ASIC has recently expressed concern about transactions involving an investor subscribing for shares in a public company being granted certain veto rights in relation to key business decisions of the company (sometimes also known as ‘reserved matters’).
Requests for these kinds of rights may be put forward by sophisticated investors who wish to have a say in the future direction of the investee company or a level of influence in relation to matters which could impact their exit from the investment (these investments are sometimes known as private investments in public equities, or PIPEs). The rights in question can relate to operational, financing or strategic matters that would otherwise normally be within the domain of the investee company’s board.
ASIC’s concern arises from Australian takeover law, which strictly regulates the acquisition of control of Australian public companies. Amongst other things, the objectives of Australian takeover law include that:
- the acquisition of control of a public company should take place in an efficient, competitive and informed market; and
- all shareholders in a public company should have a reasonable and equal opportunity to participate in any benefits accruing through a proposal under which a person acquires a substantial interest in a company.
These objectives underpin a statutory regime under which a person must not obtain an interest in more than 20% of a public company’s voting shares, unless via prescribed “gateways”, such as a regulated takeover bid.
Against this background, ASIC’s concern is that the grant of contractual veto rights can have the potential to deliver effective control of a company to an investor outside the scope of the ‘gateways’, or that the existence of veto rights may deter the making of control proposals for the company by other parties (ie, they could have a “chilling” effect on the market for control of a company which would be contrary to the “efficient, competitive and informed market” objective referred to above).
Despite ASIC’s concerns, no Takeovers Panel proceedings were commenced in the last 12 months in relation to the veto powers of a minority shareholder obtained through a PIPE investment.
There should still be scope under Australian law for investors to seek a proportionate level of veto rights
ASIC’s comments refer to “disproportionate” veto rights which have the potential to deliver “effective control” of a public company. This would appear to recognise that this issue is a matter of degree rather than a per se concern with veto rights.
First, while at one end of spectrum veto rights may be so extensive as to deliver effective control to an investor, there is scope for a range of veto rights that are reasonably proportionate to the underlying transaction to provide protection to the investor. These proportionate rights would not in any real sense deliver “effective control” of a company. For example, carefully negotiated requirements in relation to the conduct of a clinical trial imposed by a specialist biotech investor which has made a significant equity investment to fund the trial.
Second, ASIC acknowledges the common use of broad veto rights in debt arrangements. Generally, such rights are directed to protecting the financier’s interest in being repaid (and not in gaining control of the company) and are extinguished on the repayment or refinancing of the debt. The same approach could be applied in a PIPE investment which is structured as an issue of convertible debt securities, with any veto rights falling away on conversion of the debt securities into equity. Alternatively, veto rights could be negotiated to cease after a certain time period has elapsed or certain reasonably proximate events have occurred.
Third, ASIC refers to the possibility of seeking approval of veto rights by the investee company’s disinterested shareholders. ASIC’s position on the effectiveness of shareholder approval is tentative. ASIC indicates that it would be concerned if the overall arrangements of which veto rights form a part could have the effect of coercing disinterested shareholders to approve the veto rights. ASIC gives the example of where a financially distressed company seeks approval of veto rights in circumstances where that approval is inter-conditional with other material aspects of a financing transaction – in those circumstances ASIC queries the effectiveness of shareholder approval given that shareholders may have little option but to accede to the veto requirements. ASIC has also previously expressed concern about the ability of shareholders to approve certain open-ended or long duration matters that may impact control of their company (such as a convertible security with a long exercise period).
While these concerns would need to be considered carefully in any given case, we do not believe that they rule out investors from seeking shareholder approval, especially given that the Corporations Act clearly contemplates that shareholder approval is a permitted ‘gateway’ under Australian takeover law.
Other potentially relevant considerations
It is also important that an investee company follow an appropriate process when negotiating PIPE-type investments, including:
- being able to show a need for funds;
- appropriate consideration of any alternative funding options and a rational business decision to proceed with a PIPE investment;
- obtaining independent advice;
- being alert to, complying with applicable legal requirements, and potentially being more cautious where the investor is a related party of the company or already a significant shareholder; and
- making appropriate market disclosures about the terms of the investment.
While taking these steps will not of itself be determinative, they can nonetheless assist in demonstrating the overall appropriateness of an investment transaction.