Pre-emptive rights give incumbent shareholders the opportunity to buy other participants’ shares before they are offered or sold to a third party. A recent case demonstrates the need for very clear language if you are trying to apply a pre-emptive rights regime to situations where there has been a change in the control of one of the shareholders.
Who needs to know?
Anyone who is involved in negotiating or drafting shareholders’ agreements, joint venture agreements and company constitutions. The case is also relevant to corporate advisors assisting clients with transactions that may potentially trigger pre-emptive rights.
Background
The identity of the participants is absolutely critical to the success of most joint ventures and shareholder arrangements. The participants need to be able to “get along” and have at least some degree of rapport, common objectives and confidence in each others financial standing and general reputation etc. Technical skills and experience may also be key factors, as may be the involvement of key individuals. These are all reasons why shareholder and joint venture agreements place restrictions (such as pre-emptive rights) around the ability of participants to sell out their interests to third parties.
To ensure that pre-emptive rights are not undermined or easily circumvented, the pre-emptive rights are usually drafted broadly so as to be triggered by a participant if any type of ‘disposal’ is proposed or occurs e.g. any legal or beneficial transfer of shares. But what about if the other participant is itself acquired by a third party? In that situation, there is no transfer of shares in the joint venture company. The shareholders in the joint venture company remain the same, albeit control and ownership of the shares indirectly passes to the third party who now controls one of the shareholders.
In Goldus Pty Ltd v Australian Mining Pty Ltd [2015] SASC 32 (click here for a copy of the case), the Supreme Court of South Australia had to decide whether a change in the ownership of a shareholder triggered the pre-emptive rights in a joint venture agreement relating to gold mining tenements. The key provision in the joint venture agreement was as follows:
A Change of Control of a Joint Venturer (except as a result of a Change of Control of an entity that is listed on a recognised stock exchange) shall, for the purposes of clause 13, constitute a Disposal to a non-Related Company of the Participating Interest of that Joint Venturer, in which case the provisions of clause 13 shall apply.
Clause 13 contained the pre-emptive process. It was relatively standard, including:
- a general prohibition on disposals unless the procedures in clause 13 had been complied with;
- a requirement that a notice must be given by a participant if it “wishes” to dispose of all or any of its interests in the joint venture;
- the notice must state the “consideration for … , and on terms and conditions upon which, it wishes to dispose” of its interest;
- the non-disposing party had an option period of 30 days to purchase the interest for the consideration and on the terms and conditions specified in the notice; and
- if the non-disposing party did not elect to purchase the interest, then the disposing party could dispose of its interest to a third party within a period of 90 days commencing from when the 30 day option period expired. Any disposal to a third party had to be for a consideration “not less than” and on terms etc “no more favourable to the third party” than those specified in the notice given under clause 13.
The pre-emptive rights procedure worked fine when applied to simple transfers of interests in the joint venture directly. However, despite the parties clearly intending that a change of control should constitute a disposal, pre-emptive the procedures did not work very well when applied to a change of control scenario. In particular:
- no notice was actually given in this scenario and nor did the change of control clause deem a notice to be given (or require a notice to be given). How could the pre-emptive rights procedure apply without a notice (actual or deemed)? The court was not prepared to imply an obligation to require the joint venturer to give a notice on the “fictional basis” that it “wished” to dispose of its interest in the joint venture. The court said that the change of control clause could have been drafted so as to pretend (i.e. deem) that a joint venturer wished to dispose of its interest whenever a change of control occurred to it, but the drafting did not take this “additional step”. All the drafting did was to deem the change of control to constitute a disposal. The court may be viewed as taking a very narrow or uncommercial approach on this point, but even if a notice was deemed to have been given (or the joint venturer deemed to be “wishing” to dispose of its interest), the clause was unworkable for other reasons (see below);
- what was the “consideration” for the purposes of the pre-emptive rights procedure? As it happened, the participant that was taken over by the third party held several other valuable assets in addition to the interests in the gold mining joint venture, so it was not possible to simply treat the takeover price as being the same as the consideration for the joint venture interest. The court was not prepared to impose its own best guess of what the “consideration” should have been and nor was the court prepared to appoint a valuer for this purpose; and
- what were the “terms and conditions” for the purposes of the pre-emptive rights procedure? The transaction whereby the third party acquired ownership of the joint venture participant was a very different type of transaction. The court was therefore not prepared to apply those terms or make up its own terms and conditions for the purpose of allowing the pre-emptive rights procedure to function.
Overall, despite the parties clearly intending that a change of control should trigger the pre-emptive rights procedure, the drafting of the pre-emptive rights clause let them down. The court held that the pre-emptive rights procedure (when applied in a change of control context) was void because it was too vague and unworkable.
Practical Points to Take Away
- Always road test your pre-emptive rights provisions to make sure they actually work in all of the scenarios in which they may potentially be applied. Sometimes a shorthand approach will work, but as this case demonstrates, this won’t always be the case. It therefore pays to spell things out more clearly to ensure that the provisions you are seeking to apply are actually capable of applying in the relevant circumstances.
- Courts are usually reluctant to declare a contract or clause void for uncertainty or vagueness. This is particularly true for pre-emptive rights provisions where the underlying objectives of such provisions are well known to the courts and generally interpreted broadly. Nevertheless, this has its limits. As this case demonstrates, the courts won’t rewrite the contract for the parties and nor will they readily imply obligations to give transfer notices.
- In this case, it probably would have been better if the change of control clause expressly stated that a transfer notice was “deemed” to have been given for the purposes of the pre-emptive rights procedure or that the joint venturer was deemed to be wishing to dispose of its interest in the joint venture. Further, the change of control clause should have dealt with how the consideration and terms etc were to be determined e.g. included some basic sale terms and a procedure by which the price was to be agreed or determined by a valuer etc.
- In this case, the joint venture agreement contained a compulsory transfer and valuation procedure, however, this only applied if a party breached the joint venture agreement. Since the court held that the pre-emptive rights provisions were void (insofar as they purported to apply in a change of control scenario), there could be no breach of those provisions and accordingly the compulsory transfer and valuation provisions did not come into play.
- Rather than deeming a change of control to constitute a disposal, an alternative approach is to include change of control as one of the “Events of Default” or “Review Events” under the joint venture agreement or relevant document. Other events of default usually include breaches of the joint venture agreement as well as insolvency type events. Events of default often trigger compulsory transfers and valuations (see above). These provisions still need to be clearly drafted, but they are usually more amenable to addressing pre-emptive rights in a change of control scenario because they do not suffer from the “fictional basis” of pretending that the defaulting party “wishes” to transfer its shares.