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M&A: minority protection

Fundamental transactions
The types of transactions that will be specifically affected by the newly introduced minority protections are the so-called “fundamental transactions” referred to in the Act. There are three types of transactions, which have been categorised as fundamental transactions.

These are: • the disposal of all or the greater part of the assets or the undertaking of a company (typically the sale of the company's business or the majority of its assets);

• the conclusion by a company of a transaction of amalgamation or merger; being a statutory form of the transfer of assets and liabilities of the company introduced into the Act and which, in itself, constitutes a new innovation as to the manner in which merger and acquisition transactions may be entered into; and
• a scheme of arrangement.

All of these fundamental transactions give rise to newly created rights in favour of shareholders.

Required approval
All fundamental transactions must be approved by the company in general meeting in terms of section 115 of the Act by way of a special resolution. In the notice convening the meeting at which the special resolution is to be considered, shareholders have to be advised of their appraisal rights under section 164 of the Act. The relevance of this is explained later.

The requirement that the fundamental transactions be approved by way of a special resolution is not a significant change from the current position (and is indeed already a requirement for disposals of businesses under section 228 of the existing Companies Act). However, section 115 goes on to provide that if the resolution, notwithstanding that it is passed by the requisite majority, was opposed by at least 15% of the voting rights that were exercised on that resolution, any person who voted against the resolution may require the company to seek court approval. Furthermore, even if less than 15% of the shareholders voted against the resolution, any person may approach the court for leave to apply to court for a review of the transaction. A company may not implement a transaction that is subject to a pending application.

A court may set aside the resolution if it is of the view that the resolution is manifestly unfair to any class of shareholders, or that the vote was materially tainted by a conflict of interest, inadequate disclosure, failure to comply with the Act, the company's memorandum of incorporation or the applicable rules of the company, or any other significant and material procedural irregularity.

It can be appreciated that these additional rights granted to shareholders could result in significant challenges to transactions, and concomitant delays in implementing transactions whilst disputes are resolved.

However, the rights granted under section 115 to minority shareholders are not an end of the matter. Even more drastic minority protection rights have been provided for in section 164, which creates the new concept of “appraisal rights”.

Appraisal rights
Appraisal rights amount to a put option by minority shareholders of their shares against the company on the happening of certain events, including the passing of a resolution to approve a fundamental transaction.

Shareholder resolution and dissent
The Act grants a shareholder that has given a company written notice objecting to a special resolution to approve a fundamental transaction and has voted against the resolution, the right to demand that the company pay to such dissenting shareholder the fair value for all the shares of the company held by that dissenting shareholder. Provided the necessary procedural requirements set out in the Act are complied with, the rights of a dissenting shareholder in this regard are absolute.

Offer to buy out dissenters
The company is then obligated, within a prescribed period, to submit a written offer to each such dissenting shareholder to offer an amount considered by the company's directors to be the fair value in exchange for the acquisition of such shares. The offer must be on the same terms in respect of shares of the same class or series.

A dispute regarding fair value must be referred to the court for determination. No guidance is given in the Act as to how “fair value” is to be determined and this in itself is likely to be a fruitful ground for disputes between companies and shareholders. A determination by the court of the fair value will be binding on the company and all dissenting shareholders.

Priority of obligations
If compliance with section 164 would result in a company being unable to pay its debts as they fall due and payable for the ensuing 12 months, then the company may apply to court for an order varying its obligations, but the court must ensure that the dissenting shareholders are paid at the earliest possible date compatible with the company satisfying its other financial obligations.

Minority rights excessive
The section was clearly introduced in order to provide protection to minority shareholders in the circumstances outlined. From the point of view of dissenting minority shareholders, the section grants them a useful right to force the sale of their shares in certain circumstances. The question must be asked, however, why dissenting shareholders should be given the opportunity to force the sale of their shares simply because they disagree with the decision of the majority shareholders? Appraisal rights may well be an appropriate exit mechanism in certain circumstances, but the conclusion of a fundamental transaction against the wishes of certain minority shareholders is a risk of being a minority shareholder in a company. Shareholders that do not wish to run the risk of the majority of shareholders taking a decision with which they disagree, should not be minority shareholders.

Will these minority rights inhibit corporate activity?
It is feared that granting the minority rights triggered by the conclusion of a fundamental transaction could severely inhibit corporate activity. The risk of having to pay minority shareholders an undefined amount of money on the entering into of a transaction makes the planning of a fundamental transaction extremely difficult. Unless the risk of appraisal rights being exercised can be clearly quantified, a company will be uncertain in many instances whether it will be called upon in terms of section 164 of the Act and, if so, the amount of its financial obligations which will arise as a result thereof. This makes the evaluation of a transaction, and the raising of the requisite amount of finance in order to fund a transaction, extremely difficult. In many instances, standby funding will have to be arranged in the event of appraisal rights being exercised, adding to the cost of the transaction. The uncertainty as to what may constitute fair value adds to the difficulty and makes the evaluation of the financial consequences of a transaction difficult, if not impossible, to properly quantify.

The scope for abuse of section 115 is also apparent and one can but hope that the courts will exercise strict control over the application of the section in order to avoid an abuse of process.

Conclusion
Whilst the granting of protections to minority shareholders is undoubtedly a laudable objective of company law reform, it should not be at the expense of the functioning of a flexible and dynamic economy, and it is feared that these protections will prove a hindrance to corporate activity, to the detriment of all shareholders. It is suggested that the introduction of these minority protections should be reconsidered.

Kevin Cron, BCom, BLaws, MLaws (Tax), is Director and Head of the Commercial Division, DENEYS REITZ INC.

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