CODEWORD

During a recent full takeover offer, the Panel was asked to consider whether a conditional right to be issued shares in the future was an ‘equity security’ for the purposes of the Code. It was an important question in the context of the takeover, because if the conditional right was an equity security, the offeror would have to make an offer for the conditional right, and would need an independent adviser to prepare a report under rule 22 of the Code regarding the fairness of the consideration as between the classes of securities.

The conditional right to be issued shares arose out of the sale of a business to the target company. The sellers were to be issued with shares in the target company, by way of additional consideration, if certain performance targets were met following the sale (i.e., an earn-out arrangement).

It was submitted to the Panel by the acquirer that the Code does not contemplate offers being made in respect of such a conditional right, because compliance with rules 42A and 42B of the Code would be impossible.

Rule 42A requires that the class notice sent to the offeror by the target company contains sufficient information about each class of equity security to enable the offeror to formulate an offer, and rule 42A(4) states that “sufficient information” includes the terms of issue of each class of security and the number of those securities on issue in each class. It was submitted that this was problematic in the circumstances because there was no equity security (such as an option) with terms that could be disclosed in the normal sense and because the number of shares to be allotted depended on a future event and could not be included when the class notice was sent.

Rule 42B requires that the target company sends to the offeror a copy of its financial products register relating to the financial products to which the offer relates. While a right to be issued shares may be listed on a financial products register (as is often the case for convertible rights), it may not be listed at all (as was the case here). If it is not listed, it was submitted that the target company will be unable to comply with rule 42B because it cannot provide a copy of a financial products register that does not exist.

“Equity security” is defined in rule 3 of the Code as:

equity security –

(a) means any interest in or right to (whether carrying voting rights or not)—

(i) a share in a company or other body corporate; or

(ii) the share capital of a company or other body corporate; and

(b) includes an option or right to acquire any such interest or right unless that option or right is exercisable only with the agreement of the issuer; but

(c) does not include redeemable financial products that are redeemable only for cash.

Sub-clause (b) of the definition of equity security clearly includes a right to acquire a share of a company in the future. Irrespective of whether the right is conditional, one party has a right to acquire shares and the other party has a corresponding obligation to issue shares.

On that basis, the relevant “equity security” comprised the provisions in the sale agreement giving rise to the potential future issue of shares in the target company.

Accordingly, applying a purposive interpretation, compliance was achieved by providing the offeror with a description of the terms of the earn-out arrangement, including the circumstances in which the sellers would be entitled to receive shares and the number of shares to be issued or the way in which the number of shares to be issued would be determined.

The purpose of rule 42B is to ensure that the offeror is given information that enables it to send its offer to the holders of each class of equity security. It would be inconsistent with the purpose of that rule to treat the lack of a financial products register relating to the conditional right as being determinative of whether that conditional right is in fact an equity security.

Compliance with rule 42B can be achieved by creating a financial products register of equity securities specifically for the purposes of rule 42B.

This recent takeover offer demonstrates the need for target companies to fully disclose their equity securities, including conditional rights to issue equity securities.