In recent years, the capital market has witnessed more and more corporate control contests over listed companies. Many listed companies took a bad turn as the majority of shareholders lost control over their companies.
Corporate control is an important focus of governance of a listed company. As the economic benefits are enormous, the relationship of shareholders is complicated, and the securities regulator, stock exchanges, people’s courts and other administrative and judicial authorities may be involved; the corporate control contest over a listed company is both time-consuming and laborious, and can be protracted for long periods of time. It is not easy for a listed company to defend itself against the “savage” (the hostile buyer) that is amply supported with funds and professionals.
Based on practical experience in corporate control contests over listed companies, the author offers advice on how a listed company should consolidate its control from two aspects.
‘Black and white’ means
The so-called “white means” refers to the “white knight”. When a listed company becomes the target of a “savage”, the majority shareholder will seek a merger with a “friendly” company to defend the company against a hostile takeover. For example, in the equity contest of Livzon Pharmaceutical Group, Shenzhen Tai Tai Pharmaceutical was its “white knight”, which bought the outstanding A shares and B shares through the secondary market and acquired corporate shares by agreement to become the actual controller of Livzon.
On the one hand, the acquisition prevented the takeover of Livzon by the unfriendly Topsun Science and Technology. Moreover, the acquisition formed a strong synergy between Tai Tai Pharmaceutical and Livzon, as the former was in need of prescription drugs of a famous brand and sales channels, and the latter was in need of Tai Tai’s way of management to improve its overall quality and competitiveness.
The so-called “black means” refers to a “poison pill”, which was invented by Martin Lipton, an American M&A lawyer, in 1982. For the company that plans to use the “poison pill”, its board of directors first adopts a share dilution arrangement, which would become effective once the hostile buyer acquires a certain ratio of shares (generally 10% to 20%). This arrangement enables the original shareholders to buy in a large number of shares at a low price and increases the cost of takeover for the hostile buyer.
On 18 February 2005, SDO and its affiliates filed a schedule 13-D with the US Securities and Exchange Commission (SEC) to disclose that it had owned 19.5% of the outstanding common shares in Sina. Sina then launched a “poison pill”. At that time, the stock price of Sina.com was about US$35. The “poison pill” arrangement entitled shareholders of the remaining 80.5% of outstanding common shares to purchase additional shares issued at US$15. In this way, the shareholding ratio of SDO soon dropped below 20%, unless it invested more to acquire more shares. As a result, the “poison pill” deterred SDO, and Sina.com won the battle against the takeover.
Equal focus on ‘two boards’
For a listed company, “two boards” refers to its board of directors and board of supervisors. Generally, when the “savage” holds a dominant ratio of shares, it will propose an extraordinary general meeting to dismiss all former directors and supervisors, and nominate its own candidates for directors and supervisors. From previous experience, the author notes that majority shareholders of many listed companies will mess up in the face of such a situation.
They will choose to negotiate with minority shareholders, and even give up a few seats on the board of directors. The minority shareholders, however, may not be content, and they may target taking over the whole company. Once the majority shareholder has less seats on the board of directors than the quorum, an extraordinary general meeting will be held, putting the majority shareholder in a more difficult position.
The author advises that, first, the majority shareholder should respond positively, and take its stand through the board of directors, that the members of both the board of directors and board of supervisors perform their duties with due diligence and shall not be removed from their posts without proper cause as per the articles of association.
Second, the company should make full use of laws and regulations, and the rules for listed companies, to defer the extraordinary general meeting and increase the risks that the “savage” will face in the capital market in all aspects (e.g., the risk of loss). Finally, the majority shareholder should hold on to win the contest for corporate control.
Take *ST Gong Da High-tech for example. This listed company received a request from 22 minority shareholders for convening an extraordinary general meeting on 28 February 2018. These shareholders proposed to remove a majority of directors, independent directors and supervisors.
The board of directors vetoed the request but the board of supervisors agreed to convene an extraordinary general meeting. On 23 April 2018, when the two-month limit was about to expire, the board of supervisors decided to defer the extraordinary meeting due to whistle-blowing from the majority shareholders that some shareholders who proposed the extraordinary general meeting had violated laws and regulations by failing to disclose the action-in-concert relationship that should be disclosed, and were suspected of short-swing trading.
These shareholders were handed over to the regulator and judicial authority for investigation. If the extraordinary general meeting had been held as scheduled, the interests of extensive shareholders would have been damaged. On 29 May 2018, the minority shareholders irrevocably withdrew their proposal for an extraordinary general meeting, and the meeting was cancelled. In this way, the majority shareholders of *ST Gong Da High-tech successfully protected their seats on the board of directors and the board of supervisors.
In most cases of corporate control contests, majority shareholders restrict the rights of the minority shareholders on the ground that the latter fail to disclose the action-in-concert relationship that should be disclosed, and are suspected of short-swing trading. In recent years, the regulator has intensified regulations on “masked bidder”, “secret change of ownership”, tender offer, and other illegal behaviours in corporate control contests. These regulations enhance the effect of the above means for corporate control contests.
Liang Zhendong is a partner at Grandway Law Offices