Friday, March 23, 2007

What constitutes implementation for purposes of merger control?

Jean Meijer

Our Competition Act provides that the parties to an intermediate merger may not implement that merger until it has been approved, with or without conditions, by the relevant competition authority. The parties to most mergers are anxious to implement as soon as possible, particularly in international mergers where the South African element of the merger may be inconsequential in the scheme of the transaction.

In terms of the Competition Act a "merger occurs when one or more firms directly or indirectly acquire or establish direct or indirect control over the whole or part of the business of another firm." Control is widely defined and includes "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" referred to in the Competition Act.

The question, then, is what constitutes the "implementation" of a merger? Just how far can the parties to a merger go without crossing the line? Can the acquiring firm appoint directors to the board of the target firm? Can the acquiring firm pay the purchase price? Can it take transfer of the shares or business? This is not an issue to be taken lightly bearing in mind that an administrative penalty of up to 10% of a firm’s annual turnover in South Africa may be imposed for implementing a merger without the requisite approval.

The competition authorities (and lawyers) in South Africa have taken a conservative approach with regard to the meaning of "implementation". The parties to mergers have generally been advised not to take any step which might be construed as an acquisition or establishment of control until such time as they are safely in receipt of the clearance certificate.

Provisions which prevent the target firm’s management from making material changes to the business between the date of signature of the merger agreement and the closing date are generally considered to be acceptable. Provisions allowing representatives of the acquiring firm to attend board meetings as observers are generally also considered acceptable (save perhaps where the firms are competitors and an inference of some form of collusion might arise in the future). Acquiring firms have, however, generally been warned against appointing directors to the board of the target firm as the appointment of even one or two directors might give material influence and thus control. They have also generally been warned against paying the purchase price, but this for commercial rather than competition reasons. If the deal is ultimately prohibited the acquiring firm may have some difficulty in recovering the purchase price. The line has, however, always been firmly drawn against taking transfer of the shares or business prior competition clearance. This was certainly the case until the attempted hostile takeover by Harmony of Gold Fields.

As part of its hostile bid for Gold Fields, Harmony sought to acquire shares in Gold Fields in two stages. The first stage comprised an initial or early settlement offer for up to 34.9% of the shares in Gold Fields. This was followed by a subsequent offer for shares not tendered in the early settlement offer. The second offer was intended to secure enough additional shares to give Harmony more than 50% of the shares in Gold Fields. In its effort to block the hostile bid, Gold Fields sought to interdict the early settlement offer on the basis that it constituted the "implementation" of a merger prior to approval by the competition authorities.

The Competition Appeal Court (CAC) ruled that the early settlement offer was a merger, seemingly on the basis that Harmony and Norilsk would have joint control over Gold Fields after the acquisition of the shares tendered in the early settlement offer. Interestingly, the CAC permitted Harmony to proceed with the acquisition of the shares but interdicted Harmony from voting the shares or exercising any rights in relation to the shares prior to competition approval. The CAC made it clear that "implementation" and not "completion" of a merger prior to competition approval is prohibited in terms of the Competition Act. In interpreting what is meant by "implementation", the CAC clearly considered the transfer of the shares to be acceptable but not the exercise of the control arising from that transfer, for example, by voting the shares in relation to a strategic decision.

It is now conceivable that a party will not be in contravention of the Competition Act if it completes a transaction by taking transfer of a large (even a majority) stake in a company, provided that it does not attempt to vote the shares or otherwise exercise material influence over the company prior to competition approval. However, if a large block of shares is neutralised in this manner, a minority shareholder may find itself holding sufficient shares to carry the day at a general meeting. That shareholder would thus have inadvertently acquired control of the company – which it is not entitled to do without approval. To avoid "implementation", those shares could also not be voted, potentially shifting control to the next largest shareholder, and so on. As a consequence, although the CAC ruling opens the door for a new approach to what does and does not constitute "implementation" each case should be assessed on its own facts and, in particular, care should be taken to ascertain whether "completion" is possible without "implementation".