THE UPDATE SCOOP (#4/2024 )
Shareholders’ Pre-emptive Rights and Approval for Substantial Property Transaction │ Company Law
By TAY & HELEN WONG – April 15, 2024
The failed merger of two stockbroking businesses between JF Apex Securities Bhd and Mercury Securities Sdn Bhd in April 2021 (the Proposed Merger) was the subject of dispute in the recent Federal Court (FC) case of Azizan Abd Rahman & 2 Others v Concrete Parade Sdn Bhd & 5 Ors [Federal Court Civil Appeal No.: 02(F)-77-08/2022(W)]. The proper construction of sections 75, 85 and 223 of the Companies Act 2016 (the CA2016) and the inter-play among these provisions were the pivotal questions for determination by the highest court of the land. At the heart of the dispute were the rights of the management of a company to raise capital through issuance of new shares, the pre-emptive rights of existing shareholders to buy newly issued shares and the point in time the directors are to procure shareholders’ approval for the acquisition or disposal of the property or undertaking of a substantial value.
Section 75 of the CA2016 prohibits the directors of a company from exercising any power to allot shares without the prior approval of the company in general meeting; whilst s. 85 provides pre-emptive rights of shareholders in relation to the issuance of new shares but this is qualified by “subject to the constitution” (the Qualifying Words) of the company.
Background Facts in Brief
On the facts, under the Proposed Merger, Mercury would transfer its business to JF Apex which would have become one merged entity, in consideration of which Apex Equity Holdings Berhad (Apex Equity), the holding company of JF Apex, would pay RM140 million in cash and issuance of new shares; and part payment of the cash consideration was via issuance of new shares for private placement (the Proposed Private Placement). The Proposed Merger was conditional upon, inter alia, the approval of the shareholders of Apex Equity (which was also condition precedent to the Proposed Private Placement), the approvals of Bursa Malaysia and Securities Commission, and a vesting order from the High Court pursuant to Capital Markets and Services Act 2007 (the CMSA).
A Heads of Agreement (the HOA) was entered into in September 2018, followed by a tripartite Business Merger Agreement (the BMA) three months later in December 2018 together with eight conditional Subscription Agreements for the Proposed Private Placement. Two months later in February 2019, Concrete Parade, a minority shareholder of Apex Equity filed a minority oppression suit pursuant to s.346 of the CA2016 to, among others, invalidate the HOA, BMA and Subscription Agreements (the HC Oppression Suit) on the grounds of non-compliance by Apex Equity with the pre-emptive rights under s.85 and that the entering into the HOA was without condition precedent and the execution of the BMA was without the shareholders’ prior approval in violation of s.223.
Pending the disposal of the HC Oppression Suit, the Proposed Merger and the Proposed Private Placement were approved by the shareholders of Apex Equity at an EGM. Following that, the HC dismissed the HC Oppression Suit in August 2019. On appeal to the Court of Appeal (COA), Concrete Parade’s appeal was allowed in August 2022. By then, Mercury had decided not to extend the timeline and the Proposed Merger came to an end in April 2021. The matter was further taken up to the final appellate court, the FC which eventually delivered its decision on 26.3.2024. The COA decision was reversed and the HC decision was reinstated.
On Section 85 on Shareholders’ Pre-emptive Rights
Section 85 of the CA2016 is qualified by the Qualifying Words “Subject to the constitution”. In this regard, the constitution of Apex Equity in Article 11 provides that:
“Subject to any direction to the contrary (the said Phrase) that may be given by the Company in general meeting, all new shares or other convertible securities shall be offered to such persons as at the date of the offer are entitled to receive notices from the Company of general meetings in proportion, as nearly as the circumstances admit, to the amount of the existing shares to which they are entitled…” (emphasis ours)
The COA had construed the said Phrase to refer only to the manner and proportion in which the new shares proposed to be issued have to be offered to the existing shareholders; and could not mean any direction not to offer at all to existing shareholders, relying on an Indian High Court decision (Shanti Prasad Jain v Kalinga Tubes Ltd and others [1965] AIR 1535) which was purportedly on a provision similar to s.85 of the CA2016. In other words, the COA had regarded the pre-emptive rights of existing shareholders were mandatory and not capable of being renounced at all.
The FC rejected such interpretation. In doing so, the apex court applied the purposive approach of statutory interpretation; and considered the legislative history of shareholders’ pre-emptive rights, provisions in the precursor to s.85 of the CA2016 and relevant provisions of existing subsidiary legislations. The FC also pointed out that section 81 of the Indian Companies Act 1956 was in fact NOT in pari material with our s.85 as the Qualifying Words “Subject to the constitution” in the latter were not present in the former; and that the Indian Supreme Court had in fact ruled the decision of the Indian High Court in Shanti Prasad Jain as incorrect ! The FC went on to hold that where the constitution of a company provides that shareholders’ pre-emptive rights under s.85 of the CA2016 are “subject to direction to the contrary that may be given by the company in general meeting”, shareholders may at general meeting vote on a resolution to disapply or waive their pre-emptive rights in full, not just in relation to the manner and proportion in which shares are offered to existing shareholders.
The FC further held that it was not necessary for the circular for the proposed resolution to expressly explain, the nature of pre-emptive rights under s.85(1) of the CA2016, and the passing of the proposed resolution as amounting to a waiver of those rights, in order for the resolution to constitute a valid waiver of pre-emptive rights.
On Section 223 on Shareholders’ Approval for Substantial Property Transaction
Section 223 of the CA2016 reads:
“Approval of company required for disposal by directors of company’s undertaking or property
223. (1) Notwithstanding anything in the constitution, the directors shall not enter or carry into effect any arrangement or transaction for –
(a) the acquisition of an undertaking or property of a substantial value; or
(b) the disposal of a substantial portion of the company’s undertaking or property unless –
(i) the entering into the arrangement or transaction is made subject to the approval of the company by way of a resolution; or
(ii) the carrying into effect of the arrangement or transaction has been approved by the company by way of a resolution.”
The FC interpreted s.223(1)(i) and (ii) above as to be read disjunctively. Thus, where a company enters into any arrangement or transaction for the acquisition or disposal of an undertaking or property of a substantial value (substantial property) falling within s.223 of the CA2016, EITHER the agreements relating to the said arrangement or transaction are expressly made subject to the approval of the company by way of a resolution; OR, alternatively, the carrying into effect of the arrangement or transaction has been approved by the company by way of a resolution.
The apex court further ruled that where two or more agreements are construed as forming one composite transaction constituting an arrangement or transaction falling within s.223 of the CA2016 for the acquisition or disposal by a company of substantial property, then s.223(1)(i) would be satisfied if at least one of the agreements forming the composite transaction contains an express condition precedent requiring a resolution of the shareholders of the company for the said arrangement or transaction. Another option was under s.223(1)(ii) by the passing of a resolution of the company in a general meeting approving the said arrangement or transaction before the arrangement or transaction becomes unconditional and binding on the parties to the arrangement or transaction and is carried into effect.
In the BMA in Concrete Parade, it contained an express condition precedent to the effect that the acquisition was subject to shareholders’ approval at a general meeting and therefore, it was compliant with section 223(1)(b)(i). There was no necessity for a second set of shareholders’ approval to be obtained prior to the actual acquisition taking effect. The decision of the COA that had interpreted s.223(1)(i) and (ii) to be read conjunctively in effect required two sets of shareholders’ approval to be obtained, once before entering into any form of agreement for a proposed acquisition or disposal of a substantial property and a second time prior to the actual transfer or putting into effect of the transaction. This was, in the words of the FC, irrational, unreasoned, unreasonable and absurd, and the FC overturned it. Further, as the BMA could not possibly have the effect of ‘ carrying into effect ‘ or ‘ implementing ‘ or ‘ executing ‘ the agreement by reason of the existence of the condition precedent in it, it was incorrect to say that the BMA was in breach of section 223(1)(b)(i) or (ii).
In short, for the compliance of s.223(1)(b) in respect of the disposal of the company’s substantial property, it is sufficient if either s.223(1)(b)(i) OR (b)(ii) is adhered to. It is not necessary to comply with both limbs of the sub-paragraph. In practical terms this means that:
(a) At the outset of a proposed corporate transaction, it is open to the directors to enter into an agreement which is conditional upon the obtaining of shareholders’ approval for the transaction. This is to be gleaned from the words ‘subject to‘. In the event the condition is not complied with and shareholders’ approval not obtained, the corporate transaction will fail; or
(b) Alternatively, the directors can choose to obtain shareholders’ approval at general meeting at a later stage prior to the actual implementation or execution or transfer of ownership of the substantial property.
Other Aspects
Due to space constraint, we have not dwelled on the aspects of the FC decision on minority oppression and retrospective validation of shares buy-back exercise.
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Tags: [Companies Act 2016] [s.75] [s.85] [s.223] [pre-emptive rights] [transaction of substantial value]