Company response strategies

Preparation

What are the fiduciary duties of directors in the context of an activist proposal? Is there a different standard for considering an activist proposal compared to other board decisions?

The fiduciary duties of directors have been discussed in question 12. In particular, when considering all resolutions and proposals tabled in front of directors (whether they are an activist proposal or not), directors must act in good faith in the interest of the company, exercise their powers for proper purposes, must not enter into ultra vires transactions, and shall avoid conflict of interest.

It is not mandatory for directors to consider an activist proposal. The standard for considering an activist proposal is the same as other board decisions, namely reasonable care, skill and diligence (section 465 of the Companies Ordinance and Rule 3.08 of the Listing Rules). ‘Reasonable care, skill and diligence’ means the general knowledge and experience that is actually possessed by the director and that may reasonably be expected of a person carrying out the director’s functions.

What advice do you give companies to prepare for shareholder activism? Is shareholder activism and engagement a matter of heightened concern in the boardroom?

It is strongly suggested that the company shall follow the CG Code, in particular sections D.3 and E, in order to minimise the risk of facing shareholder activism.

A company may routinely review its shareholder engagement policy and regularly solicit feedbacks from shareholders on its corporate strategy and governance. A corporate governance guideline setting out the routes for the shareholders to provide feedbacks on its business operation could also be published for the sake of clarity.

A company may also enhance its transparency in its corporate decisions and management structure by publishing the guidelines or code of business conduct that it follows. As such, the activists will gain access to more information as to the company’s decision-making process and will take these information into account prior to instituting an activist campaign.

Regular strategic reviews should also be conducted. A company should regularly evaluate and compare its performance, cost structure, revenues, management structure and the independence and expertise of its directors, with its counterparts in order to discourage activist campaigns because of its underperformance.

Unusual trading of its stock shall also be closely monitored since the larger stakes held by shareholders, the more likely that they will become a shareholder activist and exercise their minority veto rights.

Companies should be open-minded towards an activist’s proposal and step into the shoes of an activist. A unilateral decision to ignore an activist may provoke the activist to start a campaign. An individual committee could be formed to analyse the activist’s proposal.

Nevertheless, the above are only general principles that a company may follow and shall be subject to the factual situation in each case.

Defences

What defences are available to companies to avoid being the target of shareholder activism or respond to shareholder activism?

Some jurisdictions allow dual-class shareholding structures, in which a particular class of share shall carry more voting rights than another. While Hong Kong also allows listed applicants with a weighted voting right structure that satisfy the requirements stated in Rule 8A.06 in the Listing Rules to apply for listing, the companies that have already listed in Hong Kong are not allowed to adopt a weighted voting right structure at this juncture according to Rule 8A.05 of the Listing Rules.

Certain procedural safeguards are already in place for the company. Assuming the company has adopted the Model Articles, under article 2 therein, the business and affairs of the company are managed by the directors (but not shareholders), who may exercise all powers of the company. Rule 3.08 of the Listing Rules also reflects the rule that it is the board, not the shareholders, who shall be responsible for the management and the operation of the company. Hong Kong courts shall intervene only when the boundaries of discretion are transgressed.

If shareholders would like to reallocate the power between general meeting and the board, they may take preventives measure to amend the articles of the company. When customising its own articles, companies may or may not grant powers to the directors subject to the control of the shareholders via a decision achieved by a certain level of majority (eg, by an ordinary resolution). Nevertheless, the alteration of the articles of Association shall not be made unfairly prejudicial to the minority or in contravention of the Companies Ordinance. Each case is fact-sensitive and whether the alteration amounts to an unfair prejudice depends on the nature and degree of the benefit to the company.

It should be noted that the resolution to alter its articles shall only be passed by special resolution. As such, companies shall take prompt actions before activists together with its alliance accumulate a total shareholding of 25 per cent.

However, even if the resolution to amend the articles is blocked by a minority shareholder holding more than 25 per cent interest, the majority shareholder may bring a claim for unfair prejudice if the articles violate the provisions in the Listing Rules. For instance, in Luck Continent Ltd v Cheng Chee Tock Theodore [2012] HKEC 567, the majority shareholder of Luck Continent Ltd successfully applied to the court for an order of amending the articles based on an unfair prejudice claim. This is because the articles of association require a special resolution for the removal of director, which is in contravention of the threshold stated in the Listing Rules, namely ordinary resolution, but the minority shareholder repeatedly exercised his or her minority veto right to block the resolution for alteration of such provisions in the article.

Reports on proxy votes

Do companies receive daily or periodic reports of proxy votes during the voting period?

A proxy form offering two-way voting on all resolutions must be sent together with the Notice of General Meeting to its shareholders and must be submitted for publication on the Exchange’s website according to Rule 13.38 of the Listing Rules. The time and place for lodging proxy forms shall be stated in the proxy form. It is a common practice in Hong Kong that shareholders shall lodge proxy forms at the share registrar of a listed company. As such, whether the companies receive daily or periodic reports of proxy votes during the voting period depends on the common practice of different share registrars in Hong Kong and the agreement entered into between the listed company and its share registrar.

Nevertheless, the SFC imposes an obligation on all share registrars to ensure all communications between the listed company and its registered shareholders that the share registrar is instructed to distribute are distributed in a timely, accurate and appropriate manner in accordance with paragraph 5.5 of the Code of Conduct for Share Registrars.

Private settlements

Is it common for companies in your jurisdiction to enter into a private settlement with activists? If so, what types of arrangements are typically agreed?

It is common for companies in Hong Kong to enter into a private settlement with activists and the types of arrangement commonly agreed between the parties include:

  • agreements to appoint shareholder activist’s designees to the board of the directors;
  • agreements to change the corporate governance of the company, such as modifying the size and composition of the board of directors of the company;
  • agreements not to enter into certain transactions; and
  • non-disparagement agreements.