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High Court provides guidance on full and fair disclosure in circular to shareholders

23 July 2020

In Mercury Securities Sdn Bhd & Anor v Concrete Parade Sdn Bhd & Anor [2020] 6 CLJ 517, the High Court provided helpful guidance on some aspects of the law relating to the requirement to make full and fair disclosure in a circular issued by a company to its shareholders.
 
Background
 
The applicants, Mercury Securities Sdn Bhd (‘Mercury’) and JF Apex Securities Berhad (‘JF Apex’), are both licensed stockbroking companies. JF Apex is a subsidiary of Apex Equity Holdings Berhad (‘Apex Equity’), a public listed company.
 
Apex Equity and the applicants had entered into a business merger agreement (‘BMA’) on 18 December 2018 whereby Mercury would transfer its stockbroking business to JF Apex. The transaction under the BMA was approved by Apex Equity in a general meeting on 19 June 2019 (‘First EGM’).
 
The applicants applied to the High Court to vest the stockbroking business of Mercury in JF Apex pursuant to section 139 of the Capital Markets and Services Act 2007 (‘CMSA’).[1]
 
The second respondent, Pinerains Sdn Bhd (‘Pinerains’), a shareholder of Apex Equity sought to intervene in the application, inter alia, on grounds that the shareholders’ circular (‘shareholders’ circular’) pursuant to which the shareholders’ approval was obtained at the First EGM was misleading. The Court upheld one of the grounds raised by Pinerains and held that the resolution passed at the First EGM was void and ineffective.
 
Following from the High Court’s decision that the resolution passed at the First EGM was void and ineffective, Apex Equity convened another general meeting to approve the transaction on 18 November 2019 (‘Second EGM’). Pinerains sought a court order to direct the chairman of the meeting to adjourn the meeting pending the appointment by the Securities Commission (‘SC’) of an independent advisor pursuant to section 218A of the CMSA. Pinerains also sought an order for the Court to appoint an independent scrutineer to attend the Second EGM to oversee the voting process.
 
The judgment deals with the decisions by the learned Judge to set aside the resolution passed at the First EGM as well as the application by Pinerains for court orders in relation to the Second EGM.
 
Applicable test under section 139 of the CMSA
 
The learned Judge first considered the role of the Court in approving an application under section 139 of the CMSA.
 
Azizul Azmi Adnan J took the view that the role of the Court in an application under section 139 is to ascertain the legality of the transaction, and not its fairness or commercial desirability. The Judge said that the position was similar to that relating to a vesting order under section 50 of the Banking and Financial Institutions Act 1989 (now repealed) where Selventhiranathan J in Standard Chartered Bank Malaysia Bhd v Eden Enterprises (M) Bhd [2003] 3 MLJ 81, said:
 
“The only grounds on which the vesting order could conceivably be called into question would be either that it did not conform with the approved agreement or arrangement, or that the approved agreement or arrangement was ultra vires the Act or ultra vires any other law which prevailed over the Act, consequentially rendering the vesting order null and void.” 
 
Justice Azizul contrasted this with the role of the Court in approving a scheme of arrangement under section 360 of the Companies Act 2016 (‘CA2016’), where the court examines to a limited extent, the fairness of the transaction and cited In Re Sateras Resources (Malaysia) Berhad [2005] 6 CLJ 194, as a Malaysian case authority that supports this proposition.
 
The Court added that, by contrast, in an application under section 139 of the CMSA, the fairness of the transaction is not a relevant consideration for the court because it would be for the shareholders to assess its fairness and to approve the transaction accordingly.
 
In assessing the legality of a transaction under consideration in an application under section 139 of the CMSA, the relevant matters include compliance with the terms of approval by the regulatory authorities (see Standard Chartered Bank Malaysia Bhd v Eden Enterprises (M) Bhd) and also the question whether shareholder approval has been properly obtained.
 
Disclosure standards in shareholders’ circulars
 
The Court summarised the law on the disclosure standards applicable to shareholders’ circulars in the following terms:
 
  1. A duty is imposed on the directors to make a full and honest disclosure to the shareholders before they vote on any resolution (John Crowther Group Plc v Carpets International [1990] BCLC 461); put another way, there is a duty not to mislead (Koperasi Nesa Pelbagai Bhd v Maika Holdings Bhd & Another Case [2008] 4 AMR 344). This duty arises both in equity as part of the fiduciary duties of directors (Fraser v NRMA Holdings Ltd 15 ACSR 590) as well as an implied duty pursuant to section 223 of the CA2016;
  1. The duty to make ‘full and honest disclosure’ (also described as ‘full and fair disclosure’) in a shareholders’ circular exists to allow a reasonable shareholder to make an informed decision regarding the transaction (Dato’ Mohd Tahir Abdul Rahim & Ors v Sykt Permodalan Kebangsaan Bhd & Ors [1991] 2 CLJ 1155, applying Kaye v Croydon Tramways Company [1989] 1 Ch 359 (CA) and Baillie v Oriental Telephone [1915] 1 Ch 503 (CA)). Implicit in this statement is that there must be a disclosure of all material matters. What is required is that the contents of the shareholders’ circular are complete in all material respects and do not contain any information that is misleading in any material particular. Azizul J added that a disclosure that is unintentionally misleading or incomplete would not constitute adequate disclosure and may result in the striking down of an affected resolution. Whether or not the failure to adhere to the applicable standard of disclosure was intentional would have a bearing on the liability of the directors;
  1. The information must be presented in a manner that enables a shareholder who scanned or read the document quickly as an ordinary person in commerce to make an informed decision (Devereaux Holdings v Pelsart Resources (No. 2) (1985) 9 ACLR 956);
  1. In the case of a company listed on Bursa Malaysia, it is not an answer to say that there has been a mechanistic compliance with the disclosure requirements contained in the Listing Requirements if there had not been full and fair disclosure; and
  1. It will not be necessary for the shareholder seeking to challenge a resolution passed at a general meeting to establish that it would have voted differently had adequate disclosure been made. According to His Lordship, “The test, as explained, is whether the information that was not disclosed or disclosed incorrectly was information that a reasonable shareholder would have required in order to make an informed decision whether or not to approve the transaction in question.” Thus, if a shareholder alleges that information contained in a shareholders’ circular was misleading and that it possessed information regarding the true state of affairs before voting on the resolution, this does not rob the shareholder of its locus standi to challenge the resolution. Even though the shareholder would not have voted any differently had the correct disclosure been made, what matters are not the actions of the specific shareholder in question, but the collective decision of the body of shareholders.
His Lordship also added that the disclosure standards would be the same in all instances, including where approval of shareholders is being sought for a scheme of arrangement.
 
Consequences of breach
 
According to the Court, the breach of a duty to make full and fair disclosure does not invalidate the transaction itself, but will render the resolution approving it to be ineffective (Kaye v Croydon Tramways Company). The practical consequence is that it would still be open to the shareholders to subsequently approve the transaction provided that there is adequate disclosure of material information at any subsequent general meeting of the company. It also means that, depending on whether the approval of shareholders has been specified as a condition precedent to the rights and obligations under the transaction, the counterparty may have a right to sue the company for breach if the transaction is not subsequently carried out.
 
Who may commence the action?
 
According to the Court, an action to set aside a resolution obtained in breach of the duty to make full and fair disclosure to the shareholders can be commenced by any shareholder, whether dissentient or absent (Kaye v Croydon Tramways Company). The Judge, citing Darvall v North Sydney Brick & Tile Co Ltd (1988) 14 ACLR 717 as an example, opined that there is no requirement under Malaysian law for the interveners in this case to state that they had intervened for the benefit of all shareholders as a whole.
 
Pinerains’ contentions
 
Pinerains raised five grounds in support of its contention that the shareholders’ circular was misleading and breached the duty placed on the directors to make full and fair disclosure and in consequence, rendered the resolution passed at the First EGM void.
 
The learned Judge considered Pinerains’ contentions in detail and dismissed four of them for the following reasons:
 
  1. description of the goodwill to be acquired: upon reading the disclosure in the shareholders’ circular as a whole, the Judge saw no issue with the way in which the goodwill to be acquired was described;
  1. non-disclosure of the results of the impairment test in the circular: the Judge was of the view that the information relating to the impairment test was not material for the shareholders to make an informed decision whether or not to approve the proposed transaction; rather, the policies on impairment were to be applied by the completion auditors at the completion date to determine any price adjustments to be made pursuant to the BMA;
  1. due diligence condition precedent: the Judge found that based on the facts, the due diligence condition precedent was fulfilled only after the latest practicable date (‘LPD’) on which information used in the shareholders’ circular was based. Although there was an omission in the shareholders’ circular to state that the due diligence condition was outstanding as at the LPD, the Judge was of the view that this omission did not materially affect the rights of any shareholder; if the condition precedent had not been fulfilled, the transaction would not proceed to completion; and
  1. non-disclosure of reservation expressed by director: although a director of Apex Equity had expressed reservations about certain aspects of the transaction, the director concerned had not voted against the transaction or opined that the transaction was not in the best interests of Apex Equity. The Judge observed that the Listing Requirements only require a director who is of the view that the transaction was not in the best interest of a listed issuer to state in the shareholders’ circular the reasons for his opinion and the factors he had taken into consideration in forming his opinion. As the Listing Requirements do not require the reservations of the director to be disclosed in the shareholders’ circular, there was no obligation to do so. The Court added that no obligation arose under either the common law or statute for such fact to be disclosed.
Exclusion of certain property
 
The learned Judge agreed with Pinerains’ fifth contention that the lack of clarity in the shareholders’ circular in relation to the assets that were excluded from the transaction, namely landed property, cash and cash equivalents, constituted a breach of the duty to make full and fair disclosure to the shareholders.
 
According to Justice Azizul, the exclusion of the aforesaid assets from the assets to be acquired under the BMA was only explained in a very oblique and almost opaque manner and it was only by comparing Mercury’s balance sheet with the proforma balance sheet of the merged entity that it could be surmised that those assets had been excluded.  
 
The Court agreed with Pinerains that the nature of the assets to be acquired was material information that was necessary to be disclosed in the shareholders’ circular in order to allow a reasonable shareholder to make an informed decision whether or not to approve the transaction. The Court added that the inclusion of Mercury’s financial statements may result in the mistaken assumption by a reasonable shareholder that all of its assets were subject to the acquisition. It was only by closely examining the proforma balance sheet that the truth will dawn. In the Court’s view, a reasonable investor reading or scanning the shareholders’ circular quickly would not appreciate this fact.
 
For the above reasons, the Judge found that the shareholders’ circular did not constitute full and fair disclosure to the shareholders and that as a consequence, the resolution passed was ineffective for the purposes of approving the transaction.
 
Valuation methodology
 
The Judge took the view that it was incumbent on the directors to explain why they had used a particular method of valuation in arriving at the acquisition price. Although this issue was not raised by Pinerains, the Judge nevertheless discussed the issue to provide guidance for future transactions. The learned Judge’s discussion may be summarised as follows:
 
  1. Although the Court acknowledged that there could have been valid reasons for the transaction to be valued using the price/earnings ratio method, the shareholder’s circular did not explain why this method was used instead of other methods, such as asset-based, cash-flow based or internal rate of return methodologies;
  1. The Judge took the view that a reasonable investor would have required an explanation as to the various valuation methodologies available, and why Apex Equity settled upon the price/earnings ratio in order to arrive at the purchase price; and
  1. The omission meant that there had been inadequate disclosure of the material facts that a reasonable investor would require in order to make an informed decision.
The Judge reiterated that he had not taken this point into account for the purposes of arriving at his decision as the point had not been advanced by the parties.
 
Azizul J also emphasised that he is not suggesting that Apex Equity was wrong to adopt the price/earnings ratio method as the basis for its pricing, but an explanation ought to have been included for the benefit of the investors.
 
Liability of advisor and Mercury
 
The Court dismissed Pinerains’ counterclaim against Alliance Investment Bank Berhad (‘Alliance’). As Alliance had been appointed by Apex Equity to act as principal advisor and placement agent in connection with the proposed transaction, it would owe a duty in contract to Apex Equity. It was plausible that Alliance, as a financial advisor to Apex Equity, would also owe fiduciary duties to Apex Equity. 
 
There was clearly no privity between Alliance and Pinerains regarding the former’s role in preparing the shareholders’ circular, advising Apex Equity on the financial aspects of the proposed transaction or liaising with the regulatory authorities for the necessary approvals. Thus Alliance could not owe any duty in contract to Pinerains.
 
Further, any fiduciary duty on Alliance would have been owed to Apex Equity and not to individual shareholders of Apex Equity.
 
The Court said that Mercury was one step removed when compared to the position of Alliance. Mercury was a counterparty to the proposed transaction and would not even have owed any duty to Apex Equity or to JF Apex. For this reason, Pinerains’ counterclaim could not be sustained against Mercury.
 
The Second EGM
 
The Court dismissed the application by Pinerains to adjourn the Second EGM pending the appointment of an independent advisor pursuant to section 218A of the CMSA. The Court held that section 218A presupposed that the proposed transaction had triggered the obligation to make a take-over offer by the acquisition of control over a listed company. In the present case, there had been no determination by the SC that there has been an acquisition of control or that the transaction will result in the acquisition of control over Apex Equity. In the absence of such determination, the powers of the SC under section 218A of the CMSA cannot be exercised.
 
In any event, the Court held that even if the proposed acquisition and a related private placement exercise resulted in a change in control of Apex Equity, the requirement to appoint an independent advisor only arises after the acquirer has obtained control of the listed entity. Therefore the request to the SC by Pinerains for the appointment of an independent advisor was premature.
 
Having considered the protracted nature of the dispute between the parties and the nature of the allegations set out in the affidavits, Justice Azizul considered it to be in the interests of the general body of shareholders of Apex Equity for an independent scrutineer to be appointed by Apex Equity.
 
Comments
 
This case is noteworthy as it provides guidance to stakeholders on some aspects of the law relating to the requirement to make full and fair disclosure in a circular to be issued to shareholders as well as some requirements that ought to be considered when preparing such a circular.
 
[1] Prior to the instant application, the applicants had obtained a court order on 1 July 2019 to vest Mercury’s stockbroking business in JF Apex pursuant to section 139 of the CMSA but this order was subsequently set aside on 15 July 2019 on grounds that there had not been full and frank disclosure at the time of the ex parte application for the vesting order. The earlier proceedings are not relevant to this case commentary.
 

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