Hong Kong: Hong Kong Takeovers Practice: Do Not Take Chain Principle At Face Value - The Sino-Forest Decision

Keywords: Hong Kong, takeovers, Sino-Forest decision, GO Obligation

A mandatory bid (or a mandatory general offer obligation) ("GO Obligation") will be triggered if a controlling block in a listed company ("Controlling Block") changes hands.

The chain principle summarised

A GO Obligation will also be triggered if what changes hands is the shareholding in the up-the-chain holding company ("Holdco") that holds the Controlling Block and (1) the value of the Controlling Block represents a significant part of the Holdco's assets portfolio (i.e., 60 percent or more) ("Significance Test") or (2) one of the main purposes of the transfer at Holdco level is to acquire control of the Controlling Block. In other words, if the proportion of the Controlling Block value to the Holdco's assets portfolio is less than 60 percent and the main purpose is not to acquire control, then no GO Obligation will be triggered. This is the gist of the chain principle.

Care should be exercised

The Sino-Forest panel decision¹ told us that the chain principle will be applied strictly.

In a creditors' restructuring where a debtor company's assets are used to settle creditors' claims, very often a new company ("NewCo") will be established for the benefit of the creditors to take control and ownership of the debtor company's assets.

If the debtor company's assets comprise a Controlling Block, a GO Obligation may be triggered because of the chain principle depending on the relative value of that Controlling Block as compared to the debtor company's assets being transferred. If the Controlling Block's relative value is less than 60 percent and the main purpose of the restructuring is not to acquire the Controlling Block (but rather to restructure the ownership of the debtor company), then no GO Obligation will be triggered - or so it was thought, but in the Sino-Forest panel decision, it was ruled otherwise.

Narrow application of the chain principle

SFC expects the chain principle to apply strictly to the very transaction that effects the transfer of the Controlling Block where a Holdco structure is already in place. But that was not what happened in the Sino-Forest restructuring plan or in a typical creditor's restructuring situation, which comprised a series of inter-conditional transactions to effect transfers in favour of NewCo and no existing Holdco structure was in place for the Controlling Block.

The chain principle will not look at a series of transactions or a larger commercial transaction (i.e., the restructuring plan in the Sino-Forest panel decision) even where the Controlling Block (i.e., those of Greenheart held by Sino-Forest) only represents an insignificant part of such a series of transactions or a larger such commercial transaction.

SFC has stated that "its focus [the chain principle] is quite narrow and that it simply looks at a transaction, whether it is an element of a larger one or not, in which statutory control of one company results in the acquisition or consolidation of control, as defined in the Takeovers Code, of a second company."

Consult SFC in advance

Market participants should consult SFC early on, before entering into a transaction or settling on a deal structure if a GO Obligation is to be prevented, or else they could run the risk of triggering a GO Obligation which would not otherwise be apparent.

Originally published 25 February 2013

Footnote

1 Panel Decision - In relation to a referral to the Takeovers and Mergers Panel (the "Panel") for a ruling on whether a Chain Principle Offer will be triggered for Greenheart Group Limited ("Greenheart", Stock Code: 94) upon the implementation of the restructuring of Sino-Forest Corporation ("Sino-Forest") which can be downloaded via this link.

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