Manipulating the headcount test in schemes

To be successful, a scheme of arrangement requires the support of:

• 75 per cent of the shares voted at the meeting, and
• a majority of shareholders who vote at that meeting.

The second test therefore requires a headcount to be conducted. In recent years, influenced perhaps by the MIM scheme in 2003 where there were allegations of share splitting, concerns have been expressed that the headcount test is subject to manipulation.

For this reason, the law was amended in 2007 to give the court the discretion to approve a scheme even if the headcount test had not been satisfied. This could be invoked if share splitting has been used to defeat the scheme.

Where share splitting is used to ensure that the vote is successful, the court could use its residual jurisdiction to refuse to approve the scheme. An illustration of this is demonstrated in the recent scheme of arrangement involving PCCW Limited in Hong Kong.

The PCCW case

In this transaction, joint bidders who held approximately 48 per cent of the shares in the company proposed a scheme under which shares would be cancelled in exchange for a cash payment.

Initially, the cash payment was to be HK$4.20, but shortly before the shareholder meeting, the amount was increased to HK$4.50, apparently in view of significant opposition to the scheme, which would have caused it to fail.

Due to the change in the terms of the scheme, the shareholder meeting was then adjourned for five weeks. During the adjournment, some curious transactions involving shares in the company occurred. This involved hundreds of new shareholders coming onto the register—the vast majority of whom had been given small parcels of shares by persons who had links to persons associated with one of the bidders.

As is the custom with listed companies in Hong Kong, the vast majority of shares in the company were held in the name of CCASS, which is the nominee company used to effect the stock exchange clearance system. This enables efficient share trading on the stock exchange. However, it means that the vast majority of shares are held in the name of a single nominee which counts as only one shareholder for the headcount purpose. No evidence was before the court as to how the individuals holding through the nominee would have voted.

At the meeting, the scheme was supported by 859 out of 1,404 shareholders and 83 per cent of the shares voted, with the shares held by CCASS being counted as a single holder.

After the meeting, the SFA began an investigation into the recent share transfers and extensive evidence was produced at the trial about this and how the share splitting was orchestrated. At first instance, the judge approved the scheme, but on appeal, this decision was overturned.

The appeal court was not satisfied that the vote reflected the correct view of the shareholders. It did not matter, in this case, that neither PCCW nor the joint bidders themselves had been active participants in the share splitting exercise.

The judges considered that share splitting had distorted the vote. In effect, the majority were coercing the minority into accepting a contrary view. This was compounded by the judges’ concerns that the price under the scheme was too low.

Law reform?

The CAMAC discussion paper on schemes of arrangement released in June 2008 raised the question of whether the headcount test, which has been part of the law for over 100 years, should be abolished. It is sometimes regarded as anachronistic, given the prevalence of shares in Australian listed companies being held in the names of nominee companies (typically for administrative ease, particularly where there are overseas investors). It is said to be unduly favourable to small shareholders and inconsistent with the one share, one vote principle. We are awaiting CAMAC’s final recommendation.

While the headcount test remains, the PCCW case acts as a reminder that a scheme is unlikely to be approved if it involves share splitting, irrespective of the merits or otherwise of the scheme.

It also acts a reminder that, in a scheme of arrangement, investors who hold through nominee companies may wish to transfer their shares into their own names to make sure their votes count for all purposes.

This article was written by Rodd Levy, Partner, Melbourne.

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