Hong Kong SFC proposes changes to the Takeovers Code

The consultation paper, published on 19 May 2023, aims to update the Codes to reflect the SFC’s current practice, to clarify and streamline certain provisions, and to introduce green initiatives (the Consultation Paper).

Key proposed changes

“Put Up or Shut Up” order

Expressly empowering the SFC to require a potential offeror to, within a specified time period, announce: (a) its firm intention to make an offer (i.e. to “put up”); or (b) that it will no longer proceed with an offer (i.e. to “shut up”).

Irrevocable undertakings

Consultation with the SFC is not required before an offeror approaches a shareholder with a “material interest” in an offeree company. A shareholder has a “material interest” in an offeree company if such shareholder (together with any concert party) controls, directly or indirectly, at least 5% of the voting rights. The maximum number of shareholders an offeror can approach in an offer is six (regardless of whether such shareholders have a “material interest”).

Form of the meeting required to approve a scheme or delisting

In light of the decisions of the High Court in Re Cosmos Machinery and Re Chong Hing Bank, making it clear that: (a) Rules 2.10 and 2.2 do not seek to prescribe the form of the meeting required to be held to approve a scheme and a delisting, respectively; and (b) the form of such meeting should be governed by the law of the jurisdiction of incorporation, and the constitutional document, of the offeree company.

Chain principle

Codifying existing practice pursuant to which: (a) the SFC will compare the total assets, net assets, gross profits, net profits and market capitalisations of the two companies; (b) no single item would, in itself, be determinative; and (c) in the event that the latest set of audited financial statements produces an anomalous result, the SFC will normally further assess at least the three most recent sets of audited financial statements.

Deduction of dividends from offer price

Codifying the effect of dividends on offer price such that, unless an offeror has specifically reserved the right to do so in a Rule 3.5 announcement, the offeror will not be permitted to deduct from the offer consideration any amount equivalent to any dividend which is subsequently paid or becomes payable by an offeree company.

“Put Up or Shut Up” prder (PUSU order)

Under the Codes, an offer period commences upon, among other things, the announcement of a possible offer.  Various requirements under the Codes apply to an offeree company as soon as an offer period commences. In particular:

• it is not allowed, without the approval of its shareholders, to enter into any contract otherwise than in the ordinary course of business, issue any share, grant any share option, or acquire or sell any asset of a material amount;
• a director is not allowed, without the consent of the SFC, to resign until, among other things, the first closing date of the offer; and
• it is required to publish an update on the progress of the possible offer on a monthly basis.

When Sinopec and ENN Energy made an unsolicited bid for China Gas in December 2011, China Gas was subject to an offer period, and was therefore required to comply with various requirements under the Codes, for nearly a year.  During such period, China Gas had to hold two special general meetings to seek the approval of its shareholders in order to exercise a pre-existing call option to acquire the remaining 51% of Panva Gas, appoint an executive director and make payment to the chairperson of the board of directors.

Given such requirements could have unintended consequences to the normal business operations of, and could be unduly burdensome to, an offeree company, an offeree company should not be put “under siege” for any longer than is reasonably necessary.

While the SFC has, upon applications by offeree companies, issued PUSU orders over the years, there is currently no expression provision in the Codes.

The proposed amendments will:

• expressly empower the SFC to, at any time following the announcement of a possible offer, require a potential offeror to, within a specified time period, announce either its firm intention to make an offer (i.e. to “put up”) or that it will no longer proceed with an offer (i.e. to “shut up”); and
• set out the key factors which the SFC may consider in deciding whether a time limit (and, if so, its length) should be imposed on a potential offeror (i.e. the duration of the offer period, the reasons for the potential offeror’s delay in issuing a firm intention announcement, the proposed offer timetable, any adverse effects that the offer period has had on the offeree company and the conduct of the parties to the offer).

Irrevocable undertakings

As deal certainty is critical to an offeror, it is common for an offeror to seek to obtain irrevocable undertakings from shareholders of an offeree company to accept an offer or vote in favour of a scheme. With a view to streamlining the process to obtain such undertakings, the SFC has reviewed its policy and proposes to amend the Codes such that:

• consultation with the SFC is not required before an offeror approaches a shareholder with a “material interest” in an offeree company (a shareholder has a “material interest” if such shareholder, together with any concert party, controls, directly or indirectly, at least 5% of the voting rights);
• consultation with the SFC is required before an offeror approaches a shareholder without a “material interest” in an offeree company; and
• the maximum number of shareholders an offeror can approach in an offer is six (regardless of whether such shareholders have a “material interest”).

Form of the meeting required to approve a scheme or delisting

Under Rule 2.10, a scheme of arrangement may only be implemented if:

• the scheme is approved by at least 75% of the votes attached to the disinterested shares that are cast at a duly convened meeting of the holders of the disinterested shares; and
• the number of votes cast against the scheme at such meeting is not more than 10% of the votes attaching to all disinterested shares.

In Re Cosmos Machinery, the High Court endorsed the “non-prohibition view”, pursuant to which an offeror and its concert parties are allowed to vote at a shareholders’ meeting held to consider a scheme of arrangement but their votes will not be counted for the purpose of satisfying Rule 2.10.

In Re Chong Hing Bank, however, the High Court favoured a different interpretation and adopted the “prohibition view”, pursuant to which an offeror and its concert parties are not allowed to vote at a shareholders’ meeting held to consider a scheme of arrangement.

In the view of the SFC, the different interpretations may be due to the reference to a “meeting of the holders of the disinterested shares” in Rule 2.10 as such reference may appear to require that:

• a meeting for the purpose of Rule 2.10 must be a meeting which is only attended by the holders of the disinterested shares; and
• a meeting which is attended by an offeror or any of its concert parties is not a “meeting of the holders of the disinterested shares” for the purpose of Rule 2.10.    

Similar issues arise in connection with Rule 2.2 which provides that a resolution to approve a delisting must be subject to, among other things, the approval by at least 75% of the votes attaching to the disinterested shares that are cast at a duly convened meeting of the holders of the disinterested shares.

Given the Codes are non-statutory in nature and are intended to work alongside (and not to override) the law of the jurisdiction of incorporation of an offeree company, the proposed amendments will make it clear that: (a) Rules 2.10 and 2.2 do not seek to prescribe the form of the meeting required to be held to approve a scheme and a delisting, respectively (by replacing the phrase “meeting of the holders of the disinterested shares” in each of Rule 2.10 and Rule 2.2 with the phrase “meeting of shareholders”); and (b) the form of such meeting should be governed by the law of the jurisdiction of incorporation, and the constitutional document, of the offeree company.

Chain principle

Under the chain principle set out in Note 8 to Rule 26.1:  

• a person may be required to make a mandatory general offer for a company (the offeree company) if, as a result of acquiring statutory control of another company (the first company), such person thereby acquires control of the offeree company because the first company holds 30% or more of the voting rights of the offeree company;
• the SFC would not normally require such person to make a mandatory general offer for the offeree company unless the holding in the offeree company is significant in relation to the first company; and
• in assessing whether the holding in the offeree company is significant in relation to the first company, the SFC would compare the assets and the profits of the two companies.

The Codes are, however, silent as to the appropriate line items (i.e. total assets or net assets and gross profits or net profits) in a financial statements, and the appropriate “look-back” period(s), to be used for such comparison.

The proposed amendments will make it clear that:

• the SFC will compare the total assets, net assets, gross profits, net profits and market capitalisations of the two companies;
• no single item would, in itself, be determinative; and
• in the event that the latest set of audited financial statements produces an anomalous result, the SFC will normally further assess at least the three most recent sets of audited financial statements.

Deduction of dividends from offer price

In a decision relating to Dalian Port, the Takeovers and Mergers Panel agreed that, unless an offeror has specifically reserved the right to do so in a Rule 3.5 announcement, the offeror will not be permitted to deduct from the offer consideration any amount equivalent to any dividend or other distribution which is subsequently paid or becomes payable by an offeree company. The SFC is also of the view that, where a dividend is subject to withholding tax, any such deduction from the offer consideration must be based on the gross amount received or receivable by the offeree company shareholders.  The proposed amendments codify such effect of dividends and withholding tax.

Please refer to the Consultation Paper for other proposals.

The SFC invites comments on the Consultation Paper by 23 June 2023, and will finalise the amendments after considering the feedback received.