Anti-takeover clauses in AOA: where is the red line?

By Jiang Fengtao and Liu Bing, Hengdu Law Firm
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The listed company “AOA War” recently spread to the A share market. For listed companies, the insertion of anti-takeover clauses in their articles of association (AOA) is the most economical and effective means of fending off takeovers. However, some anti-takeover clauses, while increasing takeover costs and difficulties for potential acquirers, also come up to a hair’s breadth from the red line drawn by the law, and with everyone getting in on the act, the lower boundary is constantly being pushed lower.

JIANG FENGTAO Managing, Partner, Hengdu Law Firm
JIANG FENGTAO
Managing Partner
Hengdu Law Firm

AOA autonomy. Company autonomy is the cornerstone of Company Law theory and practice, with its major manifestation being a company’s AOA. The new Company Law expands the autonomous space of a company’s AOA.

A company can make tailored revisions to its AOA. However, company autonomy must be carried out within the framework of the law. Its AOA may not run counter to mandatory norms of laws and regulations, and is required to conform with relevant provisions of the Administrative Measures for the Acquisition of Listed Companies, and the rights of shareholders must not be restricted in the name of “autonomy”. These two issues are the precondition for company autonomy.

VALIDITY OF CLAUSES

The anti-takeover clauses found in the AOA of listed companies can broadly be divided into three types:

  1. Provisions that limit shareholder rights. The Company Law specifies that the shareholders of a company enjoy such rights as returns on assets, participation in decision making and selection of managers, while also expressly providing for the qualification requirements and procedures for exercising such rights of shareholders as the right to present motions, the right to convene shareholder general meetings, the right to vote, etc. Accordingly, the addition or prolonging of a shareholding period requirement, raising the shareholding percentage requirement or adding procedural requirements by way of the AOA, restricts shareholders’ exercising of their right to present motions, convene shareholders’ general meetings, vote or nominate directors, and could be in contravention of current laws and present the risk of being found to be invalid or being rescinded.

    In contrast, in order to achieve the anti-takeover objective, and subject to the law, consideration can be given to imposing reasonable restrictions on things not expressly provided for in law, e.g., a director rotation system or restrictions on director qualifications. The election of directors needs to be grounded in the enhancement of the standard of corporate governance, not in the setting of unreasonable restrictions to prevent a takeover. Once incorporated into the company’s AOA, these restrictive provisions also become universally applicable and all shareholders are subject to them.

  2. Provisions that make the information disclosure obligation of the acquirer more onerous, including lowering the statutory minimum change in shareholding percentage that triggers a disclosure obligation by the acquirer, or increasing corresponding reporting and disclosure obligations. The Securities Law and the measures set out provisions concerning acquirers’ information disclosures and shareholding increase schedule. Pursuant to relevant provisions, when an investor’s acquisition of the outstanding shares of a listed company reaches 5%, it is required to perform its reporting and information disclosure obligations within three days, and is prohibited from further dealing in the listed company’s stock during that period. The measures also specify that the acquirer bears a confidentiality obligation before the information disclosure. Accordingly, an acquirer does not bear an information disclosure obligation until it reaches the 5% threshold, and a listed company may not impose undue restrictions through the revision of its AOA, as it does not have the qualifications to impose extra burdens on the acquiring entity.
  3. Provisions that increase the acquirer’s costs, including but not limited to “golden parachute” clauses, etc. With the aim of increasing an acquirer’s costs, a listed company will often include “golden parachute” clauses in its AOA, specifying that, in the event of a takeover, it is required to pay departing directors and senior management personnel a large compensation package. Chinese laws do not contain provisions that restrict this. However, such an act can give rise to a suspicion of siphoning of benefits, easily giving rise to disputes.

When defining the range of persons to be compensated, it is necessary to consider their positions and also to consider the value that they create for, and contributions they have made to, the company, to reduce the suspicions of the investor.

LIU BING, Partner, Hengdu Law Firm
LIU BING
Partner
Hengdu Law Firm

Second, the compensation should fall within reasonable bounds, such that it has a deterrent effect on takeovers but also avoids harming the interests of the listed company and the shareholders.

Third, as most of the people being compensated are the company’s directors, supervisors and senior management personnel, the payment of the above-mentioned compensation constitutes a connected transaction. Accordingly, the internal decision making procedure must be as sound as possible, e.g., when a vote is taken on such provisions at a shareholders’ general meeting, it needs to be adopted by a vote of the non-connected shareholders.

Finally, it is necessary to assess the impact of the compensation on the company’s business performance and give sufficient warning of the related risks.

With the arrival of these asset shortage times, quality listed companies will perhaps continue to be the prey fought over by various suitors for an extended period of time. The AOA revision war is continuing to play out, with everyone prodding and probing to find where the regulators have drawn their red line. If such manoeuvrings are not reined in, they could unduly increase acquirers’ takeover costs and even potentially jeopardize the normal expression of the overall restructuring function of the capital markets. Accordingly, how to properly balance the autonomy of listed companies and the expression by the market of its natural functions is an important issue facing regulators.

The authors would recommend that the regulators issue relevant policies as complementary measures, clarify the principles and the policy red line for the setting of anti-takeover clauses, and make known their thinking on typical provisions that have generated the most controversy in the market, giving the anti-takeover acts a model to follow.

Jiang Fengtao is the managing partner and Liu Bing is a partner at Hengdu Law Firm

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