Latest Developments On Pre-Emptive Rights And Shareholders’ Approval Under Companies Act 2016

In a recent landmark decision, the Federal Court resolved several critical issues on pre-emptive rights and shareholders’ approval impacting Malaysia’s corporate governance landscape.

In Concrete Parade Sdn. Bhd. v Apex Equity Holdings Berhad & Others, the Federal Court overturned the earlier Court of Appeal decision, and affirmed the High Court decision on the interpretation of sections 85(1) and 223(1) of the Companies 2016 (“CA 2016”). These sections respectively provide for shareholders’ pre-emptive rights and the requirement to procure shareholders’ approval for an acquisition or disposal of a company’s property or undertaking of a substantial value or portion.

The decision provides clarity on the approach to be adopted when there appears to be statutory constraints under the CA 2016 that may limit the operational and expansion capabilities of a company. It highlights the importance of striking a balance between the rights and interests of shareholders, powers of directors and commercial interests of a company. In this article, we will be examining the Federal Court’s decision and its impact on managing the complexities of corporate governance.

Background of the case

Concrete Parade Sdn. Bhd. (“Concrete Parade”), a shareholder of Apex Equity Holdings Berhad (“Apex Equity”), commenced a lawsuit against Apex Equity and 15 other defendants for minority oppression under section 346 of the CA2016. The lawsuit was due to the following transactions:

• share buy-back transactions conducted by Apex Equity between 2005 and 2017; and
• proposed merger of the stockbroking businesses of Mercury Securities Sdn. Bhd. (“Mercury Securities”) and JF Apex Securities Berhad (“JF Apex”), a subsidiary of Apex Equity. The merger involved (i) cash consideration of RM48 million, funded by issuance of new Apex Equity shares through private placement with other defendants (including Mercury Securities), and (ii) non-cash consideration of RM92 million in the form of new Apex Equity shares issued to Mercury Securities (collectively, the “Mercury Transaction”).

Under the Mercury Transaction, Apex Equity, JF Apex and Mercury Securities entered into a business merger agreement (“BMA”) which sets out conditions precedent to be satisfied before the Mercury Transaction can be completed, including obtaining approval of the existing shareholders of Apex Equity for the Mercury Transaction. Such shareholders’ approval was obtained only after the execution of the BMA. The same conditions precedent in the BMA are applicable in the individual share subscription agreements (“SSA”) executed in relation to the private placements.

Prior to the execution of the BMA, Apex Equity and Mercury Securities entered into a heads of agreement (“HOA”), which sets out the salient terms of the BMA, including the condition precedent relating to the approval of the existing shareholders of Apex Equity for the Mercury Transaction. The HOA is expressed to be legally binding.

Concrete Parade claimed the following:

• Contravention of section 85(1) of the CA 2016 – the proposed private placement exercise has dilutive effects on the respective shareholdings of the existing shareholders of Apex Equity. Further, there was no resolution expressly asking such shareholders to waive their pre-emptive rights prior to approving the Mercury Transaction.
• Contravention of Section 223(1) of the CA 2016 – the HOA does not contain shareholders’ approval as a condition precedent. No shareholders’ approval was obtained prior to the execution of the BMA.

Decision by the Federal Court

Section 85(1) of the CA 2016: What constitutes a waiver of pre-emptive rights?

Section 85(1) provides that where a company issues new shares which rank equally to existing shares as to voting or distribution rights, the company must first offer the new shares to the existing shareholders on a pro rata basis, unless otherwise provided in the company’s constitution. This provision safeguards the existing shareholders from a dilution in share ownership, as a result of the company issuing new shares to raise capital.

Under the constitution of Apex Equity, any issuance of new shares or other convertible securities by Apex Equity is subject to any “direction to the contrary” given by the shareholders of Apex Equity. The Federal Court held that the shareholders’ approval for the Mercury Transaction constitutes a valid “direction to the contrary” and hence amounts to waiver of pre-emptive rights.

The court ruled on the grounds that:

• Pre-emptive rights under section 85(1) are not absolute mandatory legal rights. Section 85(1) only grants statutory privilege for the existing shareholders of a company to maintain their proportional ownership in the company. Pre-emptive rights can be waived by the shareholders if the company’s constitution (which represents the contractual position between the shareholders and the company as well as among the shareholders themselves) allows so.
• There is no need for the shareholders’ resolution to expressly set out all requisite information regarding pre-emptive rights under section 85(1) (including what amounts to a waiver of such rights and the consequences of doing so). It is also not necessary for the existing shareholders to expressly stipulate their consent to waive their pre-emptive rights, as the shareholders would have known the dilutive effects of a proposed corporate transaction that involves issuance of new shares when they voted in favour of it.  
• It is not practical to offer new shares to the existing shareholders of a company and obtain their approval prior to entering into any agreement that sets out the terms for a corporate transaction which will only be performed and carried into effect upon satisfaction of certain conditions. This would only delay or prolong negotiations and potentially result in abortion of the corporate transaction.  

Section 223(1) of the CA 2016: When to obtain shareholders’ approval?

Section 223(1) provides that the directors of a company shall not enter or carry into effect any arrangement or transaction for the acquisition or disposal of an undertaking or property of a substantial value or portion unless:

• the entering into such arrangement or transaction is made subject to the shareholders’ approval by way of resolution; or
• the carrying into effect of such arrangement or transaction has been approved by the shareholders by way of resolution.

This case raises the question on the precise point in time when directors of a company are to obtain shareholders’ approval in relation to the acquisition or disposal of assets within the company.

In reversing the Court of Appeal’s decision, the Federal Court held that shareholders’ approval should not be obtained twice – first, prior to the entry into an agreement for such acquisition or disposal, and second, prior to effecting such acquisition or disposal. This was on the basis that shareholders cannot be giving approval without the full terms of the agreement having been worked out and fair comprehension of the proposed transaction. The need to procure two sets of shareholders’ approval on the same transaction would affect the business efficacy and performance of the company. It is sufficient to just have one set of shareholders’ approval, either by entering into an agreement that contains a condition precedent to obtain shareholders’ approval or by obtaining shareholders’ approval before ownership of asset is effectively acquired or divested.

Concrete Parade claimed that the contravention of section 223(1) was due to the execution of the HOA and the BMA. The Federal Court agreed with the High Court that the HOA is a mere record of the mutual understanding between Apex Equity and Mercury Securities in respect of the Mercury Transaction (including the execution of the BMA). It does not have any effect of creating enforceable obligations on Apex Equity to acquire the shares of Mercury Securities through JF Apex. Hence, the HOA does not need to contain a condition precedent to obtain shareholders’ approval. The Federal Court disagreed with the Court of Appeal that the execution of the BMA was the carrying into effect of the HOA and prior shareholder’s approval should be obtained. According to the Federal Court, the BMA contained a condition precedent to obtain shareholders’ approval and its execution cannot possibly have the effect of carrying into effect of the HOA and the Mercury Transaction. Thus, no shareholders’ approval is required prior to the execution of the BMA.

Commentary

The Federal Court’s decision is significant as it highlights the importance of striking a balance between the rights and interests of shareholders, the powers of directors and the commercial interests of a company. It provides pragmatic guidance to companies navigating the complexities of corporate governance.

From a practical standpoint, it is not feasible for a company to notify its shareholders of any intention to enter into a corporate transaction (including fundraising exercise that involves issuance of new shares and acquisition or disposal of assets) and seek their approval even before negotiations begin. The terms of such transaction are agreed upon in term sheets or similar agreements. Opportunities for growth will slip away if the company delays its expression of interest to partake in a corporate transaction due to any setback in getting votes from shareholders in a short span of time. Further, especially if the company is publicly listed, any early announcement for such intention to enter into a corporate transaction will excite the market even before any agreement is entered into, resulting in share price fluctuation which may adversely affect the bargaining position of parties to the transaction and create deal uncertainty.

If you have any questions or require any additional information, please contact Chan Xian Ai, or the Zaid Ibrahim & Co (in association with KPMG Law) partner you usually deal with. This article was prepared with the assistance of Jean Lee Jia Ying, Senior Associate at Zaid Ibrahim & Co (in association with KPMG Law).