Tuesday, February 20, 2007

By Jean Meijer

As time has passed, the competition authorities’ notion of control and commercial reality seem to have moved further and further apart. Perhaps the most concerning development is that the competition authorities have held that there can be more than one sole controller of a firm at a time – a notion which on the face of it seems absurd.

Whether or not there has been an acquisition or establishment of control is essential to determining whether a commercial transaction must be notified to and cleared by the competition authorities prior to implementation. As a result those involved in mergers and acquisitions are understandably interested in the concept of control.

The Competition Tribunal has stated that in companies that are not wholly owned it is rarely a case of absolute dictatorship. "Competition Law needs to recognise that companies can be run on either republican or monarchical lines. In a monarchy the identity of the ruler is simple. In a republic where power is mediated through sets of possibly complex relationships, the location of sovereignty is more elusive. Yet pre-merger notification systems by necessity are obsessed with the notion of control. They must find putative emperors in republics even if they are not garbed in purple robes."

The Competition Act gives some guidance as to who should be "garbed in purple robes" when it states that a person controls a firm if that person: owns more than half of the issued share capital of the firm, is entitled to vote the majority of the votes that may be cast at a general meeting of a firm or has the ability to appoint the majority of the directors of the firm, to mention the examples that most commonly arise. The provision that has caused the most debate is the catch-all provision which declares that a person controls a firm if that person has the ability to materially influence the policy of the firm in a manner comparable to a person who in ordinary commercial practice, can exercise an element of control of the kind referred to above. This has generally been understood to refer to instances where a shareholder has negative control in the sense that it can block strategic decisions by a majority shareholder. It is often referred to as joint control because consensus between the majority and minority shareholders is required.

The idea that there can be joint control of a firm is not radical in any sense. The most obvious example is where there are two shareholders that each hold 50% of the shares in a company. When a person moves from being a joint controller to being a sole controller (for example, from holding 50% of the shares to holding 100%), there is a change in the nature of that person’s control and it is not difficult to understand that the competition authorities would wish to consider such a transaction?

However, there was a move away from easily understandable concepts of control when the Competition Tribunal came to the conclusion that a firm can be subject to both sole and joint control at the same time and, indeed, can have more than one sole controller at that same time. The Tribunal has held that the examples of control given in the Act are "bright lines" for all to know. When a firm crosses a bright line it is deemed to have sole control even if it does not have sole control in the ordinary commercial sense.

In a typical empowerment transaction, the BEE shareholder would acquire the majority of the ordinary shares and have the right to vote the majority of the votes that may be cast at a general meeting. It would, therefore, cross a bright line and be deemed to be a sole controller. At the same time a funder of the transaction might holder preference shares which give it the majority of the issued share capital of the company. The funder would also cross a bright line and be deemed to have sole control of the company. The vendor who initiated the empowerment transaction, might continue to hold a significant stake, say, 49% or the ordinary shares in the company and have retained veto rights over strategic decisions. It would have material influence over the firm and would be considered to be a joint controller. In this case, there would be two sole controllers and a joint controller of the company at the same time.

Aside from the difficulty of explaining these concepts to an ordinary businessman, there may be adverse competition consequences. The Competition Tribunal has held that once a firm has crossed a bright line it does not have to notify again as a change of control is a once-off affair. Even if a firm has notified sole control at a time when that control is attenuated in some respects by other shareholders and it later acquires an unfettered right, no subsequent notification is required. Consequently, the competition authorities may approve a merger on the basis that a person has deemed sole control. That person might actually acquire sole control years later, when competition concerns arise due to changes in the structure of the market, and the competition authorities would have no right to assess or prohibit that transaction.

Is it necessary to find putative emperors in republics even if they are not garbed in purple robes? One cannot help but wonder whether it would not have been better to have retained easily understandable concepts of control that accord with commercial reality, rather than to treat as emperors those who, in truth, are not.