During the Asian financial crisis of the late nineties, Malaysian banks were faced with a high level of non-performing loans and there were a large number of distressed companies. A drastic measure was needed in the form of Pengurusan Danaharta Nasional Berhad and Pengurusan Danamodal Nasional Berhad. These vehicles were established with the aim of recapitalising the banking sector and to manage distressed assets so as to provide for an orderly sale of assets owned by distressed companies. The latter was achieved by the appointment of special administrators over distressed companies who were given extensive powers and the effect of an appointment was to impose a moratorium on debt repayment and legal proceedings against the distressed company so that an orderly sale could be achieved.
The sub-prime crisis
The sub-prime crisis finds Malaysia in a different situation. Malaysian banks have since merged into larger institutions, imposed more prudent lending policies and appear to be adequately capitalised at the commencement of this crisis. The environment going forward for Malaysia is not likely to comprise a large number of distressed companies as seen in the late 1990s. However, the reluctance of banks to lend may limit the types of transactions.
Disposals of non-core investments in Malaysia by foreign investors to repatriate funds to their home countries may become more commonplace, whether as a means to stave off insolvency or as a result of insolvency of the foreign investors in their home countries. Such a situation produces sellers. On another level, the economic downturn is likely to produce opportunities for cash-rich majority shareholders of public-listed companies to take advantage of depressed share prices to privatise listed companies. Such a situation encourages buying.
Shareholder exit without selling shares
A great number of investments are held in the form of shares of private limited companies. Shares may be disposed of without actually entering into an agreement to sell them. A typical situation is where a shareholder would like to exit a company but the other shareholders are reluctant or do not have the means to buy his shares.
Cash-rich company
Where a company is cash rich, it is possible to utilise the cash available to the company to enable a shareholder (X) to exit under certain conditions.
A selective capital reduction can be contemplated. A selective capital reduction is a proposal by the company to enable one or a group of shareholders' shares to be cancelled effectively, removing that shareholder from the company. The proposal will require court confirmation before it can be implemented. This is not a case of one shareholder buying out another shareholder because it is a proposal moving from the company. No offer moves from one shareholder to another.
A typical constraint on this type of proposal is that the cancellation of an RM1.00 ($0.3) par-value share held by X will only result in RM1.00 payable to X. So, for example, if X holds 1 million RM1.00 shares, a cancellation of the 1 million shares will only produce a return of RM1 million to X. This may of course not be the exit price that X could be agreeable to.
Payment of a consideration beyond par value
Where the company has sufficient cash to implement the selective capital reduction but the cancellation of the shares of the exiting shareholder only will not produce the required consideration payable on exit, two possible approaches may be explored.
If the company has sufficient reserves, an amount being the premium to the par value that X would receive for his agreement to exit the company may be capitalised. Capitalisation of reserves involves issuing the number of shares equal to the value of the premium to be received by X. The bonus shares should be issued only to X (and the other shareholders waiving their right to receive the bonus shares) and the original shares held by X, together with the bonus shares, can then be cancelled so that the total amount of share capital cancelled is equal to the consideration payable to X.
In a second situation, let us say the company has sufficient cash but insufficient reserves. The possible exit of X is not necessarily at a dead end. Let us say the company has three shareholders, and a total paid-up capital of RM3 million represented by 3 million RM1.00 fully paid-up shares. It is possible to consider cancelling the shares of some of the shareholders who are proposing to remain, while maintaining their relative equity holding in the company to ensure that the amount of shares cancelled is equal to the consideration payable to X. In this case, say all parties agree that X may be allowed to exit at RM1.50 a share. What has to be done is to cancel 1 million shares held by X, and another 500,000 shares of the other two shareholders, ratably. The other two shareholders will then waive their right to receive the capital arising from a cancellation of their shares, which would otherwise be returnable to them. What is left is 1.5 million shares of RM1.00 each held by the two remainder shareholders.
Company with insufficient cash
Let us consider a situation where a shareholder (Y) wishes to dispose of some or all of his shares in a company that has cash but the amount is insufficient to entirely fund an exit for Y and also to carry on business as a going concern. The other shareholders are reluctant or do not have the means to buy his shares.
Let us suppose the company has sufficient reserves that may be capitalised for the benefit of Y but insufficient cash to pay Y and also to continue business. There are several options. First, Y is allowed to partially exit: that is, to the extent permitted by the cash holdings of the company. However, if the company is in a position to provide a consideration other than cash, such as marketable securities, such securities are distributable in specie to the exiting shareholder. Secondly, if it is intended to let Y exit completely, the entire shortfall may have to be provided by another shareholder, or a third party. The shortfall would have to be injected in the form of a loan or through a subscription of shares. Alternatively, a profitable company may be in a better position to borrow against its assets to fund a shareholder exit compared to a shareholder borrowing to buy over the shares of an outgoing shareholder. Thirdly, since there are sufficient reserves, the payment of Y in instalments may be explored and can be appropriately worded in the capital reduction resolution.
Where the company does not have sufficient reserves that may be capitalised for the benefit of Y and also does not have sufficient cash to enable Y to exit completely, it will generally be difficult to structure an exit for Y unless the remainder shareholders are willing to come in and lend money to the company, while agreeing to release the company from the debt so that the company may capitalise the profits arising from the release as bonus shares to Y, which are then cancelled. This of course is equivalent to a purchase. A possible advantage here relates to stamp duty savings, as there is no acquisition of shares by the remainder shareholders, which would be subjected to stamp duty.
General considerations for capital reductions
A selective capital reduction is not necessarily suitable for all transactions to allow a shareholder to exit. In all situations where a repayment of capital is contemplated, there is always the need to ensure that creditors of the company will not be prejudiced by the exit of a shareholder, since the a shareholder is receiving his return before creditors. Creditors' interests are usually protected by either setting aside sufficient funds to ensure that they will be repaid in full or their consent is obtained. In the latter situation, the strength of the company and its relationship with its creditors will bear heavily on whether the creditors are supportive of the exit of a shareholder funded by the company.
A capital reduction should not be used to reduce the capital base of the company to a level that makes creditors nervous. The exact number of shares proposed to be cancelled should be made absolutely certain, as this will have to be inserted into the court order confirming the capital reduction. This will facilitate the calculation of whether there are sufficient reserves to implement the proposal.
All approvals and consents, regulatory or otherwise, will have to be obtained. These approvals and consents should be addressed at the inception of the proposal to determine whether they can be feasibly obtained. Where the company is a public-listed company, it will be necessary to determine if there are elements of the privatisation proposal that require a submission to be made to the securities commission.
Acquisition of business units
There may be situations where an acquiror may wish only to acquire a business unit, but not all of the shares owned by the exiting shareholder in the company. Let us consider a company with two business units, A and B. Say shareholder D wishes to exit but the company has insufficient cash. Shareholder E is not willing to pay D to acquire a company with business units A and B but he is willing to buy business unit A from the company and exit the company. The company is then left with cash that shareholder D can have access to. This may be achievable with a combination of a scheme of arrangement and a capital reduction.
A scheme of arrangement can be used to implement a clean hive-off of business unit A, ensuring that liabilities and litigation connected to business unit A are removed, leaving business unit B in the company.
The terms of such a scheme would conceivably involve the following: (i) to transfer business unit A to shareholder E in return for a purchase consideration payable to the company (and to capitalise any profits that may arise therefrom); (ii) to reduce the (enlarged) issued and paid-up capital of the company held by E; (iii) shareholder E would waive any rights he may have to a return of capital under the capital reduction; and (iv) the credit arising from the capital that is reduced can be applied to pay D.
A members' scheme is required as the scheme proposed must affect the rights and liabilities of members in their capacity as members. First, an order must be obtained from the court to convene a meeting to approve the scheme. The necessary shareholders' meetings would also be convened to approve the capital reduction and such other resolution as may be required to ensure the transaction can be implemented. After the scheme meeting, an application is made to the court to sanction the scheme and also to seek the necessary orders to vest business unit A to shareholder E.
The advantage of this method is that the transfer of liabilities relating to business unit A can be achieved, which would otherwise be difficult to achieve under a normal sale and purchase agreement. The need for court sanction may prove to be a drawback if the court is only prepared to sanction the scheme by imposing conditions that may not be beneficial to shareholder E.
The future of privatising listed companies
Economic downturns can place severe pressure on share prices. However, low share prices present an unusual opportunity for a majority shareholder to buy up the shares it does not already own in a profitable listed company at a lower price, with the aim of privatising it. There are various arguments as to the benefits of privatisation activity that will not be canvassed here.
Although the term buy-up was used above, the more popular methods of taking a listed company private in Malaysia thus far entails implementing a selective capital reduction or a scheme of arrangement (coupled with a capital reduction). These alternative methods do not involve buying shares. Less popular is making a takeover offer as a means to achieving privatisation.
The securities commission has recently indicated that it does not favour the use of selective capital reductions and schemes of arrangements to privatise listed companies if the majority shareholder does not already own at least more than 50% of the issued shares of the target. The implications of this stand will be explored by making a comparison of the different approaches in relation to a major shareholder owning less than 50% of the issued shares.
The popularity of non-takeover offer approaches is explainable. For the non-takeover approaches, meetings are used to determine whether a proposal for privatisation will succeed. A 75% majority in value of those present and voting is required (excluding the majority shareholder who is to remain) for a selective capital reduction and a majority of 75% in value and a simple majority in number of those present and voting (excluding the majority shareholder who is to remain) is required for a scheme. If the meeting results are favourable, the next step is to make a court application and the court would normally accede to the wishes of the shareholders if they approve the proposal with an overwhelming majority. In holding a meeting, shareholders who are disinterested in (but not necessarily against) the proposal effectively leave the decision to those who are prepared to attend the meeting.
Making a takeover offer on the other hand is usually a far less effective method of securing 100% of the shares in the target company as the offeror would need to receive acceptances to the offer amounting to 90% of the shares he does not own before he is able to invoke the compulsory acquisition procedure. Shareholders who are disinterested (but not necessarily against) the offer or are unable to accept the offer effectively object to the takeover offer. Shareholders who may not be in a position to accept offers include nominee shareholders who may not be able to receive the instructions of their numerous beneficiaries before the offer closes. It is therefore possible that the chances of success are lower if a privatisation is sought to be implemented by way of a takeover offer.
There are other advantages for using a selective reduction or scheme as opposed to a takeover offer. First, a potential acquiror will not need to acquire any shares if the shareholders defeat the privatisation proposal at the meeting. A takeover offer usually requires a condition that if the acceptances received allow the offeror to have more than 50% of the issued shares, the offer becomes unconditional and the offeror ends up having to pay for an additional stake but the minority shareholders are not eliminated. The second advantage is that some of the funds required to pay minority shareholders can come from the company. Financing a takeover offer may be more difficult where the offeror has no assets to charge or is reluctant to charge its own assets. The third advantage is that financiers will be less averse to lending to the target company, where it can take a charge over its (income producing) assets. The shares of a target company are less attractive as security as it will become illiquid if the privatisation exercise is successful and the repayment of a loan out of a dividend stream is often considered a more risky proposition to the financier.
The case for using the scheme or selective capital reduction approach to privatise listed companies is more compelling than for making a takeover offer. Two possible motivations for the securities commission's stand can be offered. The first is that the existing Malaysian Code on Takeovers and Mergers (Code) would not require the undertaking of a compulsory acquisition where the main shareholder already owns more than 50% of the issued shares. The second is possibly that fees can be earned by the securities commission for clearance of an offer document that is RM10,000 plus 0.05% of the offer value. A selective capital reduction or a scheme of arrangement, on the other hand, are not of themselves proposals, which requires the making of a submission to the securities commission and hence no fees for submissions of proposals are incurred.
Even if the securities commission is prepared to allow a condition that a takeover offer (for the purpose of achieving privatisation) can only become unconditional if acceptances of not less than 90% of the shares that are not owned by the offeror is received (hence there is no need to buy up shares if acceptance merely allows the majority shareholder to have more than 50% of the issued shares), it is questionable whether such a relaxation can really encourage privatisation activity. The prospect of receiving acceptances of not less than 90% of the shares not already owned by the offeror is an uphill one at best and this alone may make it difficult for potential offerors (who own less than 50% of the issued shares) to justify incurring costs for such an exercise.
It is arguable that there is at present no legal obligation for a majority shareholder who owns less than 50% of the issued shares of a listed company to make a voluntary takeover offer for privatising a listed company as a majority shareholder who seeks to privatise by way of a selective capital reduction (and a scheme in some cases) is not an acquiror because he does not engage in an acquisition of shares. The securities commission has certainly not challenged any privatisation proposal in court or directed the taking out of a mandatory offer where the majority shareholder owns less than 50% of the shares. This position may soon change as the securities commission has indicated that a new code for takeovers and mergers is in the pipeline and it is expected to curtail, if not prohibit, methods of privatisation other than by way of making takeover offers.
In the final analysis, shareholders are likely to be the real losers because selective capital reductions and schemes of arrangement as a means of privatising listed companies may only be reserved for companies where the majority already owns more than 50% of the shares significantly reducing the number of listed companies that can be taken private.
| Author biography |
Mak Lin Kum
Kadir Andri & Partners
Mak Lin Kum is a partner of Kadir Andri & Partners in Malaysia. His practice area is insolvency and restructuring and his work covers mainly corporate insolvency, corporate governance, shareholder disputes, financial reporting issues, capital reductions, corporate restructuring and related areas.
Lin Kum graduated with a Bachelor of Commerce (Hons) (accounting and finance) and Bachelor of Laws (Hons) from Monash University, Australia. His work is mainly court-based and he has recently worked on some of Malaysia's larger and more complex restructurings, including the merger of Sime Darby Berhad, Kumpulan Guthrie Berhad and Golden Hope Plantations Berhad, the privatisation of Magnum Corporation Berhad and the privatisation of UEM World Berhad. His other restructuring work includes the post-merger rationalisation of banking groups such as the absorption of Southern Bank Berhad into the CIMB Group. His work on corporate insolvency covers fraud investigations, priority disputes, appointments of receivers and managers, winding-up of companies, issues in receiverships and liquidations, schemes of arrangements for the compromise and settlement of debts, and taking out and resisting various applications in court, including injunctions and other interim relief for the preservation of property. |