CODEWORD

This guidance note sets out the Panel’s policy for dealing with the impacts of the Takeovers Code on upstream acquisitions. To keep the policy manageable, this guidance note deals with a “base case” scenario where 100% control of the upstream target entity is acquired. Of course, every case that comes before the Panel will need to be considered on its own merits and circumstances.

What is an upstream acquisition?

An upstream acquisition is an acquisition that occurs in New Zealand or overseas, that results in the acquirer of the upstream target becoming a controller of voting rights in a downstream New Zealand Code company.^[1] This acquisition of control occurs because the upstream target holds or controls voting rights in that downstream Code company and that asset (i.e., the voting rights) is acquired as part of the acquisition of the upstream target entity.

The acquisition of control of a downstream Code company may be incidental to the acquirer’s purpose of acquiring the upstream target. However, the acquisition of an upstream entity can also be effected for the purpose of indirectly acquiring control of an interest in the downstream Code company.

Application of the Code

In an upstream acquisition, if the upstream target entity holds or controls more than 20% of the total voting rights in a New Zealand Code company, the upstream acquirer may also become the effective controller of the voting rights in the downstream Code company and must comply with the Code in respect of that downstream acquisition.

The question of whether an upstream acquisition results in an acquirer becoming an effective controller of voting rights in a downstream Code company is not always certain. There are clear cases where effective control over the downstream parcel will be achieved (for example, the takeover succeeds and the upstream acquirer obtains 100% control of the upstream entity). 

The Panel assumes that any acquisition of more than 50% of the voting rights of an upstream target would result in the upstream acquirer obtaining effective control over the downstream Code company. However, an acquirer may be able to establish that the Panel’s assumption about obtaining control would not apply to its specific circumstances. If the upstream acquirer acquires 50% or less of the voting rights of the upstream target, the extent to which it will gain control of the downstream Code company, and therefore be subject to the Code, will depend on the circumstances.

Prior shareholder approval or prior takeover offer

In order to comply with the Code, before the upstream acquirer gains control of the upstream target (and therefore of the target’s voting rights in the downstream Code company), the acquirer must have either:

(a) obtained approval for the upstream acquisition by the downstream Code company’s shareholders by way of ordinary resolution under rule 7(c) of the Code; or

(b) completed a takeover of the downstream Code company under rule 7(a) of the Code. 

Where the upstream acquirer made a takeover offer for the downstream Code company, it would need to do so contemporaneously with, or in advance of, its acquisition of the upstream target. It would, in order to comply with the Code, need to have included in the upstream takeover offer appropriate conditions to ensure that it did not gain control of the upstream target, and, therefore, of the upstream target’s stake in the downstream Code company, until the takeover offer for the downstream Code company succeeded. Likewise, downstream shareholder approval of the upstream acquisition, under rule 7(c) of the Code, would have to have been completed before the upstream acquisition became unconditional. 

Both these compliance options are impracticable, if not impossible, in some cases. The alternative to complying with the Code’s requirements is to obtain an exemption from those requirements. The Panel has decided to give guidance to the market as to how it would exercise its discretion to grant exemptions in such circumstances.

Application for exemption

The Panel will consider applications for exemptions from the Code in relation to upstream acquisitions on a case by case basis.

The exemption process is set out below and illustrated in the diagram at the end of this guidance note. The purpose of this guidance note is to set out the Panel’s general policy in respect of upstream acquisitions. It does not attempt to address every possible scenario that might occur. Accordingly, this guidance note sets out the “base-case”.

Unconditional exemption

The Panel will normally grant an unconditional exemption from rule 6(1) of the Code for an upstream acquirer, where the upstream acquisition would result in the upstream acquirer becoming the controller of more than 20% of the total voting rights in a downstream Code company, if: 

(a) the upstream target is listed on a “recognised exchange” (as described below); and

(b) acquiring control of the voting rights in the downstream Code company would not reasonably be regarded as a significant purpose of the upstream acquisition (“purpose test”). 

If the value of the interest held by the upstream target in the downstream Code company is less than 25% of the enterprise value of the upstream target (or such other valuation methodology that the Panel considers may be appropriate in the circumstances),^[2] the purpose test will be prima facie satisfied (“value test”). However, the value test is only a proxy for purpose, and if the Panel considers that a significant purpose of the upstream acquisition is to acquire control of the downstream Code company voting rights, the meeting of the value test will be disregarded.^[3] Where the interest held by the upstream target in the downstream Code company is more than 25% of the enterprise value of the upstream target, it is possible that the meeting of the value test may be disregarded if the Panel is satisfied that it is not a significant purpose of the acquisition to acquire the downstream Code company. 

“Recognised exchanges” are New Zealand Exchange Limited and foreign exchanges in jurisdictions with a comparable level of investor protection to New Zealand. The Panel has identified the following foreign exchanges to be “recognised exchanges”: the Australian Securities Exchange, the American Stock Exchange LLC, Deutsche Börse AG, Euronext Amsterdam NV, Euronext Paris SA, Italian Exchange SpA, JSE Securities Exchange South Africa, Kuala Lumpur Stock Exchange, London Stock Exchange plc, The NASDAQ Stock Market Inc, New York Stock Exchange Inc, Singapore Exchange Limited, The Stock Exchange of Hong Kong Limited, Swiss Stock Exchange, Tokyo Stock Exchange, The Toronto Stock Exchange Inc.

Conditional exemption

If the purpose test is not satisfied or the upstream acquisition is of a target that is not listed on a recognised exchange, the Panel will most likely not grant an unconditional exemption. 

However, the Panel will normally grant a conditional exemption in these circumstances. The exemption would be subject to the condition that the upstream acquirer elects, and undertakes, one of the following compliance options, to either:

(a)  decrease the upstream target’s holding or control of securities carrying voting rights in the downstream Code company to 20% or less by no later than six months after the upstream acquisition becomes unconditional, and ensure that pending the decrease occurring the upstream target does not exercise any more than 20% of the total voting rights (“decrease compliance option”);^[4] or

(b) make a follow-on offer for the rest of the shares in the downstream Code company no later than 60 days after the upstream acquisition becomes unconditional.

The election of the compliance option must be notified to the Panel and to the downstream Code company (and, if either of the upstream target or the downstream Code company has its ordinary shares quoted on a New Zealand registered exchange, notified to the registered exchange) no later than either:

(a)  14 days after the follow-on offer price is determined (see below for details about the determination of the follow-on offer price); or

(b) the day after the upstream acquisition becomes unconditional.

The above timing allows the election of the compliance option to be made after the follow-on offer price is determined. However, the election of a compliance option could be made at any time in advance of the follow-on offer price being determined.

Requirements of a decrease

If the decrease compliance option is elected, the upstream acquirer must undertake to the Panel that it will procure the upstream target to decrease its holding so that the upstream acquirer would hold or control no more than 20% of the total voting rights in the downstream Code company after the decrease. This must be achieved no later than six months after the upstream acquisition becomes unconditional. The upstream acquirer must also undertake to the Panel that pending the decrease occurring it will procure the upstream target to not exercise any voting rights in the Code company above the permitted 20% level. If the shares are divested, any acquirer(s) of the shares must themselves comply with the Code. That means, for example, that the upstream acquirer could not sell the shares to any associates unless the associates obtained the approval of the Code company shareholders, in accordance with rule 7(c) of the Code.

Requirements of a follow-on offer

The consideration for the follow-on offer must be cash (or include a cash alternative) and must be determined as follows:

(a)  if the Panel is satisfied that the price effectively being offered to the upstream target for its shares in the downstream Code company can be clearly and accurately determined from the upstream offer consideration (the “see-through price”), the follow on offer consideration will be not less than the see-through price. Only in rare cases will the see-through price be able to be clearly and accurately determined, for example, where the only assets of the upstream target were the shares in the downstream Code company;

(b) where the see-through price cannot be clearly and accurately determined, the follow on offer consideration will be not less than the fair and reasonable value per share,5^[5] as determined by an independent expert that is appointed by the Panel;

In relation to the follow-on offer compliance option, the following additional conditions of exemption would apply:

(a)  the offeror must pay the reasonable fees, costs and expenses of the independent expert in relation to its determination of the follow-on offer price;

(b) the offeror must include with the offer document that is sent to shareholders for the follow-on offer a copy of the independent expert’s valuation and an explanation of how the follow-on offer price is derived from that valuation; and

(c)  any other terms and conditions of the follow-on offer, included by the offeror in the offer document, must be in a form approved by the Panel.

The other terms and conditions of the follow-on offer (referred to in paragraph 20(c), above) that the Panel may approve, could include: 

(a) the usual conditions of takeover offers that are made pursuant to the Code (the Panel would need to have approved the wording of these and all other conditions);

(b) that the requisite regulatory approvals (such as from the Overseas Investment Office or Commerce Commission) are obtained, and that the upstream acquirer will use its best endeavours in good faith to obtain all such approvals. 

However, there could be no minimum acceptance condition included in the follow-on offer, other than that stipulated by rule 23 of the Code. 

Also applicable to the follow-on offer conditions is rule 25(1) of the Code, together with the Panel’s Guidance Note on Restrictive Conditions, dated May 2006, which can be found on the Panel’s website under Publications.^[6] 

It would not be a condition of the exemption granted by the Panel that a follow-on offer must succeed.

Appointment of an independent expert

The independent expert would be appointed by the Panel as follows. The upstream acquirer would request that the Panel appoints an independent expert. The request must include a list of the advisers from whom the upstream acquirer has already received advice in relation to the upstream acquisition and the resulting downstream acquisition. The upstream acquirer should not make any suggestions as to who it thinks would be appropriate for appointment by the Panel. However, the upstream acquirer should also advise the Panel of any firms that it considers might be conflicted, and why it considers them likely to be conflicted. 

The Panel would then undertake a closed tender process inviting applications from experts that it considers suitable. The Panel would approach those experts on a confidential basis. The independent expert would be selected on the basis of independence and appropriate qualifications and experience. The Panel would also take all the experts’ quoted fees into account when selecting the expert for appointment. 

The appointment process is consistent with the appointment process for an independent expert under rule 57 of the Code, which can be found on the Panel’s website under Publications.^[7] 

At least 14 days should be allowed for the appointment process and up to a further four weeks for the valuation to be undertaken by the appointed expert. The expert will undertake a valuation on the basis of all available information at the time of the valuation. 

A follow-on offer must be made no later than 60 days after the upstream acquisition becomes unconditional. Accordingly, it would be advisable for the upstream acquirer to approach the Panel for an exemption as early as possible in the acquisition (or pre-acquisition) process. If a conditional exemption is granted to the upstream acquirer by the Panel, requiring the upstream acquirer to elect a compliance option (to decrease or to make a follow-on offer), it may be pragmatic to request at that time that the Panel appoints an independent expert. This would help to ensure that the compliance timeframes were able to be comfortably met. The Panel will keep confidential any exemptions granted, where it is proper to do so on the ground of commercial confidentiality.

Market disclosure

The market for shares in the downstream Code company must be adequately informed in relation to the upstream acquisition. The upstream acquirer must notify its election to the Panel and to the downstream Code company, no later than either:

(a)  14 days after the follow-on offer price is determined; or

(b) The day after the upstream acquisition becomes unconditional.

If the follow-on offer compliance option is elected, the notification must include full details of both the upstream and downstream acquisitions, including the timing and consideration for the acquisitions. (The consideration for the downstream acquisition must be disclosed only if that consideration has been determined at the time of the announcement). If the upstream target or the downstream company is listed on a New Zealand registered exchange, the notification must also be given to the New Zealand registered exchange at the same time that it is given to the Panel and to the downstream Code company.

Compliance with rule 64 of the Code – prohibition on misleading or deceptive conduct

Rule 64 of the Code prohibits misleading or deceptive conduct in relation to Code regulated transactions or events. 

Rule 64 provides that: 

(1) A person must not engage in conduct that is

(a) conduct in relation to any transaction or event that is regulated by [the] Code; and

(b) misleading or deceptive or likely to mislead or deceive.

(2) A person must not engage in conduct that is

(a) incidental or preliminary to a transaction or event that is or is likely to be regulated by [the] Code; and

(b) misleading or deceptive or likely to mislead or deceive.

Any statements, actions or other conduct by any person in relation to the downstream Code company (or potentially the upstream acquisition) would be subject to the rule 64 prohibition. 

Particular care should be taken over ‘last and final statements’. For example, if the upstream acquirer were to state that it was going to elect the decrease compliance option, that would constitute a last and final statement under rule 64. The Panel would likely find that rule 64 had been breached if the upstream acquirer did not then elect the decrease compliance option. 

Likewise, shareholders, directors and any other persons are subject to the rule 64 prohibition against misleading or deceptive conduct. 

The Panel’s policy on last and final statements is set out in CodeWord Number 22 (available on the Panel’s website under Publications).^[8]

If the purpose test is not satisfied or the upstream acquisition is of a target that is not listed on a recognised exchange, the Panel will most likely not grant an unconditional exemption.

However, the Panel will normally grant a conditional exemption in these circumstances.