Following a consultation paper issued on 19 May 2023, and its consultation conclusions released on 21 September 2023, the Securities and Future Commission (“SFC”) amended the Codes on Takeovers and Mergers and Share Buy-back (the “Codes”) with effect on 29 September 2023.

The amendments seek to codify existing practices of the Executive Director of the SFC (the “Executive”), clarify the SFC’s position on certain aspects of the Codes, streamline processes and introduce green initiatives.

Below are some of the key changes to the Codes which might be of interest. This article does not intend to be a full summary of all the amendments made to the Codes.

Expanding the definition of “close relatives”

Background –  The term “close relatives” is primarily relevant to the definitions of “acting in concert”, “associates” and “disinterested shares”. In the Codes:-

“Acting in concert”

The term “acting in concert” is crucial in determining whether a mandatory offer obligation arises under Rule 26 of the Codes.

The Codes define “acting in concert” as “comprising persons who, pursuant to an agreement or understanding (whether formal or informal), actively cooperate to obtain or consolidate “control” of a company through the acquisition by any of them of voting rights of the company”, and presume nine classes of persons to be acting in concert with others in the same class (unless the contrary is established).  The term “close relatives” is relevant to the following three of the nine classes:

• Class (2): “A company with any directors (together with their close relatives, related trusts and companies controlled by any of the directors, their close relatives or related trusts) of it or of its parent”;
• Class (6): “directors of a company (together with their close relatives, related trusts and companies controlled by such directors, their close relatives and related trusts) which is subject to an offer or where the directors have reason to believe a bona fide offer for their company may be imminent”;
• Class (8): “An individual (including any person who is accustomed to act in accordance with the instructions of the individual) with his close relatives, related trusts and companies controlled by him, his close relatives or related trusts”.

“Associates”

The term “associates” is primarily relevant to the disclosure of dealings under Rule 22 of the Codes.  Amongst other things, the term “associates” include:

• “the directors (together with their close relatives, related trusts and companies controlled by any of the directors, their close relatives or related trusts) of any subsidiary or fellow subsidiary of the first person”.

“disinterested shares”

The term “disinterested shares” is primarily relevant to the approval or acceptance threshold for a delisting or privatisation proposal. The term refers to “shares in the company other than those which are owned by the offeror or persons acting in concert with it”.

Amendment – The definition of “close relatives” is expanded to include a person’s grandparents, grandchildren, sibling’s spouse (or de facto spouse), sibling’s children, and the parents and siblings of the person’s spouse (or de facto spouse).

With the expanded definition of “close relatives”, a larger group of persons will be presumed to be “acting in concert” and/or are “associates” with disclosure obligations. Practically, this may mean more time and effort are needed to gather information on the relevant parties’ relationships and to rebut presumptions. In the case of a Rule 3.5 announcement, requiring more time for its preparation increases the burden of maintaining confidentiality. A larger group of presumed “concert parties” may also mean that less shares will qualify as “disinterested shares” in delisting or privatisation transactions.

Clarifying the definition of  “voting rights”

Background – The term “voting rights” is used extensively throughout the Codes. For example, it is used in the context of defining the concept of “control”, in determining whether a mandatory offer obligation has been triggered, whether a partial offer will be subject to certain requirements or whether an acceptance condition can be imposed or has been met.

Previously, voting rights was defined as “voting rights currently exercisable at a general meeting of a company whether or not attributable to the share capital of the company”. This caused confusion as to whether shares subject to voting restrictions (which rendered their voting rights not currently exercisable) would be treated as voting rights for the purpose of the Codes.

Amendment – A new note is added to the definition of “voting rights”, clarifying that voting rights subject to any restrictions to their exercise by agreement, by operation of law and regulations or pursuant to a court order will still be taken into account as “voting rights” for the purposes of the Codes, except for those attached to treasury shares.

The amendment provides certainty in structuring deals, for example when considering whether a mandatory offer obligation will be triggered. It also removes the potential abuse of increasing or reducing the number of voting rights to suit one’s purposes by entering into or terminating agreements to restrict the exercise of such voting rights.

“90% disinterested share” threshold for delistings and compulsory acquisitions

Background – Delistings and compulsory acquisitions following an offer are dealt with under Rule 2.2 and Rule 2.11 respectively:-

Rule 2.2 – Approval of delistings by independent shareholders

Rule 2.2 provides that neither the offeror (nor any persons acting in concert with the offeror) may vote at any meetings of the offeree company’s shareholders (convened in accordance with the Listing Rules) to approve a delisting. The resolution to approve the delisting must be subject to:

(a) approval by at least 75% of the votes attaching to the disinterested shares that are cast either in person or by proxy at a duly convened meeting of the holders of the disinterested shares;

(b) the number of votes cast against the resolution being not more than 10% of the votes attaching to all disinterested shares; and

(c) the offeror being entitled to exercise, and exercising, its rights of compulsory acquisition.

The Note to Rule 2.2 provides that the Executive is prepared to waive the compulsory acquisition requirement in (c) above for an offeree company which is incorporated in a jurisdiction where compulsory acquisition is not available, if arrangements are put in place to meet certain conditions, one of which is:

• “the resolution to approve the delisting is subject to the offeror having received valid acceptances amounting to 90% of the disinterested shares.”

Rule 2.11 – Exercise of rights of compulsory acquisition

Rule 2.11 provides that where an offeror seeks to acquire or privatise a company through the use of compulsory acquisition rights, it can only be exercised if:

“acceptances of the offer and purchases (in each case of the disinterested shares) made by the offeror and persons acting in concert with it during the period of 4 months after posting the initial offer document total 90% of the disinterested shares.”

While both the Note to Rule 2.2 (regarding companies in jurisdictions without compulsory acquisitions) and Rule 2.11(regarding companies in jurisdictions with compulsory acquisitions) contain a similar requirement – the acquisition of 90% of the disinterested shares, Rule 2.11 explicitly includes purchases made by the offeror (and its concert parties) in determining whether the 90% threshold has been met, while the Note to Rule 2.2 is silent as to whether such purchases would also be included in determining the 90% threshold. In practice, the Executive has allowed such purchases to be included in determining the 90% threshold.

Moreover, while the existing language of Rule 2.11 only counts purchases made after the posting of the initial offer document towards the 90% threshold, in practice the Executive has always included shares purchased after the publication of a Rule 3.5 firm intention announcement.

Amendments – The SFC revised both the Note to Rule 2.2 and Rule 2.11 to align them in allowing shares acquired by an offeror and its concert parties from the date of the Rule 3.5 announcement to be counted towards the 90% threshold under both rules.

The amendments provide certainty and flexibility in meeting the 90% threshold requirement as required in the Codes. Nevertheless, for Rule 2.11, as compulsory acquisition rights are governed by the company law of the place of incorporation of the offeree company, care must still be taken in determining whether the corresponding threshold has been met under the relevant law.

Attendance and voting at meetings held to consider a scheme of arrangement, capital reorganisation or a delisting proposal

Background – Whether the deal is a privatisation by way of a scheme of arrangement, or an offer leading to delisting, both require shareholders’ approval at a duly convened meeting, as shown below.

Rule 2.10

Pursuant to Rule 2.10, a privatisation by way of a scheme of arrangement may only be implemented if the following requirements are met:

(a) the scheme is approved by at least 75% of the votes attached to the disinterested shares that are cast either in person or by proxy at a duly convened meeting of the holders of disinterested shares; and

(b) the number of votes cast against the resolution to approve the scheme at such meeting is not more than 10% of the votes attaching to all disinterested shares

Rule 2.2

Rule 2.2 provides that the resolution to approve a delisting must be subject to:

(a) approval by at least 75% of the votes attaching to the disinterested shares that are cast either in person or by proxy at a duly convened meeting of the holders of the disinterested shares;

(b) the number of votes cast against the resolution being not more than 10% of the votes attaching to all disinterested shares; and

(c) the offeror being entitled to exercise, and exercising, its rights of compulsory acquisition.

Note: The first two conditions of Rule 2.2 are equivalent to those provided in Rule 2.10.

In SFC’s “Takeovers Bulletin” of December 2021^[1], the Executive noted from two recent local judgments^[2] that there were two schools of thought regarding the form of shareholders’ meetings under Rule 2.10:-

• “Prohibition view” – the offeror and his concert parties are prohibited from voting on the relevant resolution.
• “Non-prohibition view” – the offeror and his concert parties are not prohibited from voting, but their votes cannot be counted for the purposes of complying with the Takeovers Code.

Prior to these recent judgments, the Executive had always taken the non-prohibition view to be the correct view, as it would allow the Codes to operate alongside the company laws of those jurisdictions which permitted an offeror and its concert parties to attend court meetings in a privatisation scheme. The adoption of the “prohibition view” in the case of Re Chong Hing Bank Limited created uncertainty.

Amendments – References to “duly convened meeting of the holders of the disinterested shares” in Rules 2.2 and 2.10 are replaced with “duly convened meeting of shareholders”, and a new Note 8 is added to Rule 2 to clarify that the expression “duly convened meetings of shareholders” refers to shareholders’ meetings which are duly convened in accordance with an offeree company’s constitutional documents and the company law of its place of incorporation. For the purposes of the Codes, any votes cast by the offeror and its concert parties will simply be disregarded.

The amendments remove the uncertainty created by Re Chong Hing Bank Limited and confirm the “non-prohibition view” regarding shareholders’ meetings, thereby allowing the Codes to operate alongside the company laws of different jurisdictions.

Irrevocable commitments

Background – Often as a tactic to securing a deal, an offeror might seek irrevocable commitments from significant shareholders to accept (or not accept) an offer or vote favorably on resolutions relating to an offer.

Under the previous version of the Codes, an offeror may only approach “a very restricted number of sophisticated investors who have a controlling shareholding” for irrevocable commitments. In all other cases the Executive will have to be consulted.

Amendment – Note 4 to Rules 3.1, 3.2 and 3.3 is amended to streamline the process of obtaining irrevocable commitments such that:-

• an offeror does not need to consult the Executive in advance before approaching a shareholder with a “material interest”. In this context, a shareholder has a “material interest” when he and his concert parties control directly or indirectly 5% or more of the voting rights of an offeree company);
• an offeror must continue to consult the Executive when approaching “non-material” shareholders; and
• the maximum number of shareholders an offeror can approach is six, which includes both shareholders who have a material interest and those who do not.

The amendment provides certainty and flexibility in structuring a deal.

Adding the “market capitalization” test for the purpose of applying the Chain Principle

Background – In determining whether a “chain principle offer” has to be made when someone acquires statutory control of a company (the first company) which directly or indirectly controls 30% or more of the voting rights of a listed company (the second company), the SFC will apply a principle-based approach on a case by case basis and consider: (a) whether the holding in the second company is significant in relation to the first company, based on such factors as the assets and profits of the two companies (the “Substantiality Test”), and (b) whether one of the main purposes of acquiring control of the first company was to secure control of the second company (the “Purpose Test”). If either the Substantiality Test or the Purpose Test is satisfied, the Executive will require a “chain principle offer” to be made.

Amendments – Codify the existing practice and add the following guidance to Note 8 to Rule 26.1 in respect of the Substantiality Test:-

• where both companies in question are listed companies, the SFC will also consider the respective market capitalization of the two companies under the Substantiality Test.
• Where anomalous results would be produced from using the asset and profit values in the most recent audited statements, a “look-back” period of the three most recent audited financial periods can be taken into account.

Practice Note 19 has been revised to provide further guidance on the Executive’s approach to the Substantiality Test, including the specific line items for assets and profits to be taken into account and the reference dates for market capitalisation.

Executive granted explicit powers to end an offer period and to issue “put up or shut up” orders

Background – Under the previous version of the Codes:

• An offer period would end upon the occurrence of one of the events described in the definition of “offer period”, none of which events is within the control of the offeree company while some require certain initiative on the part of the offeror or potential offeror. As an offeree company is subject to additional requirements and restrictions once an offer period starts, a prolonged offer period may affect the company’s normal business operations.
• The Executive does not have an express power to end an offer period and would need to rely on his implicit power to do so under Section 2.1 of the Introduction to the Codes which gives the Executive the power to modify or relax any rule under the Codes.

Amendments – The Codes are amended to expressly grant the Executive the powers to:-

• end an offer period; and
• to issue a put up or shut up order (“PUSU order”) (i.e. requiring a potential offeror to announce its firm intention to make an offer within a set time period (put up), or to announce that it will no longer proceed with an offer (shut up), which is one of the events that will end an offer as described under the definition of “offer period”).

In determining whether to issue a PUSU order, the Executive will take all relevant factors into account, including: (a) the current duration of the offer period; (b) the reason for the offeror’s delay in issuing a firm intention announcement; (c) the proposed offer timetable; (d) any adverse effects that the offer period has had on the offeree company; and (e) the conduct of the parties to the offer.

Such amendments give certainty to offer periods and allow offeree companies to avoid unnecessary disruptions to normal business operations caused by prolonged offer periods.

Definition of on-market share buy-back

Background – On-market share buy-back is the most utilized “exemption” to the more stringent requirements for share buy-backs under the Codes.

Amendment – The definition of “on-market share buy-back” is amended to clarify that (i) such share buy-backs must be made pursuant to the Stock Exchange’s automatic order matching system; and (ii) the company and its directors must not have any involvement in the solicitation, selection or identification of the seller of the securities, whether directly or indirectly.

The amendment prevents companies from arranging what is in effect a “pre-selected” off-market share buy-back conducted via the Stock Exchange’s facilities to enjoy the “on-market share buy-back” exemption.

Takeaways

This was the first time since 2018 where the Executive has conducted a comprehensive review of the Codes. Overall, the amendments provide greater certainty, clarified market concerns regarding the application of the Codes, as well as streamlined the relevant processes.

For a complete overview of the amendments made to the Code, please refer to the SFC’s Consultation Conclusions.

^[1] The Takeovers Bulletin of December 2021 can be retrived from: 20211229SFC-Takeover-Bulletine.pdf

^[2] See (i) Re Cosmos Machinery Enterprises Ltd (HCMP 601/2021, [2021] HKCFI 2088) in which the “non-prohibition view” was adopted and (ii) Re Chong Hing Bank Limited (HCMP 968/2021, [2021] HKCFI 3091). ) in which the “prohibition view” was adopted.