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Unpacking Shareholders’ Pre-emptive Rights and Minority Oppression: A Case Analysis of Concrete Parade v Apex Equity

posted 3 weeks ago

Introduction

The Federal Court’s recent judgment in the case of Concrete Parade Sdn Bhd v Apex Equity Holdings Bhd & Ors [2021] 9 CLJ 849 marked the end of a protracted legal battle that reverberated through Malaysia’s corporate landscape. In this article, Lum Man Chan and Khew Gerjean provides an overview of the case, shedding light on the complexities surrounding pre-emptive rights of shareholders and the obtaining of shareholder’s approval in corporate exercises pursuant to the Companies Act 2016 (“the Act”).

In summary, the Federal Court’s answers to the legal questions that arise in this case are as follows:

1) Under S.85 of the Companies Act 2016 (“CA 2016”), pre-emptive rights of the shareholders is not mandatory but subject to the constitution of the company, which may renounce, disapply, or fortify such pre-emptive rights.

2) S.223(1)(i) and (ii) of the Act should be read disjunctively, so shareholders’ approval could be obtained either before entering into an agreement for the transaction or before the actual transfer of ownership of the asset.

3) The oppression action was not properly brought by the Concrete Parade Sdn Bhd because the shareholders who had voted in favour of the corporate exercises were not named in the oppression suit.

Background of the case

Concrete Parade Sdn Bhd (“Concrete Parade”) initiated a minority oppression action under S.346 CA 2016 against Apex Equity Holdings Berhad (“Apex Equity”) premised upon the following grievances:

a) proposed merger transaction between Apex Equity and Mercury Securities which would see Mercury Securities emerging as the largest shareholder in Apex Equity through shares allotment; and

b) Apex Equity has conducted share buy-back transactions in 2005 to 2017 in violation of its own M&A.

Proposed Merger Transaction

Unpacking Shareholders’ Pre-emptive Rights and Minority Oppression: A Case Analysis of Concrete Parade v Apex Equity

Apex Equity, along with its subsidiary JF Apex, planned a merger with Mercury. The proposed merger aimed to transfer Mercury’s stockbroking business to JF Apex in exchange for:

i. RM48 million cash

ii. RM100 million worth of new shares in Apex Equity

The parties entered into a Heads of Agreement (HOA) on 21 September 2018, followed by a Business Merger Agreement (BMA) on 18 December 2018. Additionally, subscription agreements (SAs) were signed with seven placees for a private placement of new shares (collectively referred as “the Merger Agreements”). After the execution of these documents, the shareholders’ resolutions were passed.

Share Buy-back Transactions

Between 2005 and 2017, Apex Equity undertook multiple shares buy-back transactions (“the transactions”). These transactions were conducted based on mandates and approvals granted by the company’s shareholders. However, in 2018, Concrete Parade brought to the attention of the Apex Equity’s management that the company’s Memorandum and Articles of Association (M&A) did not permit such transactions.

Despite the shareholder’s objection, the Apex Equity’s board sought a further mandate in 2018 to continue with the transactions. However, this resolution was voted against by the shareholders. Hence, Apex Equity filed a proceeding to validate the share buy-back transactions undertaken between 2005 and 2017 and it was eventually allowed by the High Court.

The Key Issues and the High Court Findings

1. FIRST ISSUE: Whether Apex Equity breached S.85 and S.223 of CA 2016.

Concrete Parade argued that it was denied its statutory and contractual pre-emptive rights to be offered new shares in Apex Equity. S.85(1) mandates that existing shareholders should be offered new shares before they are offered to outsiders. However, Apex Equity’s memorandum and articles of association, particularly Article 11, did not expressly ensure the protection of Concrete Parade’s pre-emptive rights.

Unpacking Shareholders’ Pre-emptive Rights and Minority Oppression: A Case Analysis of Concrete Parade v Apex Equity

The High Court Judge concluded that there was no breach of pre-emption rights since shareholders had approved the proposed placement. The shareholders would reasonably understand that a private placement would dilute their interest, even without explicit mention in the circular. Thus, the absence of specific language denoting pre-emption waiver couldn’t be deemed as oppressive as long as the transaction’s effects were reasonably clear to Apex Equity’s shareholders.

Further it was held that the shareholder’s approval sufficed either through prior general meeting approval or documentation specifying approval as a condition precedent. Since the BMA required shareholder approval for the acquisition of Mercury’s business, there was no violation. S.223(1) applies only when transactions create enforceable obligations on a company to acquire or dispose of substantial assets. The HOA, although legally binding, did not commit parties to the sale and purchase, thus not mandating shareholder approval.

Even if the HOA breached S.223(1), it was superseded by the BMA, which complied with shareholder approval requirements. S.223 should be construed in a disjunctive manner to allow for flexibility, stating that it suffices if either the entry into the arrangement is made conditional on shareholder approval OR if the carrying into effect of the transaction is approved by shareholders.

2. SECOND ISSUE: Whether the Share Buy-Back Transactions are valid and legal.

Concrete Parade contended that the share buy-back transactions were illegal due to the contravention of S.67 of the Companies Act 1965 and/or S.123 of the Companies Act 2016. The directors’ actions in seeking validation from the Court without amending the M&A were a blatant disregard of the company’s governing documents. The directors of Apex Equity should have obtained consent and authority from the shareholders before filing for validation proceedings. They argued that the filing of validation proceedings without prior knowledge or approval of the shareholders resulted in unfair prejudice to Concrete Parade, as it impinged upon their substantive rights.

The High Court ruled that the share buy-back transactions undertaken by the Apex Equity between 2005 and 2017 were valid, despite objections raised by the shareholder. While it is acknowledged that Concrete Parade were not notified of the validation proceedings, but it could not establish prejudice to its shareholder rights for recourse under S.346 of the CA 2016.

Dissatisfied with the High Court’s decision, Concrete Parade appealed to the Court of Appeal.

Court of Appeal Findings

The Court of Appeal found that Article 11 did not amount to a complete waiver of Concrete Parade’s pre-emptive rights. It was held that the Merger Resolutions passed after the execution of several agreements related to the proposed merger did not effectively waive the Concrete Parade’s statutory pre-emptive rights. For the Merger Resolutions to constitute an operative direction waiving the pre-emptive rights, specific information regarding the shareholders’ rights under the CA 2016 needed to be included. This information should have clarified that existing shareholders had a statutory pre-emptive right to be offered any new shares and that by voting in favour of the Merger Resolutions, they would be indirectly waiving these rights. Since this information was not provided, the court concluded that Concrete Parade’s pre-emptive rights had been unfairly denied, resulting in an unjustified dilution of their shareholding.

Next, it was held that S.223 is to be read conjunctively notwithstanding the use of the phrase ‘or’ between the two provisos. It imposes two separate requirements: one for entering the transaction and another for carrying it into effect. The Court of Appeal found that the Merger Agreements formed one composite transaction. For compliance with S.223, the HOA should have been subject to or contained a condition precedent for shareholder approval. Additionally, since the BMA was executed before shareholder approval was obtained, it failed to comply with the requirement of prior approval. Therefore, the Court concluded that Apex Equity had failed to fulfil the shareholder approval requirement under S.223, rendering the proposed merger invalid. The Court of Appeal imposed a duty on directors to inform shareholders at both the entry and execution stages of the transaction. It held that failure to obtain prior shareholder approval at either stage renders the transaction void.

The Impact of the Court of Appeal’s Decision

The Court of Appeal’s interpretation, where S.223(b)(i) and (ii) are read conjunctively, requires the directors to secure shareholder approval twice: once before entering into any form of agreement for a proposed acquisition or disposal of a substantial asset and again before executing it. This approach seems overly burdensome and impractical, potentially leading to the abandonment of many transactions and necessitating the preparation of two sets of documents. Such a requirement could hinder business operations and create unnecessary complexities.

The Court of Appeal further held that the share buy-back transactions remained illegal despite the validation order granted by the High Court due to the contravention of relevant sections of the Companies Act and the failure to obtain shareholder approval. Moreover, the filing of validation proceedings without prior shareholder consent or approval was unjust and prejudicial to the Concrete Parade’s rights. It emphasised the importance of obtaining shareholder authorisation before taking actions that significantly affect the company’s operations or financial transactions.

Analysis of the Federal Court’s Judgment

1) S.85 – Pre-emptive rights are subject to company’s constitution

S.85(1) grants shareholders the privilege to maintain their proportional ownership by offering them the opportunity to purchase shares before they are issued to outsiders. However, this right is subject to the constitution of the company, which may renounce, disapply, or fortify such pre-emptive rights. The Federal Court disagreed with the Court of Appeal interpretation that the pre-emptive rights are mandatory and pointed out the Court of Appeal’s failure to consider the purpose and intent of the Act in interpreting the provisions.

It was held that S.85(1) allows for discretionary application of pre-emptive rights based on the company’s constitution. The constitution prevails over statutory pre-emptive rights, allowing shareholders to determine whether to relinquish or retain such rights. Shareholders have the flexibility to determine the extent of their pre-emptive rights, as reflected in the constitution. Parliament did not intend to restrict directors’ powers or mandate pre-emptive rights but provided shareholders the freedom to decide through general meetings.

Interpretation of S.75 and 85: The Federal Court discussed the relationship between sections 75 and 85. S.75 deals with the power of directors to allot shares, requiring prior approval by the company before directors can proceed. However, exemptions in S.75(2) allow for issuance without general meeting approval for certain purposes, such as financing acquisitions.

When read together, S.75 and 85 establish the framework for pre-emptive rights of existing shareholders in the issuance of new shares. S.75 guarantees the general principle of pre-emptive rights, while S.85 allows companies to specify the details of these rights in their Articles of Association. The Articles of Association, as mentioned in S.85, can provide exceptions or modifications to pre-emptive rights, subject to the company’s constitution.

Interpretation of Article 11: The Court of Appeal interpreted the phrase “subject to direction to the contrary by the company at general meeting” as requiring the company to inform shareholders of their pre-emptive rights before any proposed issuance of new shares for raising capital. This interpretation imposes obligations on the company to seek explicit consent from shareholders before deviating from standard procedures regarding share issuance. However, the Federal Court disagreed with this interpretation. It asserted that pre-emptive rights are discretionary and can be applied based on the company’s constitution. The Federal Court emphasised that the phrase allows flexibility for the company to adapt its operations or decision-making processes as required by specific circumstances. Rejecting the imposition of additional conditions on the company could hinder its ability to efficiently conduct corporate transactions.

2) S.223 should be read disjunctively and there is no requirement for 2-tier approval

The Federal Court disagreed with the Court of Appeal’s interpretation. It argued that the word “or” should be read disjunctively, meaning that compliance with either sub-paragraph (b)(i) or (b)(ii) sufficed. According to this interpretation, shareholders’ approval could be obtained either before entering into an agreement for the transaction or before the actual transfer of ownership of the asset.

The Federal Court reasoned that requiring compliance with both sub-paragraphs would lead to impractical consequences for companies. It emphasised the importance of upholding the purpose and intent of the Companies Act, which aims to balance regulatory requirements with the efficient operation of businesses. This interpretation aligns with the overarching goal of ensuring transparency and shareholder awareness without unduly hindering corporate activities.

In conclusion, the Federal Court held:

– S.223(1)(i) and (ii) of the Act can be read disjunctively, meaning compliance with either sub-paragraph suffices.

– At least one agreement forming a composite transaction must contain an express condition precedent requiring shareholder resolution, and shareholder approval in a general meeting satisfies S.223(1)(ii).

– S.223(1) of the Act does not impose an incumbent duty on directors to inform shareholders of an intention to enter into or carry out an acquisition or disposal of substantial assets based on previous court decisions.

3) Was Concrete Parade unfairly prejudiced?

The Federal Court disagreed with the Court of Appeal’s assessment of whether the Concrete Parade suffered unfair prejudice compared to other shareholders. The Federal Court argued that since the majority of shareholders had approved the merger, there was no unfair prejudice. It suggested that the oppression claimed may have been more indicative of a management versus shareholder conflict rather than a minority-majority shareholder dispute. Additionally, the Federal Court questioned the Court of Appeal’s decision not to include the majority shareholders, who approved the transactions, as parties to the oppression action. This omission, according to the Federal Court, could have influenced the assessment of whether the Concrete Parade was unfairly prejudiced. It emphasised the principle of majority rule in corporate governance and stated that claims of oppression under S.346 of the CA 2016 cannot be used to circumvent legitimate decisions made by the majority.

4) Was the oppression action properly brought by Concrete Parade?

Given the lack of established contraventions of relevant sections of CA 2016 and the failure to conclusively establish illegality regarding the share buy-back transactions, the Federal Court questioned the suitability of the oppression remedy.

It was asserted that an oppression finding couldn’t be made under S.346 when shareholders had the opportunity to vote on transactions, approved them, and weren’t party to oppression proceedings. The Federal Court highlighted the failure of the Court of Appeal to grasp this fundamental issue.

Concrete Parade’s failure to join the majority shareholders, who allegedly oppressed them, was deemed fatal to the oppression action. By solely targeting the directors, Concrete Parade’s complaint lacked grounds for oppression action, suggesting it should have been brought against the officers or directors for contravening CA 2016. The Federal Court argued that Concrete Parade’s grievance was essentially against majority rule, disguised as an oppression action, constituting an abuse of statutory remedy.

The conduct of Concrete Parade was scrutinised, particularly its decision to pursue an oppression action despite majority approval of transactions. The Federal Court questioned whether the action was filed to hinder the proposed merger rather than to address actual unfair prejudice. Concrete Parade’s failure to demonstrate how it uniquely suffered prejudice, coupled with its attempt to hold directors accountable for majority decisions, indicated an abuse of the statutory process.

In essence, the Federal Court concluded that Concrete Parade ‘s oppression action lacked merit and appeared to serve a collateral purpose, constituting an abuse of the statutory process under S.346 of the Act.

5) S. 582: Share Buy-Back Transactions are not illegal under CA 2016

The Federal Court upheld the High Court’s decision. Despite finding that the transactions lacked proper authorisation under CA 2016, the Federal Court disagreed with Court of Appeal conclusion that they were unlawful and void. Instead, the Federal Court criticised the Court of Appeal’s legal interpretation, arguing that the transactions, while ultra vires, did not automatically constitute illegality.

The Federal Court refrained from definitively addressing whether S.582(3) could rectify an illegality, citing the conclusion that oppression wasn’t established. Nonetheless, Federal Court acknowledged the general view, that S.582 should not rectify illegality. It was highlighted that uncertainty regarding whether the lack of authorisation for share buy-backs amounted to illegality under S.67A and 127 of the Act. Since the focus was on whether the transactions unfairly prejudiced Concrete Parade, this issue wasn’t deemed crucial for resolution.

Regarding the High Court’s validation order, the Federal Court emphasised that while certain aspects of the transactions were unauthorised, it didn’t automatically render the entire process void. Ultimately, even if the transactions are contravened the company constitution/ rendered as void, there is no oppression on Concrete Parade because this would affect all the shareholders instead of Concrete Parade alone.

6) The Importance of Accurate Legal Citations in Judicial Proceedings

Federal Court also took the opportunity to address an important issue regarding the citation of legal precedents. They highlighted a case where incorrect and outdated decisions were cited to the Court of Appeal, potentially leading to an erroneous judgment. Such errors, they emphasised, could have significant consequences, impacting corporate transactions and potentially causing confusion in legal interpretations.

Federal Court stressed the responsibility of legal counsel to ensure the accuracy and relevance of cited cases, emphasizing the importance of thorough research. They noted that failure to do so could range from mere oversight to misleading the court, which is unacceptable conduct for any legal practitioner.

Federal Court also referenced a previous case to underscore the importance of well-researched advocacy, particularly in appellate proceedings. It is emphasised that judges rely heavily on the arguments and authorities presented by counsel, and any inaccuracies could lead to misinterpretations of the law and undermine the administration of justice.

In Malaysia, where legal professionals can appear before courts at various levels, maintaining high standards of advocacy is crucial for ensuring the accuracy and integrity of legal proceedings.

Conclusion

In complex transactions like mergers, the interpretation and application of provisions in CA 2016 require careful consideration of legal nuances and procedural requirements. The Federal Court’s analysis provides clarity on the scope and application of the provision, guiding companies and legal practitioners in navigating the intricacies of company law.

The Court of Appeal’s failure to recognize the significance of majority rule in the context of the merger approval is a critical oversight. By overlooking the fact that shareholders collectively voted in favor of the merger at a general meeting, the Court of Appeal failed to grasp that any alleged prejudice suffered by Concrete Parade would have affected all shareholders equally.

Moreover, it is essential to emphasise the paramountcy of majority rule in corporate governance. While S.346 of the CA 2016 introduces a statutory mechanism to address oppression, it is incumbent upon claimants to substantiate claims of unfairly prejudicial conduct. Attempting to invoke S.346 to circumvent situations where majority rule legitimately prevails, as demonstrated in this case, undermines the integrity of corporate decision-making processes.

In essence, the principle of majority rule serves as the cornerstone of corporate governance, and statutory remedies for oppression should not be misused to challenge bona fide decisions made by the majority of shareholders.


About the authors

Lum Man Chan

Partner

Dispute Resolution

Halim Hong & Quek

[email protected]

Khew Gerjean

Pupil-in-Chambers

Dispute Resolution

Halim Hong & Quek

[email protected]

Author

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