One of the key features that the Companies Act, No 71 of 2008 (Companies Act) introduced when it came into force in May 2011 is the substantially revised and simplified process for the implementation of a scheme of arrangement between a company and its shareholders (or other securities holders), in s114 of the Companies Act.
A scheme of arrangement is probably the most popular method utilised in practice to effect a takeover of a public, especially listed, company with a great number of shareholders, as the essence of a scheme is that if the requisite majority of votes can be obtained by way of a special resolution, the whole class of shareholders is bound by that arrangement and is thereby expropriated whether or not they voted in favour thereof. S311 of the previous Companies Act, No 61 of 1973 dealt with schemes of arrangement and entailed a meeting of shareholders and a strictly court-sanctioned process. The new scheme process does away with the requirement for a court order approving the scheme (unless dissenting shareholders compel a court review of the special resolution under s115(3)), and has replaced same with the requirement that an independent expert's report be prepared and circulated to the holders of the company's securities.
S114 provides that unless it is in liquidation or in the course of business rescue proceedings, the board of a company may propose any arrangement between the company and the holders of any class of its securities by way of a range of methods, namely:
- a consolidation of securities of different classes;
- a division of securities into different classes;
- an expropriation of securities from the holders;
- exchanging any of its securities for other securities;
- a re-acquisition by the company of its securities; or
- a combination of the methods contemplated above.
The scheme must be approved by a special resolution at a general meeting under s115, and the notice convening the meeting would typically include the expert's report.
The independent expert would typically be a merchant bank or audit firm or other such institution that has the requisite expertise to opine on the financial effects, and fairness and reasonableness, of the proposed scheme. An interesting question which arises in this context is, what are such experts' potential liability and duties in respect of the report which they prepare and which is submitted to the shareholders? A recent March 2014 case in the Court of Chancery of the US state of Delaware has made some noteworthy points in this regard (In re Rural Metro Corporation Stockholders Litigation, CA No. 6350-VCL (Del. Ch. Mar. 07, 2014)). Given that the Companies Act has shown some leanings towards US law (particularly in the context of fundamental transactions), these principles may be very relevant and applicable in South Africa should a similar legal question find itself before our courts under the still relatively new and untested s114. The case specifically dealt with the expert's duty to avoid a conflict of interest and to provide truly independent and objective advice.
In the Rural Metro case, the court reviewed the validity of a 2011 merger between Rural Metro Corporation (Rural) and a company within the Warburg Pincus LLC group (WP). The plaintiffs (shareholders of Rural) contended that Rural's board of directors breached its fiduciary duties by approving the merger and failing to make material disclosures in its notice to shareholders (a 'proxy statement' as known in the US). They also claimed that RBC Capital Markets LLC (RBC), which acted as the financial advisor to the Rural board, aided and abetted the directors' breaches of fiduciary duties. Although the Rural board settled before the trial, the case proceeded against RBC as the financial advisors.
Before addressing the liability of RBC at trial, the court discussed the duties, role and responsibilities of financial advisors in the course and context of mergers and acquisitions, and the importance of holding them liable for aiding and abetting breaches of fiduciary duties. The court likened the role of the advisors to 'gatekeepers', and stated: "The threat of liability helps incentivize gatekeepers to provide sound advice, monitor clients, and deter client wrongs... [T]he prospect of aiding and abetting liability for investment banks who induce boards of directors to breach their duty of care creates a powerful financial reason for banks to provide meaningful fairness opinions and to advise boards in a manner that ensures directors carry out their fiduciary duties..." If a case were brought against an independent expert under the general principles of the South African law of delict, considerations such as these would undoubtedly be used in support of an argument that it is apt and reasonable to place a legal duty on the independent expert to provide a sound and objective opinion, failing which the expert should be held liable to shareholders for damages.
Accepting the existence of this fiduciary duty, the court found that RBC ignored multiple conflicts of interest in negotiating with WP on behalf of Rural. Specifically, the court found that while RBC was negotiating with WP, it was simultaneously trying to secure a role as financier of the acquisition, a fact it failed to reveal to Rural's board. More egregiously, the court found that at the same time RBC was attempting to convince WP to use its financing to make the acquisition, it was also revising its valuation of Rural downward. In other words, RBC, motivated by an opportunity to participate in the financing of the deal, intentionally and covertly made WP's bid look more appealing than it actually was by purposely undervaluing the company. Because these materially false valuations were included in the proxy statement, but not revealed to the Rural board, the court held that RBC prevented the Rural board from fulfilling its obligation to get the best price for its shareholders.
With the breach of duty established, the question then turned to the appropriate remedy and measure of damages to be claimed from RBC. However, at this stage of the trial the court did not have enough information regarding the fair value of the Rural shares, and ordered the parties to make submissions in that regard at a future hearing in order for the court to be in a position to quantify damages. In the South African law of delictual damages, for instance, the measure of damages awarded is calculated (subject to a number of qualifications and nuances) by comparing the present financial/ pecuniary position of the plaintiff, to the position in which he would have been had the damage-causing event (breach of duty) not occurred.
Companies that undertake schemes of arrangement, and particularly the experts they retain for this purpose, should take note of developments like this in the law pertaining to their potential liability to shareholders. The Rural Metro case is one of a number of interesting examples from abroad which may have some influence on our local laws.