Test for minority buy-out rules

Lawyer BRIGID McARTHUR* has some advice for Fletcher Forests shareholders as the CNIF vote approaches.

The Companies Act 1993 minority buy-out provisions look set to be tested again after the Fletcher Challenge Forests special meeting on August 13.

The purpose of the meeting is to seek shareholder approval for Fletcher Forests to acquire from the receivers of the Central North Island Forests Partnership the partnership's assets for US$650 million.

Shareholder approval will also be sought for some related financial transactions. The transactions require 75 per cent shareholder approval as "major transactions" under the Companies Act 1993, and this is what triggers minority buy-out rights.

The minority buy-out provisions in sections 110 to 115 of the act were new in 1993. Derived from Canadian precedent, their aim is to provide a ready exit mechanism for shareholders who disagree with a significant transaction of the company, or some significant change affecting the company.

Sure, the dissenters can always sell on market, but the market price may be affected by the very transaction complained of. So the act allows these shareholders the option of exiting at a fair and reasonable price.

In the only publicly known buy-out case to date, Chapman Tripp advised Natural Gas Corporation on its legal position when utilities investor Infratil sought to exit, disagreeing with NGC's investment in TransAlta.

The NGC board's provisional determination of a fair and reasonable exit price for Infratil was $1.30 a share. Eight sitting days, 500 pages of written briefs and 900 pages of expert witness transcripts later, this price was upped through arbitration to $1.68 a share - as spelled in NGC's media release of July 2, 2001.

The arbitrator's decision is confidential, but the point is that there is scope for enormous differences in approach to the difficult question of what is a fair and reasonable exit price.

The particular warning I would give to Fletcher Forests dissenting shareholders is not to assume automatically that they will be entitled to exit at the 37c Seawi is paying for Rubicon's Fletcher shares (which itself represents an 85 per cent premium to the pre-announcement share price).

Nor, however, should they necessarily believe that they stand to get market price. To some extent, the market will already have factored the announced deal into the Forests share price.

I can offer, by way of guideline, some general principles. The buy-out provisions are designed to provide the dissenter with a means to exit the company, without that shareholder suffering a penalty for the dissent.

The dissenter should not enjoy a price premium at the expense of remaining shareholders; this is no free ride. If the dissenter has voted against, he or she cannot at the same time share in the benefit of any resulting increase in share value.

Nor are the provisions intended to provide a free option; the shareholder should not be allowed to wait and see how the price moves after the vote, then exercise buy-out rights if the price moves up or down and claim a different (pre-vote or post-vote) price as the appropriate buy-out price.

Importantly, the buy-out provisions are not intended to insulate shareholders from the ordinary risks of equity ownership.

The price paid to exiters must be fair and reasonable both to them and to the remaining shareholders.

For a listed company in which the shares are freely traded, the strongest starting point in establishing "fair and reasonable" is the company's quoted share price (on the basis that this price incorporates all publicly known information about the company at the relevant time).

The correct valuation date is unclear, and ultimately may not matter. But depending on the date selected (eg, date of announcement, date of shareholders meeting or date of buy-out notice) adjustments to the market price need to be made effectively to discount, or add back, the price movement attributable to the transaction complained of.

So what is the key message in all this for Fletcher Forests shareholders?

It is more likely than not that a fair and reasonable price for dissenters' shares should be calculated using the current share price as a starting point. The big issue will be the extent to which that price already reflects the CNIFP deal announced on May 20.

In other words, what proportion of the movement in Forests' share price is attributable to the announced deal, and what proportion is attributable to other factors?

The price clearly moved up after the announcement. How many cents a share should be deducted from that price to determine a fair and reasonable exit value? How many cents should be added, or deducted, to reflect other factors which are mere incidents of equity ownership?

Finally, a couple of comments on procedure. Any shareholder seeking buy-out must vote all his or her shares against the relevant resolution.

It is the registered shareholder who must give the notice. Check if your shares are held through a custodial company or trust.

There is an interesting issue as to the buy-out rights of American Depository Receipts holders which they should get checked quickly (in essence, are they shareholders?).

The buy-out notice must be given within 10 working days of August 13.

Fletcher Forests will have options as to how it responds (for example, it can arrange for another person to buy the shares, or it can seek a court-ordered exemption on grounds of inequity or insolvency), but in reality a Forests buyback is probably the only option.

As a dissenting shareholder, you can simply vote against the resolutions. You do not have to exercise minority buy-out rights.

The Fletcher Forests notice of meeting spells out quite clearly some of the general risks associated with a buy-out notice, including that if the level of buy-outs exceeds US$7.5 million ($16.5 million) then the CNIFP acquisition may not proceed.

This, says the explanatory memorandum, could itself have a significant negative effect on the market price for Forests shares (although one would have thought that the latest possible valuation date would be the date of the buy-out notice which, in itself, would dictate giving notice sooner rather than later within the permitted 10-working-day period).

It is up to shareholders to take on board the Forests warnings. Ultimately, their assessment of the overall benefits of the CNIFP transaction will dictate their response. But no shareholder should assume the buy-out rights give them a totally free option at 37c.

* Brigid McArthur is a partner with law firm Chapman Tripp. She is not involved in any aspect of the Fletcher Forest proposals, but Chapman Tripp's Auckland office has been advising banks involved in the transaction.