Further refinements for the minority buy-out regime

In May 2008 the Commerce Select Committee reported back on the Companies (Minority Buy-out Rights) Amendment Bill 2007 which sets out to improve the efficiency and effectiveness of the Companies Act's minority buy-out regime. As expected, the Committee has recommended further modifications to the Bill, although some may see its recommendations as falling short on certain aspects of the buy-out regime. In this article, solicitor Jennifer Coote outlines the Committee's key proposed amendments to the Bill.

BACKGROUND

The current minority buy-out regime allows a dissenting shareholder to require the company to buy its shares for a "fair and reasonable" price when the shareholder has unsuccessfully voted against a fundamental change in the structure or direction of the company.

The rationale underlying the regime is that a minority shareholder should not be forced to continue to own an interest in a company which is materially different from when the shareholder invested in the company. It is also of little benefit to the company if a disgruntled minority is forced to remain as shareholder. Instead the minority should be able to exit the company at a price which is fair and reasonable.

Although the minority buy-out regime is generally viewed as desirable, in practice its operation has proved difficult for both shareholders and companies largely as a result of the uncertainty surrounding the mechanisms for establishing a "fair and reasonable" price. In an early case brought under the current regime (sections 110 to 115 of the Companies Act 1993), Natural Gas Corporation Holdings Ltd v Infratil¹ (Natural Gas), Justice Doogue went so far as to describe the current procedures as "defective" and "substantially flawed".

This judgment culminated in a Law Commission Report (Report 74: Minority Buy-Outs) in 2001, and it is this report which, six years later, formed the basis for the Companies (Minority Buy-out Rights) Amendment Bill introduced in November 2007. For commentary on the Bill see the article "New bill to improve "practical operations" of the minority buy-out regime"in the Spring 2007 issue of Commercial Quarterly.

In general there has been widespread support for the reform of the minority buy-back regime and general support for the detailed reform contained in the Bill. There has been some concern however over certain aspects of the Bill, particularly with regard to some of the Law Commission's recommendations adopted in the Bill which are considered to be too far in favour of the dissenting shareholder.

PROPOSED AMENDMENTS TO THE BILL

The Commerce Select Committee, which released its report on the Bill in May, has recommended that the Bill be passed subject to some further amendments.

Share valuation methodology

The main focus of the Bill is to provide a statutory framework for calculating a fair price for the dissenting shareholder's shares. Following the Law Commission's recommendations, the Bill provides for the price to be an "honest estimate" calculated in accordance with certain prescribed guidelines on the valuation date, the treatment of the effect of the triggering event and the valuation base. The Commerce Committee has recommended that changes be made to each of these aspects of the Bill.

Fair and reasonable price

The Commerce Committee has rejected the Bill's use of a new "honest estimate" approach to the valuation of shares in favour of a return to a "fair and reasonable" valuation method. The Committee preferred the current "fair and reasonable" valuation method, noting that it is "well established and requires an objective assessment of value".

This is a sensible amendment as it is difficult to see how a reference to an "honest estimate" of value would give a board any greater guidance in determining the correct valuation. Submissions on this aspect of the Bill pointed out that "honest estimate" is not used in financial reporting practice nor has it been the subject of judicial consideration.

Valuation base

One of the more controversial sections in the Bill is the requirement to, in determining a "fair and reasonable price":

• base the valuation on the entire class of shares split pro-rata among the shareholders; and

• exclude any effects of the event proposed or authorised by the resolution to which the shareholder dissented (the triggering event).

As drafted, the Bill only permits a departure from this methodology where the shareholders are being bought out in the event of an amalgamation under section 221 of the Companies Act. In these circumstances, the valuer is entitled to take the benefits of the amalgamation into account when assessing fair value, on the basis that 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.

Submissions on this aspect of the Bill pointed out that there were other circumstances where it would not be appropriate to use this valuation technique, both for exiting shareholders as well as for the company.

Submissions identified that shareholders may also be squeezed out in other situations and, given it is not practicable to list all these situations, recommended that the existing exception be replaced with a broad catch-all exception.

It was also pointed out that this methodology effectively excluded the application of a minority discount to the dissenting shareholder's shares, which may provide an opportunity for the potential misuse of, or gaming by use of, the buy-back provisions, especially in the case of listed companies.

In response to these submissions the Committee has recommended replacing the amalgamation exception with a broader exception to allow the use of a different valuation method whenever the prescribed methodology would be "clearly unfair" to the shareholder or the company (see new section 112(3) of the Bill).

Date of valuation

Another key criticism of the existing minority buy-out regime is the absence of a specified valuation date. As drafted, the Bill provides for the valuation date to be fixed as the date on which the company gives the notice agreeing to buy the shares, this being the date on which the contract to buy-back the shares comes into existence. The Commerce Committee, however, has recommended that the valuation takes place "as at the close of business on the day before the date on which the resolution was passed".

The Commerce Committee considers that the advantages of the original scheme for the date of valuation were outweighed by the fact that it required the shareholder and the company to "anticipate events, and that it could result in different shareholders having different valuation dates."

Under the Commerce Committee's recommendations it will also be possible to choose an alternative valuation date under the new broad exception in section 112(3), noted above, should the board or the arbitrator determine that the "fair and reasonable" methodology is "clearly unfair" to the shareholder or the company.

Procedural changes

The Commerce Committee has also recommended certain changes be made to the new procedural provisions.

Arbitration determinations in cases of objection

The Bill is to retain the provision for the price to be determined by arbitration in the event the shareholder and the company can not agree on the purchase price. This will be seen by many as a missed opportunity to make a substantial improvement to the buy-out regime. Submissions received on this aspect of the Bill called for the arbitration provisions to be replaced with an analogous regime to rules 57 and 58 of the Takeovers Code which would require the price to be determined by an independent expert who is experienced in company valuations. This regime has been successfully used to determine values for the purposes of the compulsory acquisition provisions in the Takeovers Code, and is noted as being a relatively quick and inexpensive process in comparison with the experiences of those who have dealt with similar matters through arbitration.

The Commerce Committee, however, has recommended some further clarification of the arbitration process. It recommends that the Bill be amended to specify that the provisions of the Arbitration Act 1996 will apply when a matter is referred to arbitration. Further, it has also clarified the wording of the Bill to confirm that either party will be entitled to initiate arbitration proceedings if there is a dispute as to value and not just the company.

Damages and interest

Another aspect of the Bill which has been the subject of some criticism is the addition of the provision to allow the arbitrator to award a shareholder damages for any shortfall in the initial payment. This is seen by some as inappropriate, as any delay in a price determination should be adequately covered by the interest provisions (especially under the Committee's suggested amendments to the interest provisions noted below). However, the Committee has decided to retain this provision subject to the removal of the ability of an arbitrator to award such damages where the shortfall was not foreseeable. The Committee considers that the ability of an arbitrator to award damages in itself should provide adequate incentive for a company to avoid delays in offering an adequate price for the shares.

The Commerce Committee has also recommended that the arbitrator is given discretion to award an interest rate for outstanding balances "on the basis and at the rate that the arbitral tribunal thinks fit having regard to all the circumstances", as opposed to an award being restricted to being within the Judicature Act 1908 interest limits.

Passing of legal and beneficial title

The Commerce Committee received a number of submissions on the inappropriateness for the legal and beneficial title to remain with the dissenting shareholder pending final resolution of the arbitrated price. In response, the Committee has recommended that the legal title to the shares passes to the company on notification of the company's decision to purchase the shares as effectively this is the date on which the contract for sale is formed. From this date, the shareholder will not be entitled to vote in relation to its shares, receive distributions, or exercise any other rights attaching to those shares.

Although legal title to shares normally transfers when the transfer is entered on the company's share register, it is appropriate that a dissenting shareholder, who has signalled its intention to exit the company, should no longer be able to participate in the benefits of being a shareholder, during the period in which the company determines the price of those shares and while any objection to this valuation is being resolved (during which time the shareholder receives the benefit of payment of the provisional price).

NEXT STEP

The Bill is now awaiting its second reading and is included amongst the Government's raft of legislation that it would like to see passed before the House rises for the General Election.

We will update you with any further developments on its passage.

To access a copy of the Commerce Committee's report on the Companies (Minority Buy-out Rights) Amendment Bill visit Parliament's website at www.parliament.nz.

 

¹ [2000] 3 NZLR 727

Enquiries and information

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