Transactions

BEFORE THE TAKEOVERS PANEL

Background

[1]  Tranz Rail Holdings Limited (“Tranz Rail”) is a New Zealand incorporated company and is party to a listing agreement with the New Zealand Exchange Limited. As such, Tranz Rail is a code company for the purposes of the Takeovers Act 1993 (“the Act”) and the Takeovers Code (“the Code”).

[2] On 3 June 2003 Toll Group (NZ) Limited (“Toll”), a wholly owned New Zealand incorporated subsidiary of Australian company Toll Holdings Limited, gave notice under rule 41 of the Code of its intention to make a full offer (under the Code) for all the shares in Tranz Rail that it did not already hold (“the June takeover offer”). At the time of the offer, Toll owned 19.9% of the issued shares of Tranz Rail.

[3] On 6 June 2003 Tranz Rail and Her Majesty the Queen in Right of New Zealand (the “Crown”) announced that they had entered into an agreement (the “Original Tranz Rail/Crown Heads of Agreement”) which proposed:

(a) an allotment of new shares to the Crown, which would result in the Crown having 35% of the shares in Tranz Rail; and

(b) the purchase by the Crown of Tranz Rail's rail network and network assets (“the rail network”); and

(c) a commitment by the Crown to making improvements to the rail network over several years.

The Original Tranz Rail/Crown Heads of Agreement was conditional, among other things, on the approval of Tranz Rail shareholders and that there was no change in control of Tranz Rail.

[4] On 24 June 2003 Toll sent its offer document, dated 23 June, to the shareholders of Tranz Rail, to Tranz Rail and to the Takeovers Panel (“the Panel”).

[5] On 7 July 2003 the Crown, Toll and Toll Holdings Limited entered into an agreement (the “Toll/Crown Agreement”) to the effect that:

(a) Toll, with the consent of the Panel, would withdraw the June takeover offer and make a further offer for Tranz Rail (the “July takeover offer”); and

(b) if Toll's July takeover offer became unconditional, Toll would use its best endeavours to procure Tranz Rail to enter into a revised Heads of Agreement with the Crown (the “Revised Tranz Rail/Crown Heads of Agreement”). The Revised Tranz Rail/Crown Heads of Agreement would be an agreement to sell the rail network to the Crown, for the Crown to commit to making improvements to the rail network (with an investment of $200 million) and for Toll to commit to upgrading Tranz Rail's rolling stock (with an investment of $100 million); and

(c) the Crown would not agree on a date for the Tranz Rail shareholder meeting to consider the Original Tranz Rail/Crown Heads of Agreement until the July takeover offer was withdrawn or lapsed.

[6] On 7 July 2003 the Panel consented to the withdrawal of the June takeover offer.

[7] A takeover notice under rule 41 of the Code for the July takeover offer was forwarded to Tranz Rail by Toll on 8 July 2003. Toll sent its offer document, dated 26 July, to the shareholders of Tranz Rail, to Tranz Rail and to the Panel on 28 July 2003.

[8] Clause 1 of the Toll/Crown Agreement (the “Toll Exclusivity Clause”) provides that neither party will, until the July takeover offer is withdrawn or lapses, enter into any negotiations or arrangements which are inconsistent with the terms of that agreement, and in particular includes a clause that no alternative to the Revised Tranz Rail/Crown Heads of Agreement will be negotiated or entered into by either party.

The issues raised by Infratil Limited for consideration by the Panel

[9] Infratil Limited (“Infratil”), a listed public company, holds 7% of the issued share capital of Tranz Rail.

[10] On 17 July 2003 the Panel received a letter from Infratil (through its manager Morrison & Co) alleging that the Toll/Crown Agreement, and in particular the Toll Exclusivity Clause, constituted defensive tactics for the purposes of rule 38 of the Code.

[11] On 22 July 2003 the Panel received a letter from Infratil requesting that the Panel convene a meeting under section 32 of the Act in relation to this issue.

[12] The Panel met on 28 July 2003 to consider the request from Infratil. After consideration the Panel resolved as follows:

“On 22 July 2003 the Panel received a request from Infratil that it convene a meeting under section 32 of the Act in relation to Tranz Rail.

On 7 July 2003 the Crown and Toll (with Toll Holdings Limited, the parent company of Toll) entered into an agreement (the “Toll/Crown Agreement”) to the effect that:

(a) Toll, with the consent of the Panel would withdraw its takeover for all of the shares in the Tranz offer dated 23 June 2003 and make a further offer for Tranz Rail (the “July takeover offer”); and

(b) if Toll's July takeover offer becomes unconditional, Toll will use its best endeavours to procure Tranz Rail to enter into a revised Heads of Agreement with the Crown (the “Revised Heads of Agreement”). The Revised Heads of Agreement would be an agreement to sell Tranz Rail's rail network and other rail assets to the Crown and for the Crown to commit to making improvements to the rail network.

The Toll/Crown Agreement contains a clause which specifies that neither party will, until the July takeover offer is withdrawn or lapses, enter into any negotiations or arrangements which are inconsistent with the terms of the agreement, and in particular no alternative to the Revised Heads of Agreement will be negotiated or entered into by either party.

Infratil allege that Toll has acted in contravention of Rule 38 of the Code because:

(a) the exclusive nature of the Toll/Crown Agreement could effectively result in an offer for Tranz Rail being frustrated and/or the shareholders of Tranz Rail being denied an opportunity to decide on the merits of an offer; and

(b) in respect of the Toll Crown Agreement, Toll is acting on behalf of the directors of Tranz Rail or is a director of Tranz Rail itself under paragraph (f) of the definition of “director” in the Code.

The Panel has decided to convene a meeting under section 32 of the Takeovers Act 1993. The Panel considers that Toll, by entering into the agreement with the Crown, may not have acted or may not be acting or may intend not to act in compliance with rule 38 of the Code.The Panel has decided not to issue any restraining orders.”

[13] The Panel gave notice on 29 July 2003 of its intention to hold the meeting. Tranz Rail, Toll, Infratil and the Crown were requested to provide submissions to the Panel by 12 noon on Wednesday 30 July 2003. The submissions were circulated amongst the parties and parties were asked to provide any further submissions in response by Thursday 31 July 2003.

Relevant rule of the Code

[14] Rule 38 of the Code states:

(1) If a code company has received a takeover notice or has reason to believe that a bona fide offer is imminent, the directors of the company must not take or permit any action, in relation to the affairs of the code company, that could effectively result in-

(a) an offer being frustrated; or

(b) the holders of equity securities of the code company being denied an opportunity to decide on the merits of an offer.

(2) Subclause (1) does not prevent the directors of a code company taking steps to encourage competing bona fide offers from other persons.

(3) Subclause (1) is subject to rule 39.

Parties' submissions

Infratil's submissions

[15] Infratil argued that if Tranz Rail had been a party to the Toll/Crown Agreement and had undertaken to enter into the Revised Tranz Rail/Crown Heads of Agreement, this would have been a clear breach of rule 38. This is because:

(a) the agreement confers significant economic benefits to Tranz Rail; and

(b) those benefits are effectively denied to any potential rival bidders because of the Toll Exclusivity Clause.

[16] Infratil noted that the independent adviser's report prepared by Grant Samuel upon the instructions of the independent directors of Tranz Rail stated that the assessed value range of Tranz Rail's shares in the event that the Revised Tranz Rail/Crown Heads of Agreement is entered into would be between $1.34 and $1.64 per share. Without the Revised Tranz Rail/Crown Heads of Agreement, but with the Original Tranz Rail/Crown Heads of Agreement, the assessed value range would be between $1.00 and $1.10 per share. Toll has offered 95c per share.

[17] Infratil argued that the added value of the shares as a result of the Toll/Crown Agreement places rival bidders at a significant disadvantage because of the Toll Exclusivity Clause. Infratil submitted that unless rival bidders are able to enter into equivalent agreements in respect of the rail network with the Crown, that no rival bidders will be able to compete on value with the Toll offer. Accordingly the Toll Exclusivity Clause in the Toll/Crown Agreement effectively frustrates possible competitive offers for Tranz Rail shares and/or denies Tranz Rail's shareholders the opportunity to decide on the merits of any such offers. Infratil submitted that the effective frustration of competing offers is a significant detriment to Tranz Rail and its shareholders.

[18] Infratil submitted that the substantive effect of the Toll Exclusivity Clause constitutes the very mischief that rule 38 is aimed at, namely prohibiting arrangements which deter competing bids, in this case by 'locking-in' an existing offer. Infratil submitted that the wording of the rule should be interpreted having regard to this policy objective.

[19] Infratil acknowledged that rule 38 expressly refers to action taken or permitted by the directors of the code company i.e. Tranz Rail. Neither Tranz Rail nor its directors were a party to the Toll/Crown Agreement. However, Infratil argued that in the circumstances Toll could be considered to be acting as the directors of Tranz Rail for the purposes of the Code. Rule 3(1) of the Code defines director as follows:

director -

(a) in relation to a company, means a person occupying the position of a director of the company, by whatever name called; and

...

(f) includes a person in accordance with whose directions or instructions a person referred to in paragraphs (a) to (d) may be required or is accustomed to act in respect of the exercise of duties or powers as, or comparable to those of, a director.

[20]  Infratil submitted that Toll had negotiated the terms of the Revised Tranz Rail/Crown Heads of Agreement (which will not be entered into unless and until Toll's offer becomes unconditional) on behalf of Tranz Rail and not on its own behalf. In Infratil's view a commitment to enter into the Revised Tranz Rail/Crown Heads of Agreement could only be given by Tranz Rail. In order to fulfil its obligations under the Toll/Crown Agreement Toll needed to be acting on behalf of the directors of Tranz Rail. On this basis Infratil submitted that Toll had assumed the status of a person in accordance with whose instructions the directors of a code company may be required to act, and accordingly was a director under paragraph (f) of the definition of “director” in the Code.

[21] Infratil further argued that the phrase “may be required” in paragraph (f) of the definition of “director” has an element of “futurity” and should be seen as including a relationship which, although at the present time is contingent, may become actual at some point in the future. Infratil submitted that on the basis that Toll's takeover offer is successful and becomes unconditional, Toll will be in a position to control the way in which directors of Tranz Rail vote and thereby ensure that those directors “may be required” by Toll to procure Tranz Rail to enter into the Revised Tranz Rail/Crown Heads of Agreement.

[22] Infratil also submitted that in order for rule 38 to apply there does not need to be an actual imminent offer which would be frustrated by the effect of the Toll Exclusivity Clause. Infratil submitted that the references to “an offer” in paragraphs (a) and (b) of rule 38 are not limited to an offer of which the directors already have notice but more broadly cover any offer that may be made especially when a company is under offer as Tranz Rail is now.

Toll's submissions

[23] Toll, in its submissions, argued that there were three issues to be addressed in response to the allegations of Infratil:

(a) whether Toll could be a deemed director of Tranz Rail under paragraph (f) of the definition of “director” when it entered into the Toll/Crown Agreement; and

(b) whether there existed “an offer” which could be frustrated for the purposes of rule 38; and

(c) whether, if there were “an offer”, the actions of Toll could frustrate that offer or deny shareholders of Toll an opportunity to decide on its merits.

[24] Toll, argued that the terms of rule 38 are limited to actions taken or permitted by the directors of the code company. The rule did not extend to the actions of other parties such as the bidder.

[25] Toll did not agree that it could be considered to be the directors of Tranz Rail under paragraph (f) of the definition of “director”. Toll submitted that the words “may be required” in paragraph (f) of the definition of “director” related to a right existing on 7 July when the Toll/Crown Agreement was entered into. It did not have the future connotation asserted by Infratil. Toll argued there had to be an existing relationship at the relevant time between a director of the code company and the person in accordance with whose directions or instructions such a director may be required to act.

[26] Toll further submitted that rule 38 is designed to restrict defensive tactics in relation to an actual discernible offer and not to the mere possibility of future offers. Toll accepted that the threshold for a “discernible” offer would be likely to be lower than an offer identified in a takeover notice but submitted that the code company would need to have knowledge of at least who the offer would be made by and its general terms.

[27] Toll submitted that as there was no evidence of another definite offer then for the purposes of rule 38, the only offer which could be frustrated was its own. Toll therefore submitted that as the Toll/Crown Agreement would not frustrate the Toll offer there could be no breach of rule 38.

[28] Toll disagreed with the submission of Infratil that the Toll/Crown Agreement would effectively frustrate rival bidders. Although Toll conceded that the Toll/Crown Agreement might be an impediment to rival bidders it did not go as far as frustration. Toll argued it was entirely possible that a rival bidder could make an offer for Tranz Rail conditional on being able to enter into a similar agreement with the Crown.

Tranz Rail's submissions

[29] Tranz Rail submitted that it supported the position of Infratil. In its view the Toll Exclusivity Clause could inhibit competition by other bidders for the shares in Tranz Rail.

[30]  Tranz Rail submitted that the best outcome for Tranz Rail shareholders would be one that permitted other bidders for Tranz Rail shares to negotiate an agreement on the same terms as the Toll/Crown Agreement. Tranz Rail advised the Panel that it had sought that opportunity from the Crown and had been told that it should come back to the Crown if Toll's offer lapses or is withdrawn.

The Crown's submissions

[31] The Crown was not represented at the meeting. The Crown's written submission stated that as the directors of Tranz Rail were not involved in the negotiation of the Toll/Crown Agreement, and Tranz Rail was not a party to it, rule 38 could not apply. The Crown argued that Toll could not be deemed to be the directors of Toll for the purposes of the Code.

Panel analysis

[32] The issue which the Panel is required to determine is whether the Toll/Crown Agreement constitutes a defensive tactic for the purposes of rule 38.

[33] Rule 38 refers specifically to actions taken or permitted by “the directors of the code company”. Accordingly, in order for the Toll/Crown Agreement to constitute defensive tactics under rule 38, it must be shown that the agreement was the result of action taken or permitted by the directors of Tranz Rail.

[34] The argument put forward by Infratil requires the Panel to assume the appointment by Toll of yet-to-be-ascertained directors of the Board of Tranz Rail who will carry out Toll's wishes, specifically the implementation of the Revised Tranz Rail/Crown Heads of Agreement, at that time in the future which follows a successful takeover of Tranz Rail by Toll. The Panel is invited to treat those possible future events as current actions taken or permitted by those yet-to-be-ascertained directors.

[35] The Panel's view is that to give the interpretation to the definition of “director” suggested by Infratil would be an abuse of both the express wording of rule 38 and the intention of rule 38 which focuses on actions taken by the incumbent directors and those persons who control them at the time an offer has been made or is anticipated.

[36] The Panel does not accept that “directors” for the purposes of rule 38 can include persons in accordance with whose instructions the directors of Tranz Rail may be required to act at some point in the future, particularly if that “requirement” to act can only occur after control has passed. Rule 38 directs itself to actions taken by directors of the target company after the target company has received a takeover notice or has reason to believe that an offer is imminent. Toll cannot be treated as the directors of Tranz Rail within the terms of paragraph (f) of the definition of “director” at that time.

[37] At no time had Toll the authority of, or ability to act for, any of the directors of Tranz Rail. The current directors of Tranz Rail did not, and do not, appear to be accustomed or required to act in accordance with Toll's instructions or directions.

[38] Rule 38 requires some action by the directors of Tranz Rail in relation to that company's affairs which frustrates an offer or denies its shareholders the opportunity to decide on the merits of an offer. The directors of Tranz Rail have not taken any such action.

Determination

[39] The Panel considers that Toll's entering into the Toll/Crown Agreement, including the Toll Exclusivity Clause, does not constitute action taken or permitted by the directors of Tranz Rail which would qualify as defensive tactics for the purposes of rule 38 of the Code. Accordingly the Panel determines that it is satisfied that Toll by entering into the Toll/Crown Agreement acted in compliance with the Code.

Other issues

[40]  Other matters of interpretation of the Code were raised in the submissions of the parties on which the Panel would like to comment.

“An offer” for the purposes of rule 38

[41] In respect of the interpretation of rule 38, the Panel does not agree with the narrow interpretation suggested by Toll that rule is 38 is designed to restrict defensive tactics only against an actual discernible offer and not any future offer that might possibly eventuate.

[42] The initial trigger point in rule 38 is that the code company has received a takeover notice or has reason to believe that a bona fide takeover offer is imminent. Once this occurs the actions of the directors of the code company are restricted in that they must not take or permit any action, in relation to the affairs of the code company that could result in-

(a) an offer being frustrated; or

(b) the holders of equity securities of the code company being denied an opportunity to decide on the merits of an offer.

[43] The Panel is of the view that the references to “an offer” in paragraphs (a) and (b) of rule 38(1) are not restricted to a specific offer of which the code company has notice or reason to believe is imminent, but can include a possible future offer or offers which could arise during the likely offer period.

[44] To interpret rule 38 narrowly as suggested by Toll would allow target companies to take steps to “lock-in” a particular offer provided that the target company was not aware of a specific competing offer at that time. This may create barriers to other potential bidders making offers and so deny the target company shareholders the ability to decide for themselves the merits of such takeover offers. This frustration of potential bidders would therefore discourage competitive bids for code companies which is contrary to the objectives in section 20 of the Act.

Frustration of an offer

[45] Infratil submitted that the effect of the Toll Exclusivity Clause in the Toll/Crown Agreement is to frustrate rival bidders and that if Tranz Rail had been a party to the agreement it would have constituted defensive tactics for the purposes of rule 38.

[46] Although the Panel is not required to determine this issue, the Panel considers that the Toll Exclusivity Clause may effectively frustrate rival bidders.

[47] In general terms, if an incumbent board of directors entered into an arrangement with another party in the face of an offer or an imminent offer which conferred significant economic benefits on the target company but was only available to one particular bidder, that would be likely to constitute defensive tactics.

[48] The independent adviser's report prepared by Grant Samuel indicates that the Toll/Crown Agreement would provide Toll, as owner of Tranz Rail, with a significant benefit. If rival bidders cannot negotiate a similar deal with the Crown they will find it very difficult to compete on value at an equivalent level of conditionality. As the level of impediment required in order to constitute frustration under rule 38(1) is commercial impediment rather than strict legal frustration, the exclusive nature of the Toll/Crown Agreement may frustrate rival bids.

Costs

[49] The Panel will deal with costs separately in terms of the Takeovers (Fees) Regulations 2001.

DATED at Auckland this 6th day of August 2003

SIGNED for and on behalf of the Panel by the Acting Chairman

D O Jones