DealMakers - Q2 2021 (August 2021)

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Appraisal rights
by Lance Fleiser and Liesl Oosthuizen
 

What is an appraisal right?

The appraisal right is a right granted by the Companies Act, 2008 entitling a shareholder, in certain circumstances, to a cash payment equal to the fair value of the shareholder’s shares.

 

This enables a shareholder to exit its investment in a company at fair value if certain specified events are contemplated which will or might:

  • materially change the subject matter of the shareholder’s investment; or

  • compel the shareholder to exit the company at less than fair value.

A company triggers the appraisal rights process if it puts a resolution to shareholders seeking approval for:

  • (i) a ‘scheme of arrangement’ in relation to the company, (ii) an ‘amalgamation or merger’ involving the company; or (iii) a disposal by the company of ‘all or the greater part of the assets or undertaking’ of the company; or

  • an amendment to the company’s memorandum of incorporation (MoI) which alters the rights attaching to any class of shares in a manner materially adverse to the rights or interests of the holders of that class.

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Lance Fleiser
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Liesl oosthuizen

If a resolution contemplated above is adopted by shareholders, a shareholder can:

  • exit the company at the fair value of its shares, rather than exiting the company under the corporate transaction at a price it believes undervalues its shares; or

  • exit the company rather than continuing to hold its shares. 

 

A court has recently held that a transaction entailing the buy-back of more than 5% of the company’s issued shares of a particular class also triggers appraisal rights protections. It is possible that the court’s decision will be taken on appeal.

How does a shareholder go about exercising the appraisal right?
A shareholder cannot exercise an appraisal right if it votes in favour of the transaction or amendment to the MoI. 

A shareholder initiates the process by sending certain notifications to the company. Absent agreement between the company and the shareholder on fair value, fair value is determined/‘appraised’ by the courts.

Who can exercise an appraisal right?
The appraisal right is available to shareholders of any South African-incorporated company. 

In a recent case, the court held that only the registered shareholder (i.e. the person registered in the securities register) can exercise an appraisal right. A person who is the beneficial owner of a share can only act with the authority of the registered shareholder. 

Can the appraisal right be used to block the implementation of corporate transactions or amendments to MoIs?

Importantly, the exercise of the appraisal right does not in and of itself delay or block a corporate transaction or amendment to the MoI. Rather, the appraisal rights process runs in parallel. The shares in relation to which the appraisal right is exercised will simply not form part of the transaction.

  • protection of individual shareholders; andIn this way, a balance is sought to be achieved between the:

  • right of the majority to determine the direction of a company.

 

The exercise of appraisal rights can, however, lead to the failure of the transaction in the following way: as there is no certainty as to what might be held to be fair value pursuant to the appraisal rights process, target companies need to consider the implications of opening themselves up to an unlimited financial exposure. 

If so, they might seek the right to walk away from the transaction if shareholders holding more than a specified percentage level of the shares exercise the appraisal right. This is achieved by making the transaction conditional on that level not being exceeded. The inclusion of such a condition precedent has become a common practice in the South African market. 

What constitutes ‘fair value’?
The Companies Act does not define ‘fair value’ in the context of appraisal rights, nor does it prescribe the valuation methodology to be used.

  • the extent of the deal protections afforded to the favoured bidder by the target company (such as a right to match a competing bid) might have unduly restricted competing offers. The thinking here is that if substantial deal protections have been granted to a preferred bidder, third parties which might otherwise have submitted competing bids, possibly at higher prices, might have been discouraged from doing so;One matter that the courts are likely to grapple with in determining fair value is how much weight to place on the fundamental transaction price itself in determining fair value. In other jurisdictions, it has been held that the magnitude of the weight to be afforded to the transaction price will depend on the following considerations, amongst others:

  • how arm’s-length the transaction is – whether there is a competitive/auction process, with bidders being granted similar rights to conduct due diligence;

  • whether there were significant negotiations with the favoured bidder, which led the bidder to increase its initial proposed price;

  • how well-informed, independent and experienced the directors of the target company are; 

  • whether there were extensive interactions with other potential bidders; and

  • the price at which the share traded in the period before the announcement of the recommended transaction (referred to, colloquially, as the unaffected share price). 

 

What risks are assumed by a shareholder which exercises the appraisal right?
While, on the face of it, it might appear that a shareholder has nothing to lose from exercising the appraisal right, the time and cost implications of a court process might negate the financial benefit which would be derived from a higher appraised fair value. 

Opportunistic utilisation of the appraisal rights mechanism?
The appraisal rights mechanism might be utilised by an opportunistic party to purchase shares in the market after the announcement of a transaction, in the hope/expectation of making a profit on the subsequent exercise of the appraisal right.  

In some other jurisdictions, certain thresholds have been included to limit opportunistic parties’ ability to use the appraisal

mechanisms in this way.

Waiver of the appraisal right?
In the course of negotiating a shareholder agreement, a shareholder should give consideration to requesting that other shareholders agree to a waiver of its ability to exercise appraisal rights in the future (that is, without any specific transaction being on the table). 

A shareholder which is requested to grant such a waiver should consider the importance of retaining the appraisal rights in all circumstances, or in certain circumstances, such as where a drag-along right is exercised. 

A drag-along right is a right granted to a shareholder which is selling its shares to require the other shareholders to also sell their shares, typically at the same price per share. Retaining a right to exercise appraisal rights if the drag-along right is exercised would give the shareholder the flexibility to seek a fair value payment from the company, rather than being forced to sell its shares at what it might regard as an undervalued price, pursuant to the drag-along provision.

The South African courts have not yet determined whether a general upfront waiver by a shareholder of its right to exercise an appraisal right is enforceable.

As a point of interest, The Court of Chancery of the State of Delaware held in 2019 that it was legally permissible for an appraisal right granted under the Delaware General Corporation Law statute to be contractually waived upfront. The decision was, however, based on the specific facts – the court held that the shareholder waiving its appraisal rights was a sophisticated investor which had been fully informed and represented by legal counsel when it signed the agreement, and that the waiver was expressed in clear and unambiguous terms. 

Fleiser is a Partner and Oosthuizen a Senior Associate, Bowmans South Africa.
 

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