The Shoeshine Column: Bad law behind NGC's buyout battle

Friday 9th February 2001

Perhaps that's using the imagination a bit too freely. But it's still an imaginable consequence of a law that needs urgently to be rewritten to provide certainty about what our lawmakers intend.

Do directors have a duty to exploit bad law for their shareholders' gain? The answer to that question could have big implications for corporate New Zealand if Infratil triumphs over Natural Gas Corporation in its arbitration over minority buy-out rights. With a little imagination you could picture an obscure and appallingly drafted provision of the Companies Act bringing commercial activity into a state of near-paralysis.

The section in question, 110, first appeared in the act's latest rewrite in 1993. That seven years passed before it was invoked makes you wonder if it serves any useful purpose.

It is designed, presumably, to protect the rights of minority shareholders when boards decide to pursue major change.

It allows minorities to require the company to buy back their shares in any of three circumstances requiring approval by special resolution of shareholders: a merger with another company, a "major transaction" involving more than half the company's assets, or a change to the constitution that imposes or revokes a restriction on the company's activities.

The minority shareholder must have voted its shares against the resolution, which must subsequently have been approved.

Infratil's legal boys spotted it back in March last year when NGC proposed to pay $834 million for a 75.8% stake in TransAlta New Zealand.

The acquisition, after a cleanup of the TransAlta minorities, made NGC the country's biggest energy trader and generator by market capitalisation but it didn't please Infratil, which had a 6.7% stake.

With the share price at around 130c Infratil voted against the transaction. Chairman Kevin O'Connor explained his directors "consider the new direction of NGC no longer fits well with its energy investment strategy" and demanded NGC buy back its shares under s110.

So far so good. But the issue has already been in and out of the courts and is now heading for arbitration.

That's because the law is so badly drafted. It says the board of the company required to buy back shares must nominate "a fair and reasonable price." If the seller thinks they're worth more, the company has to pay over the amount owed according its own assessment and refer the matter to arbitration.

The act doesn't say at what point the seller must hand over the shares and Infratil and NGC had to sort that out in court. NGC won and got its shares back.

Now the arbitrator, a retired judge, has the daunting task of deciding what the shares were worth.

NGC's offer of 130c was based on the market price at the time it announced its intention to bid for the TransAlta stake, with adjustments for dividends, etc.

Infratil reckons it should be paid the shares' "economic value," which it puts at 180c a share. As it had 26.6 million shares, $13.3 million is at stake.

The omission of a price formula by the law's creators seems particularly craven because it obscures what they had in mind in the first place.

In the US similar legislation has been used mainly to protect shareholders in private companies where there is little or no market liquidity.

NGC will no doubt argue that, where there is an active market, the market price is the only true determinant of shares' worth. Infratil could have sold on-market if it didn't like the company's plans.

In fact it's pretty difficult to sell such a large line of stock into the market in short order without driving the price down. The act seems to recognise this by providing that a board can, instead of offering a price for the shares, arrange for someone else to buy them - by institutional placement, for example.

But Infratil was never going to agree to that. It wants 180c and no institution would pay that big a premium.

The decision will be of great interest to professional investors - if it ever sees the light of day, which it won't unless both sides agree to release it.

There's no "appeal" from arbitration - it was designed to deliver finality - and very limited avenues for relief from the courts.

While arbitration decisions don't create "precedence from higher authority" as court judgments do, where the facts in two cases aren't materially different arbitrators tend to regard previous decisions as highly persuasive.

So the NGC-Infratil decision could set the ground for all future cases. Heaps of companies trade at a discount to their economic value, net tangible asset backing, discounted cash flow value or what have you.

If the decision goes Infratil's way, what will happen when one of those companies wants to make a major transaction, to merge or to alter its constitution?

If a shareholder genuinely thinks the change will be bad for the company he won't sell on-market. He'll go straight to the arbitrator to capture the higher value.

Even if a shareholder thinks the change will be positive he'll have to ask himself whether a bird in the bush - the possible improvement in the share price - is better than the bird in the hand of arbitrated payment.

Institutional investors, and companies like Infratil and GPG, will be duty-bound to get the best deal for their investors or shareholders, even if that means voting the resolution down and running to the arbitrator.

And if enough of them do that the company won't be able to muster the 75% of votes needed to approve a special resolution - even if many of the shareholders don't have any genuine objection to its plans.

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