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Appraisal rights – protecting minority shareholders in holding companies

Authors: Jeff Buckland – Special Counsel & Head of Corporate and Bradley Frolick – Associate



The South African Companies Act 71 of 2008 (“the Companies Act”) introduced a number of novel provisions into our law, which are clearly shareholder-centric and protectionist as far as minority shareholders are concerned. Section 164, which contains the new appraisal rights, is one of these novel provisions.


Appraisal rights in company law originated over a century ago in the United States of America and the remedy is found in other jurisdictions, such as Australia, Canada, and New Zealand.[1] The remedy provides welcome alternative relief for dissenting minority shareholders in the form of a surrender to the company in which they are invested of all their shares in the company, in consideration for payment by the company to them in cash of the fair value of their shares.


The appraisal remedy is available to minority shareholders not aligned with and opposing certain key decisions of the majority shareholders, who would otherwise be trapped in the company or in the “group of companies” to which that company belongs. Now they may exercise their appraisal rights, cash-in their shares and exit the company or the group.


One of the key decisions majority shareholders in a company may wish to implement and approve by the adoption of a special resolution at a meeting of shareholders, which would trigger the appraisal rights, is a disposal by that company of all or a greater part of the assets of that company contemplated by section 112(2) of the Companies Act. Minority shareholders in the disposing company who oppose that decision of the majority shareholders may exercise their appraisal rights and exit the disposing company.


Viewed in the context of a “group of companies” to which a disposing company belongs, the disposal by a company in the group, or disposals in a series by one or more companies in the group, might significantly impact minority shareholders invested in any intermediate holding company or in the ultimate holding company in relation to the disposing subsidiary company in the applicable group. Such minority investors at each holding company level could have been trapped in the applicable holding company in the applicable group to which the disposing company belongs, without the statutory appraisal remedy.


However, the appraisal remedy protecting dissenting minority shareholders, comes at a cost.


A “group of companies” / cost implications of the appraisal remedy

A disposing company is often a company in a “group of companies”, being “a holding company and all of its subsidiaries”.


Having regard to the possible “subsidiary company”/“holding company” “relationships”, as defined in the Companies Act, a company may be a subsidiary company in relation to one or more holding companies, and each holding company (with its own set of “group of companies”) may have majority shareholders, and corresponding minority shareholders with appraisal rights against that holding company.


In other words, a subsidiary company may be part of multiple sets of “groups of companies”, each with its own intermediate holding company, up to the ultimate holding company, possibly with multiple sets of minority shareholders with appraisal rights in relation to the disposing company and each applicable holding company.


It follows that if a subsidiary company intends to enter into a disposal, then each holding company (with its own set of “group of companies”) in relation to the disposing subsidiary company would need to be identified to ascertain each shareholder base (and corresponding minority shareholder base with appraisal rights) entitled to vote on the special resolution/s required by the Companies Act to approve the disposal and to quantify the contingent cost to the group if each applicable minority shareholder base were to exercise its appraisal rights in full.


The proceeds of the disposal by the disposing subsidiary company, received by the disposing subsidiary company from the third-party purchaser, could be applied to fund the payments of respective fair value for the shares of each respective set of minority shareholders exercising their appraisal rights at each applicable layer in the group/s of companies. These respective contingent liabilities within the disposing subsidiary company and each intermediate and ultimate holding company would need to be factored into the cost/benefit analysis of the proposed disposal, and possibly into the price negotiations with the purchaser.


The effect of the novel appraisal remedy protecting dissenting minority shareholders, in circumstances where the possible net proceeds of the disposal by a disposing subsidiary company, after deducting all probable contingent appraisal remedy liabilities, might not justify a proposed disposal, could be restrictive on the disposal and acquisition of assets and undertakings in the market, which might adversely affect the efficiency of markets, and would certainly need to be considered when planning and structuring “groups of companies”.


The statutory framework regulating disposals

The relevant provisions of the Companies Act regulating the disposal by a company, in a “group of companies”, of all or a greater part of its assets or undertaking, are contained in sections 112, 113, 114, 115, and 164 of the Companies Act. These sections are interrelated; in the sense that they refer to each other in cascading sequence.


Under section 112(2), a company may not dispose of all or a greater part of its assets or undertaking unless (a) the disposal has been approved by a special resolution of the shareholders, in accordance with section 115, and (b) the company has satisfied all other requirements set out in section 115, to the extent those requirements are applicable to such disposal by that company.


The reference in section 112(2) to “the shareholders, in accordance with section 115” is a reference to the shareholders of the subsidiary company, and the shareholders of the applicable holding company, respectively, as contemplated by section 115(2).


Section 112 is clearly subject to section 115.[2] In other words, the subsidiary company cannot implement the disposal in terms of section 112(2) without the approval of the special resolutions in accordance with section 115.


Section 112 does not create any appraisal right. It contemplates approval by the adoption of special resolutions in accordance with section 115.[1] It is section 115 that establishes the requirement and creates the obligation to obtain the necessary special resolutions.


Section 115(8) then links to the appraisal relief in section 164. In terms of section 115(8), “the holder of any voting rights in a company is entitled to seek relief under section 164” if that person notified the company in advance of the intention to oppose “a special resolution contemplated in section 115”, was present at the shareholders’ meeting, and voted against the special resolution.


Section 115(2) contemplates the following shareholders’ meetings and special resolutions, in the context of a subsidiary company in a “group of companies” proposing a disposal of all or the greater part of its assets or undertaking (contemplated by section 112(2)):

First, at a disposing subsidiary company level, section 115(2)(a) requires a meeting of shareholders of the disposing subsidiary company to consider and adopt a special resolution approving the proposed disposal by the subsidiary company (of all or the greater part of the assets or undertaking of the subsidiary company).


Second, at a holding company level, section 115(2)(b) requires a meeting of shareholders of a holding company (in relation to that subsidiary company) to consider and adopt a special resolution approving the disposal by the subsidiary company, where such disposal by the subsidiary company, having regard to the consolidated financial statements of the holding company, constitutes a disposal of all or a greater part of the assets or undertaking of that holding company.


It is possible in terms of section 115(2) that a special resolution of the shareholders of an intermediate holding company is required, but not of the ultimate holding company, having regard to the respective consolidated financial statements of the intermediate holding company and ultimate holding company and consideration of whether the disposal by the disposing subsidiary company constitutes a disposal of all or a greater part of the assets or undertaking of the applicable intermediate holding company but not of the ultimate holding company.


The respective minority shareholders in the disposing subsidiary company and applicable holding company, in question, who disagree with the special resolution to dispose of all or a greater part of the assets or undertaking by the subsidiary company (which also constitutes a disposal of all or a greater part of the assets or undertaking of the applicable holding company), and follow all the applicable procedural steps, including objecting to the special resolution before the shareholders’ meeting called to adopt the resolution, attending the meeting and voting against the special resolution in question, may then surrender all their shares in the company in question and demand that the company in question make an offer to them to pay them the fair value of all of the shares of the company held by that shareholder.


The respective dissenting minority shareholders in the disposing subsidiary company and the applicable holding company are thus each given an option to cash in at the respective fair value of their shares and exit the subsidiary company and/or applicable holding company.


Deemed disposal by the holding company

Reading section 115(2)(b) together with section 112(2), it appears that although the holding company does not itself actually dispose of any asset or undertaking, section 115(2)(b) deems the disposal by the subsidiary to “constitute a disposal by the holding company of all or a greater part of the assets or undertaking of the holding company”.


Such a deemed disposal by the holding company, is a disposal which on its own would require approval by way of a special resolution of shareholders of the holding company in terms of section 112(2).


In effect, the holding company is then, by virtue of the subsidiary company entering into the disposal contemplated by section 112(2), itself in terms of section 115(2)(b) also regarded as if it is also entering into a disposal contemplated by section 112(2).


Section 164(2) requires the notice of the meeting of shareholders of the subsidiary company and the notice of the meeting of shareholders of the holding company, respectively, to include a statement informing the applicable shareholders of their appraisal rights under section 164 (against the subsidiary company and against the holding company, as the case may be).


It follows that (i) dissenting minority shareholders in the subsidiary company could exercise their option to surrender all their shares and exit the subsidiary company, at fair value of shares in the subsidiary company, and (ii) dissenting minority shareholders in the holding company could exercise their option to surrender all their shares and exit the holding company, at fair value of the shares in the holding company.


The Cilliers case

The interpretation of section 115(8), having regard to its purpose and context (including textual context), was considered in Cilliers v La Concorde Holdings Limited and others[1] (the “Cilliers case”).


In the Cilliers’ case, the wholly-owned subsidiary (KWV SA (Pty) Ltd) of a holding company (La Concorde Holdings Ltd), entered into an agreement to dispose of its business to a third party. Both the subsidiary company and the holding company accordingly called meetings of their respective shareholders and requested approval by special resolution, as required by section 112(2) read with section 115(2).


Dissenting minority shareholders in the holding company (Cilliers and others) objected to the special resolution, attended the meeting of shareholders of the holding company, and voted against the special resolution. They then exercised their appraisal rights and demanded the company make them an offer to pay them the fair value of their shares in the holding company.


The holding company initially represented to its shareholders in the circular and notice calling the meeting, and in its offer to the dissenting minority shareholders to acquire their shares at an offered fair value, that section 164 appraisal rights were available to them.[2]


However, when the dissenting shareholders subsequently rejected the holding company’s written offer and brought their application to court requesting the court to appoint appraisers to assist the court to determine the fair value of their shares, the holding company only then in the court application changed its mind, arguing in a preliminary point that in terms of section 115(8) appraisal rights are only available to shareholders in the disposing subsidiary company, and are not available to shareholders in the non-disposing holding company.


In this preliminary point, the holding company asked the court to interpret the words in section 115(8) that “the holder of any voting rights in a company” can seek relief under section 164 restrictively to mean that only “the holder of any voting rights in the subsidiary company” can seek relief under section 164.


The holding company argued that one has to read section 115(8) in context, and that includes textual context. Therefore, section 115(8) had to be read in the context (and textual context) of section 164(5)(b) and section 164(2) which give rise to the appraisal remedy, read with section 112(2) which probits a company from disposing of all or the greater part of its assets or undertaking, where the references to ‘the shareholders’ and the ‘company’ in these sections must be to the shareholders in the subsidiary company.


The restrictive interpretation contended for by the holding company in its about-turn on this aspect goes as follows: As section 164(5)(b), which creates the appraisal right, provides that “a shareholder may demand that the company pay the shareholder the fair value for all the shares of the company held by that person if – the company has adopted the resolution contemplated in” subsection 164(2), and as the company that must adopt the resolution in subsection 164(2) is the disposing subsidiary company (as this is the company that must in terms of subsection 164(2) notify its shareholders of a meeting to consider adopting a resolution to “enter into a transaction contemplated in section 112, 113 or 114”), and as section 112 only prohibits a company from disposing of all or a greater part of the assets of that company unless “the disposal has been approved by a special resolution of the shareholders, in accordance with section 115”, it follows, according to the holding company, that the reference to the shareholders in section 115(8) who are entitled to seek relief under section 164 should be restricted to and mean the shareholders of the disposing subsidiary company (referenced to in section 164(5), section 164(2) and section 112).


The court rejected this restrictive interpretation. Relying on the modern approach to the interpretation of documents in Natal Joint Municipal Pension Fund v Endumeni Municipality[2](“Endumeni”), the court considered the context, purpose, and background of the Companies Act and the plain language of “the holder of any voting rights in a company” in section 115(8), and the related sections 112, 115, and 164, and held that the wording is clear, unambiguous and is not limited as contended for by the holding company.


The court reasoned that section 112 (which sets out the requirements to be met before a company may dispose of all or the greater part of its assets or undertaking) is clearly subject to the provisions of section 115(2)(b) which “creates a requirement and establishes an obligation” for shareholders in the disposing company’s holding company to consider a special resolution to enter into a disposal contemplated by section 112, if, having regard to the consolidated financial statements of that holding company, the disposal by the subsidiary constitutes a disposal of all or the greater part of the assets or undertaking of that holding company. Once this requirement in section 115(2)(b) is triggered, the court held, the shareholders of the holding company have the right to vote on the matter, and the moment the shareholders of the holding company are given notice of the meeting to be held to consider adopting a resolution to enter into a transaction in terms of section 112, the appraisal rights in terms of section 164 are triggered by section 164(2).


The court held that sections 112, 113, 114, 115, and 164 of the Companies Act (which regulate fundamental transactions) “are interrelated, in the sense that they refer to each other in cascading sequence”. Relying on inter alia Prof. Yeats’ journal article, the court noted that “to treat the dissenting shareholder in the holding company any differently in the circumstances of this case, would undermine the clear purpose of minority shareholder protection embodied in the policy and the Companies Act …” and that “the disposal of the assets of the subsidiary in this context, will have a material effect on the investment of the shareholders in the holding company”.


Accordingly, the court found that minority shareholders on both levels – the subsidiary and holding company level – are entitled to exercise the appraisal rights.


Conclusion

The appraisal remedy is indeed novel in South Africa and provides welcome alternative relief to dissenting minority shareholders otherwise trapped in a disposing subsidiary company or in an intermediate or ultimate holding company, within applicable sets of “groups of companies” in relation to that subsidiary company.


The courts are interpreting the provisions of section 164 in a manner that enhances and promotes the rights of dissenting minority shareholders, and attempts to persuade a court to interpret these provisions restrictively and avoid the exit and cost implications of the appraisal remedy will likely fail, as they did in the Cilliers’ case.


When structuring or restructuring “groups of companies”, including planning for future disposals, careful consideration will need to be given to the dissenting minority shareholder exit provisions and cost implications contemplated by the appraisal remedy.


Time will tell if the effect of the appraisal remedy and its cost implications has any adverse outcome on the efficient disposals and acquisitions of assets and undertakings in the market.


Minority shareholders of companies at all levels within a “group of companies” will need to stay alert as always to possible dissipation of value of their respective investment in the applicable group by ‘under the radar’ structuring and disposals (that is, activities that do not trigger the requirement of a special resolution of shareholders of any company in the applicable group, and thus do not trigger the protection of the statutory appraisal remedy).


Red-flags for shareholders could include evidence of multiple disposals of ‘non-core’ assets over some time by one or more companies in the group, each of which on its own does not trigger the requirement for a section 112(2) special resolution, or a section 115(2)(a) special resolution, or a section 115(2)(b) special resolution, but when considered as a ‘series of disposals’ contemplated by section 115(1) might well do so. Clues for shareholders of attempted ‘under the radar’ activities might be gleaned from a careful study of publicly available information and/or the financial statements provided by companies in the group to their respective shareholders.



 

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