholder from the triggering event would have been to set the valuation date immediately prior to the date of the special resolution approving the event (or the corporate action to which it relates), but as the Commission points out in its report, this would not adequately prevent a shareholder from being prejudiced from a fall in the value of the shares where, for instance, the event was already known to the market prior to the resolution being passed. Instead the Government has opted to take the approach put forward by the Law Commission and provide for the value to exclude any "fluctuation (whether positive or negative) in the class value that has occurred (whether before or after the resolution was passed) that the board reasonably considers was due to, or in expectation of, the event proposed or authorised by the resolution."
However, where the shareholders are being bought out in the event of an amalgamation under section 221 of the Act, the amendments provide for the valuer to take the benefits of the amalgamation into account when assessing fair value. To do otherwise would be preventing shareholders who were being squeezed out of participating in the amalgamation from sharing in any benefit of the amalgamation to the company.
Some procedural improvements
In addition to the proposed valuation amendments, the bill also adopts the Law Commission's recommendations on each of the following key features.
Notice of rights
Under the bill the company will be required to give shareholders notice of their buy-out entitlements in every case to which the buy-out regime applies.
Details of calculations
Under the present regime the company must give the shareholder notice of the price, but it has no obligation to advise the shareholder of the basis on which the share price was nominated. Under the amended provisions the notice must include details of how the overall price and any adjustments to the price were calculated. This provides more transparency to the pricing mechanism and while it may leave the company more open to attack, it may also serve to reassure shareholders that an acceptable price has been reached.
If a shareholder rejects the company's buy-out offer, the current regime provides for the value of the shares to be determined by arbitration. The bill, in a new section 112A, goes one step further and also provides for the arbitrator to determine the remedies available to the shareholder in the event the arbitrator's determination differs from the company's valuation.
The key change is directed at avoiding strategic delays in using arbitrators to resolve value disputes. Under the new provisions, where the provisional price paid is less than the price determined by the arbitrator, the arbitrator will have the power to recognise the time value of the money and allow damages for loss (whether foreseeable or not) attributable to the shortfall in the provisional payment. It is also hoped that this provision will be a deterrent to setting an inadequate price at the outset.
The bill also makes it clear that the arbitrator has an express power to require the unsuccessful party to pay costs to the successful party (including the arbitrator's fee and expert witness fees) by stating that clause 6 of Schedule 2 of the Arbitration Act 1996 may not be excluded from the arbitration agreement.
Timing of transfer of shares
The current wording of the Act is silent on whether the shares are to be transferred on payment of the provisional price, or following the completion of arbitration and the establishment of the final price. Under the proposed amendments a new section 112C provides for both legal and beneficial title to pass only after the price is ascertained and paid in full. However, any purported disposition by the shareholder between payment of the provisional price and completion is of no effect under the new provisions.
It is generally accepted that there is an urgent need for reform of the Companies Act minority buy-out regime. However, it is unlikely that the bill in its current form will receive sufficient support to come through the parliamentary process without changes being made to it. Many consider that although there is a need to provide more detail in the buy-out regime, some of the Law Commission's recommendations adopted in the bill are too far in favour of the dissenting shareholder. There are also those who have a number of other views on the current buy-out regime which are not addressed in the bill.
We will keep you informed of the progress of the bill and would be happy to assist with any submissions you may want to make on the bill during the select committee stage. For further information, please contact your usual Bell Gully adviser.
To access a copy of the Companies (Minority Buy-out Rights) Amendment Bill 2007, visit www.parliament.nz
To access a copy of the Law Commission's 2001 Minority Buy-out Report visit www.lawcom.govt.nz
For more information on any of the cases, articles and features in Commercial Quarterly, please email Diane Graham or call her on 64 9 916 8849.
This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.