Schemes of arrangement: voting in court meetings

Schemes of arrangements have often been used as a means to privatise a company. To implement a scheme for a Hong Kong public company, in addition to satisfying statutory requirements imposed by the Companies Ordinance (Cap. 622) (Companies Ordinance), pursuant to Rule 2.10 of the Codes on Takeovers and Mergers (Takeovers Code) (Rule 2.10), (i) the scheme must receive approval from disinterested shareholders holding 75% in value or more present and voting at a shareholders' meeting in person or by proxy, and (ii) the number of votes cast against the scheme must not be more than 10% of the votes attaching to all the disinterested shares.

Contrary to Harris J's view in Re Cosmos Machinery Enterprises Limited [2021] HKCFI 2088 (Cosmos Machinery), Linda Chan J in Re Chong Hing Bank Limited [2021] HKCFI 3091 (Chong Hing Bank) held that, for meetings convened by the Court to approve privatisation or takeover schemes (Court Meeting) involving parties acting in concert with the offeror:

• where the shareholders who are also concert parties have (i) undertaken to the Court not to attend and vote at the Court Meeting, or (ii) agreed with the company or the offeror to be bound by the terms of the scheme or the offer, one Court Meeting would be convened for all the shareholders (or the disinterested shareholders only); and
• otherwise, two Court Meetings would be convened for the disinterested shareholders and the concert party shareholder(s) respectively.  Although the second Court Meeting may be dispensed with if the concert party shareholder(s) agreed with the company or undertaken to the Court that they will be bound by the terms of the scheme at the time when the Court Meeting was convened.

Background

In Cosmos Machinery, the Court had outlined the two schools of thought on whether Rule 2.10 would operate to exclude the attendance and votes of concert party shareholders in a Court Meeting:

1. Prohibition View: Rule 2.10 would prohibit the offeror's concert parties from voting in a Court Meeting.
2. Non-Prohibition View: Rule 2.10 would not prohibit the concert parties of an offeror from voting in a Court Meeting, but their votes will not count for the purpose of compliance with Rule 2.10.

While the scheme in Cosmos Machinery ultimately did not attain the requisite majorities and therefore an interpretation of how Rule 2.10 might apply was not strictly necessary, Harris J expressed support for the Non-Prohibition View, indicating that he would have allowed a meeting of scheme shareholders comprising both the offeror's concert parties (who did not undertake to abstain from voting in that case), and other "disinterested shareholders" under the Takeovers Code.

Harris J reasoned that the Non-Prohibition View was more consistent with the natural and ordinary meaning of Rule 2.10 and section 674(2) of the Companies Ordinance. He considered that Rule 2.10 did not prohibit attendance or voting by a shareholder who is also a concert party of the offeror, but only the counting of the votes cast by that shareholder:

Therefore, if the Prohibition View were correct, a scheme may include shareholders acting in concert with the offeror only if they all undertake not to vote at the meeting of shareholders. In my view it should not be permissible for the notice of meeting to exclude these offeror concert parties because they are also parties to the scheme. (Harris J, Cosmos Machinery, [7])

Tonly Electronics Holdings Ltd

Cosmos Machinery (and the subsequent Chong Hing Bank) referred to the Cayman Islands judgment given by Segal J in Tonly Electronics Holdings Ltd, Re (Cayman Grand Court, 9 March 2021) (Tonly Electronics).

Tonly Electronics also involved the privatisation of a Hong Kong listed company, but unlike Cosmos Machinery and Chong Hing Bank, Tonly Electronics Holdings Ltd was incorporated in the Cayman Islands.

The proposed scheme in Tonly Electronics was made between the company and all of its shareholders (except the offeror). The company initially sought to convene one Court Meeting for the disinterested shareholders only, omitting the concert parties of the offeror.

In his judgment, Segal J held that it was impermissible to order a meeting of the disinterested shareholders when they only represented a sub-set of the parties to the scheme.

Segal J explained that in the absence of an undertaking, an order convening a Court Meeting of the disinterested shareholders only would require such shareholders to constitute (i) a separate class of shareholders, or (ii) the only parties to the scheme.

It would have been permissible (and in Segal J's view, more orthodox) to treat the scheme as being all shareholders (except the offeror) and for the court to convene a Court Meeting of all the shareholders, but with the concert parties agreeing to not attend. Lastly, the court could also recognise the concert parties as a separate class of shareholders, dispense with a meeting on the basis that such shareholders have all agreed to support and be bound by the terms of the scheme.

Tonly Electronics shows that a Cayman Islands court could convene a Court Meeting attended by both the shareholders who are concert parties and other shareholders. This would be prohibited under the Prohibition View, and Harris J cited this in Cosmos Machinery to support his argument for the Non-Prohibition View.

However, Segal J also noted that he considered it "strongly arguable" that concert parties constituted a separate class of shareholders requiring a separate meeting, but accepted that this is a matter to be determined at the sanctions hearing:

It also seemed to me to be strongly arguable that the Concert Parties and the Disinterested Scheme Shareholders should be treated as separate classes. It would not be appropriate for the Concert Parties to vote together with the Disinterested Scheme Shareholders (it is difficult to see how the Concert Parties could consult together with the Disinterested Scheme Shareholders with a view to their common interest) at a single meeting...

However, I accept that it is also arguable ... that where a bidder and its associates are to receive the same treatment under the scheme as other shareholders ... would suggest that they be treated as being in the same class as other shareholders since they have the same rights as other shareholders (it is only their interests which are different, and any concerns about different interests would fall to be dealt with as a matter of the Court's discretion at the sanction hearing.) (Segal J, Tonly Electronics, [17])

Chong Hing Bank Limited

In the later Hong Kong decision of Chong Hing Bank, the Court considered the view espoused in Cosmos Machinery as obiter, and revisited the application of Rule 2.10 in Hong Kong schemes.

SFC's views

In the proceedings for Chong Hing Bank, the Court has invited the Securities and Futures Commission (SFC) to provide its view on Rule 2.10, particularly on whether it agreed with the Non-Prohibition View espoused in Cosmos Machinery.

The SFC concurred with the view given in Cosmos Machinery, and later submitted that as long as the votes cast by the parties acting in concert would not be counted towards Rule 2.10, it is not concerned with whether the concert parties could in fact cast those votes.

Notwithstanding the above, the Court did not find the SFC's response to be determinative of the issue at hand.

Court's interpretation of Rule 2.10 in Chong Hing Bank

With input from the appointed amici curiae, the Court ultimately endorsed the Prohibition View contrary to Cosmos Machinery, finding that:

• The Ordinary and natural meaning of Rule 2.10: Notwithstanding the SFC's submissions, Rule 2.10 clearly mandates a meeting (a) constituted only by holdings of disinterested shares, and (b) at which only holders of disinterested shares are entitled to attend and vote;
• Interpretation of Tonly Electronics: Harris J in Cosmos Machinery had only focussed on the fact that one Court Meeting was allowed in Tonly Electronics but not Segal J's ruling that a single Court Meeting of a subset of a class of shareholders is not permissible;
• Essential condition governing the conduct of a separate meeting: Requiring a separate Court Meeting ensures that discussions between disinterested shareholders would not be hampered by the presence of others who may have a different interest;
• Drafting history of Rule 2.10: The Prohibition View is consistent with, and supported by the drafting history of Rule 2.10. In particular, the difference between the drafting of the former Rule 2.10 ("... a duly convened general meeting of the shareholders") and the current version ("...a meeting of holders of disinterested shares") shows that the current version is meant to be more prohibitive than the former one; and
• Protection of minority interest: The Prohibition View would result in more coherence in the interpretation of related rules in the Takeovers Code that aim to protect minorities' interests, such as Rule 2.2 of the Takeovers Code, which expressly prohibit voting by concert parties.

Further, the Court's interpretation of Rule 2.10 is inconsistent with the Companies Ordinance :

• Power to summon more than one meeting: While the Prohibition View would prevent shareholders acting in concert from attending the Court Meeting for the disinterested shareholders, the Court is empowered under section 670(1) of the Companies Ordinance to order another or multiple meetings "in any manner that the court directs"; and
• Votes cast at another general meeting: With multiple meetings, the Prohibition View does not necessarily contravene section 674(2) of the Companies Ordinance requiring requisite votes from "members" present and voting (as opposed to votes from "disinterested shareholders" only in Rule 2.10), given the statutory percentage for approval of the scheme may well embrace votes of concert parties cast at the separate meeting.

Three possible types of Court Meetings

In light of the above, the Court in Chong Hing Bank concluded that there are three possible types of Court Meetings:

• One Court Meeting would be convened for: (i) all of the shareholders to be bound by the scheme of arrangement (including those who are concert parties), provided that each concert party has given an undertaking to Court to not attend and vote at the Court Meeting, OR (ii) the disinterested shareholders only, provided that each concert party shareholder has agreed with the company or the offeror to be bound by the terms of the scheme.
• Two Court Meetings would be convened for each of (i) the disinterested shareholders; and (ii) any concert party shareholders, respectively.  However, the Court may dispense with the latter if such concert party(ies) have agreed with the company or undertaken with the Court that they would be bound by the terms of the scheme by the time when the Court Meeting was ordered.

Implications and the way forward

Although the Court has stated in Chong Hing Bank that "the responsibility of deciding whether to summon a single meeting or sperate meetings rests in the company", given its interpretation of Rule 2.10, it is clear that Hong Kong Courts would be quick to dismiss petitions for a scheme where the concert party shareholder(s) do not have a separate meeting (or otherwise given their word to be bound by the scheme and/or to abstain from attending or voting).

Unlike Tonly Electronics, Chong Hing Bank did not express latitude for future arguments for allowing a concert party shareholder to vote in the same manner as any other disinterested shareholders. 

This was explicitly left open in Tonly Electronics, and naturally permissible under the Takeovers Code with the Executive's blessing. 

Regardless, given Chong Hing Bank, practitioners and potential offeror should consider undertakings with their concert party shareholders as a priority early in a scheme of arrangement, as the alternative is the burdensome task of arranging two separate Court Meetings, agreeing with the SFC on the treatment of votes cast by concert parties, and then embarking on the quest to discern those votes cast by the concert parties (in person, by proxy and/or via the HKSCC Nominees) from the others.