We look at the curious circumstances behind the failed privatisation of Glorious Property (0845) and call on the Cayman Islands and Bermuda, where 75% of HK-listed companies are incorporated, to follow HK in abolishing the headcount test.

Glorious failure in the Cayman Islands
19 January 2014

On Friday 17-Jan-2014, independent shareholders of Glorious Property Holdings Ltd (Glorious, 0845) vetoed the privatisation offer by majority shareholder Zhang Zhi Rong (Mr Zhang) by a very narrow margin. The case highlights the need for the Cayman Islands and Bermuda to catch up with Hong Kong and abolish the headcount test.

The offer was made using a scheme of arrangement (SoA) under the Cayman Islands Companies Law. In the Cayman Islands, as in Bermuda and the UK, there are two criteria to approve a Scheme of Arrangement:

In addition, there is a criterion in the Hong Kong Takeovers Code, to bring SoAs into line with general offers to purchase shares by protecting significant minorities against compulsory purchase:

The Glorious SoA easily satisfied the first criterion: of the voted shares, 96.92% were in favour and 3.08% against. It therefore follows that they satisfied the third criterion: the shares voted against were only 1.91% of the disinterested shares. But the deal failed on the headcount test, with 58 shareholders in favour and 62 against. If only 3 shareholders had voted the other way, the deal would have passed by 61 to 59.

Registered v beneficial owners

Note that the only "shareholders" that count in the headcount are registered shareholders, or in legal terms, the members of the company, the largest of which is HKSCC Nominees Ltd (HKSCCN), the depository of the Central Clearing and Automated Settlement System (CCASS). HKSCCN represents "CCASS Participants", including banks, brokers and custodians, and the clients behind them, none of whom is counted separately, and the court has no way of knowing for sure how many holders each custodian represents. Beneficial shareholders always have the option of removing their shares from custody and putting them on the register, thereby becoming members.

Although the Cayman Companies Law does not provide for anything other than a majority of registered shareholders, the court has a conflicting Practice Direction 2 of 2010 (the relevant part of which is identical to Practice Direction 1 of 2002), which includes a section on "Looking through the register" and allows for this possibility in paragraph 4.4:

"Custodians and clearing houses may be required to specify both the number of clients or members from whom they have received instructions in addition to the number of shares voted. The majority in number will be calculated on the basis of the number of clients or members giving instructions to the custodian or clearing house."

Whether or not this extra counting is required is a matter of discretion for the Grand Court, and apparently until 2012, they never did. In the Jan-2012 privatisation of Little Sheep Group Ltd (Little Sheep), the judge directed before the circular went out that HKSCCN should be treated as a "multi-headed member", looking through to the next layer and counting the CCASS Participants, in line with the Practice Direction. The privatisation circular included on page 10 the following words:

"the number of votes cast [by HKSCCN] in favour of the Scheme and the number of CCASS Participants on whose instructions they are cast and the number of votes cast [by HKSCCN] against the Scheme and the number of CCASS Participants on whose instructions they are cast will be disclosed to the Grand Court and may be taken into account in deciding whether or not the Grand Court should exercise its discretion to sanction the Scheme" (our underline)

As it turned out though, the Little Sheep offer was so popular that only 1 shareholder voted against so the point was moot. Later in 2012, a different judge, in the privatisation of Alibaba.com Ltd, was not as certain about the law, but ordered that (clearer law report here) the information on CCASS Participants be provided for the court's discretion. In the end, it didn't make a difference to the outcome in that case, although the judge did call for a review of the inconsistent Practice Direction.

Why did Glorious fail?

Now interestingly, on 7-Jan-2014, HKSCC put out a circular to CCASS Participants regarding the SoA for Glorious, advising that the numbers of participants would be counted and disclosed to the Grand Court for consideration, using the same words as in the Little Sheep circular above. In Friday's announcement, Glorious noted that (as advised by HKSCCN) 82 CCASS Participants voted in favour and 35 against. If added to the member count of 58:62, this would take it to 139:96, a clear majority in favour, but the announcement said the vote had failed and it thereby appears to rule out presenting those figures to the Grand Court for its discretion.

Unlike Little Sheep, there was nothing in the Glorious privatisation circular about counting CCASS Participants separately and submitting the tally to the court, so we don't know why HKSCC thought that would be the case. Did the company tell them? Did the Grand Court direct that the information be provided, as it did in Alibaba.com Ltd? It is puzzling that Glorious gave up so easily rather than take the CCASS Participant information to the Grand Court and try to persuade the judge to approve the deal. Could it be that Mr Zhang, who was financing the bid with borrowed money, got cold feet?

Decapitate the headcount in the former British Empire

Readers may recall that after a long battle launched on the back of the PCCW headcount vote-rigging scandal in 2009, Webb-site was successful in 2012 in persuading the HK Government to amend the HK Companies Ordinance, scrapping the headcount test for SoAs involving takeover offers and instead adopting the objection test into law from the Takeovers Code. The result is Section 674(2) of the Companies Ordinance 2012, which comes into effect on 3-Mar-2014. You may thank us later. For HK-incorporated companies, no longer will a few small registered shareholders be able to block a proposal which less than 10% of the independent shares oppose.

Unfortunately, Webb-site Who's Who shows that only 209 HK-listed companies are incorporated in HK, or 12.7% of the market, with the Cayman Islands having the largest share at 44.3% followed by Bermuda with 30.4%. Only 185 (11.2%) are incorporated in mainland China, mostly State-Owned Enterprises. As far as we can tell from looking at the web site of the Cayman Islands Law Reform Commission there is no plan on the agenda to amend the headcount test. We are not aware of any plans in Bermuda either. Bermuda completed an overhaul of its Companies Act in 2011. Both of these British colonies should follow a former one, Hong Kong, in abolishing the headcount and adopting the objection test. Fiddling around with counting CCASS Participants, who are not beneficial owners, is not an acceptable compromise. Similar concerns apply in the UK and throughout the former British Empire, whose members inherited this perverse aspect of company law.

So given that about 75% of HK-listed companies are incorporated in either Bermuda or the Cayman Islands, companies domiciled there which propose privatisations by SoA will continue to risk "glorious failure" of otherwise popular proposals due to the vagaries of the headcount test, even when it isn't rigged - and we have not inspected the Glorious share register for any evidence of that.

There is an alternative open to all of them - an offeror can make a "general offer" to buy the shares, and if he succeeds in acquiring 90% of the shares in the offer, then he can compulsorily acquire the rest. This is what happened in the last 3 Cayman privatisations in HK after Alibaba.com Ltd: PCD Stores (Group) Ltd, Trauson Holdings Co Ltd and ERA Mining Machinery Ltd.

And by the way, on Mr Zhang

For what it's worth, we are surprised that the offer received the support it did. The $1.80 bid was at a substantial 39% discount to net asset value of $2.95 at 30-Jun-2013, but perhaps investors felt they had no choice. The hilarious reason given for the offer was:

"The Offeror [Mr Zhang] considers that the depressed price of the Shares has had an adverse impact on the Company's reputation with customers, and therefore on its business, and also on employee morale. The implementation of the Proposal would eliminate this adverse impact."

But this is rather confusing cause and effect - it was in fact Mr Zhang who had an "adverse impact on the Company's reputation", and probably on its business and employee morale, when the US SEC pursued his private investment company for insider dealing in shares of Nexen Inc before its takeover by CNOOC Ltd, an allegation that was settled on 18-Oct-2012 for US$14m, twice the amount alleged to have been made. Mr Zhang resigned as Chairman and director of Glorious on 26-Nov-2012, at which point investors were sitting on a 66.6% loss from the 2-Oct-2009 listing day. On the same day, he resigned as Chairman of shipbuilder China Rongsheng Heavy Industries Group Holdings Ltd (CRHI, 1101) which had a negative return of 80.3% from its listing day on 19-Nov-2010 until his resignation. He has sold some of his controlling shareholding in CRHI but is still its single largest shareholder at 29.3%, and his father Zhang De Huang owns 11.4%.

© Webb-site.com, 2014

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