Time to revisit headcount test for scheme meetings: observers

Singapore

THE use of a headcount test in scheme meetings - a matter of contention during the recent attempted merger of Sabana Shari'ah Compliant Real Estate Investment Trust (Sabana Reit) and ESR-Reit - should be reviewed, some market players said. There is precedent for its abolishment in Hong Kong, and the rule continues to be debated in other jurisdictions.

At present, Singapore's regulatory regime requires that a scheme of arrangement must cross two thresholds. It must be approved by creditors or shareholders representing three-fourths in value of those voting at a scheme meeting. And it must also be approved by a simple majority, in number, of the scheme company's creditors or shareholders present or voting at the meeting - the so-called headcount test.

In theory, the headcount test protects minority shareholders from being easily outvoted by those with large holdings. In practice, and particularly in the present environment, it can distort the outcome of a vote.

Jeckle Chiu, a partner at law firm Mayer Brown, said that with custodian banks gaining popularity, the headcount test may not be the most accurate representation of shareholders' decisions.

In order to facilitate calculations for the headcount test, custodian banks or nominee companies that hold shares on behalf of multiple shareholders are considered as a single shareholder and are only allowed to vote one way.

Mr Chiu also argued that there is nothing wrong with giving investors who have "poured in more money to own more shares to have more say".

His views were echoed by David Webb, an activist investor in Hong Kong: "The headcount rule is archaic and inconsistent with the principle of 'one share, one vote'. The rule invites gaming of the system for or against the scheme."

Mr Webb had in 2009 alerted the Hong Kong Securities and Futures Commission (SFC) to potential ballot rigging in a privatisation deal involving Hong Kong-listed telco PCCW, then-Singapore-listed Pacific Century Regional Development (PCRD), and China Netcom Corp.

After regulatory and judicial intervention, PCCW's privatisation via a scheme of arrangement failed to go through - to the joy of minority investors.

The privatisation deal - initially voted through by majority shareholders - was overturned after the Court of Appeal ruled in favour of the SFC's bid to block it.

On Dec 17, 2009, Hong Kong's Financial Services and the Treasury Bureau launched the first phase consultation on the draft provisions of the Companies Bill, which sought consultation on whether the headcount test should be retained, abolished, or whether to give the court discretion to dispense with the test.

In an e-mail response to the first phase consultation, the Hong Kong Institute of Certified Public Accountants acknowledged that schemes of arrangement still require the sanction of the court - an additional step that protects the interests of minority shareholders. At the same time, it said it preferred that the test be abolished.

Another response from the Hong Kong Institute of Directors said that "with many shares in listed companies being held by nominees and custodians, a headcount test is not necessarily indicative of the decisions of the beneficial owners of the shares".

A compilation by the Bills Committee stated that the majority of deputations in fact supported the abolition of the headcount test. Other reasons provided were that giving the court the discretion to dispense with the test would create uncertainty, the need to incur extra resources to investigate share splitting or vote manipulation, and that other jurisdictions were moving to abolish the test.

Such jurisdictions included the Cayman Islands and New Zealand. In the UK and Australia, too, the committee said specialist government advisory committees had recommended the test be abolished.

Ultimately, when the new Hong Kong Companies Ordinance (CO) took effect in 2014, the headcount test was abolished, with the exception of creditors' schemes and members' schemes that do not involve a general offer or takeover offer. However, the court has been given a new discretion to dispense with the test for a members' scheme that retains it.

Other jurisdictions were less successful in their attempt to abolish the test. In Australia, the courts were instead given the power to dispense with the test in 2008.

In Singapore, this power was provided to the Court under a revision to the Companies Act in 2016. (see clarification note)

In the UK, the attempt was unsuccessful. In a Parliament reading in May 2006, Lord Sharman, who was then sitting in the House, had said: "The majority in number, focusing on a majority of registered holders is an anachronism, now that most retail holders hold through the Crest nominees, where one registered holder may represent many thousands of beneficial owners."

However, he later withdrew his amendment after it was argued that the removal would mean "larger creditors and members could impose their will unfairly on smaller creditors and shareholders".

Even if the test is to remain, some pundits have suggested new means of making the system more equitable.

For instance, custodian banks do not currently have a standardised way of determining their proxy vote.

They can, for instance, determine their vote using an "offsetting" or a "simple majority" rule.

Assuming investors A and B held shares of a company via a custodian bank, and A submits three votes in favour while B submits two votes against, a custodian using the "simple majority" rule would submit three votes in favour but none against the resolution. And under the "offsetting" rule, the same situation described above would see the custodian submit only one vote in favour. The votes against would be offset by the votes in favour.

Keith Ong, co-founder of real estate investment platform RealVantage and a former capital markets practitioner, said there are "merits to harmonising this for consistency".

"More than just the direction of a vote, the nominee's vote needs to reflect the strength of the vote," he said, adding that the "offsetting rule" provides greater clarity of the percentage of votes for and against a resolution, based on the difference.

To illustrate the disparity brought about by the lack of consistency, Zhang Wei, associate professor of law at the Singapore Management University's (SMU's) School of Law, painted the following scenario: Assume custodian A holds 1,000 shares while custodian B holds just 10 shares.

If custodian A has 501 shares voting for and 499 against, under the "offsetting" rule it would submit two votes in favour of a resolution.

Meanwhile, if custodian B uses the "simple majority" rule, and has six shares voting against the same resolution, it would submit six votes against the resolution. The resolution would then be defeated by a margin of six to two. But in reality, 505 shares voted in favour of it.

The one-proxy vote approach results in a "substantial number of minority votes (being) disregarded in the process", said Prof Zhang.

Furthermore, given how the percentage of votes is denominated against the number of shares represented at the meeting rather than the entire outstanding units, this can "significantly distort the real intention of shareholders", he added.

In the above example, only eight shares would be voted out of the total 1,010 shares. The denominator used for the 50 per cent and the 75 per cent thresholds in a scheme meeting would be eight, rather than 1,010.

RealVantage's Mr Ong suggested full disclosure of the actual votes cast to be provided by custodians.

"Fundamentally, if the investors do not have exposure to an accurate representation of their voice, there must be some ability to be flexible," he said.

Alternatively, new safeguards such as the 10 per cent objection rule in Hong Kong could also be introduced here. In Hong Kong, the "additional requirements" in the Code on Takeovers and Mergers stipulate that votes cast against the resolution should not be more than 10 per cent of the voting rights attached to all disinterested shares.

A research done by three SMU professors that was published in 2018 found that the 10 per cent objection rule contributed to better returns for minority shareholders.

Of the 11 schemes of arrangement that took place in Singapore from 2008 to 2014, the average of premium to net asset value (NAV) offered stood at 24 per cent. Meanwhile, in Hong Kong, the average across 24 schemes of arrangements in the same period was some 148 per cent.

The headcount test could soon be put to the test again. Sunningdale Tech chairman Koh Boon Hwee is teaming up with Novo Tellus PE Fund 2 to take the company private at S$1.55 in cash per share via a scheme of arrangement.

The time is ripe for local regulators to review the relevance of such a test today. As Mayer Brown's Mr Chiu puts it: "The decision to remove the headcount test in Hong Kong was to improve on a very old legal regime."

Perhaps it's time for Singapore to do the same.

Clarification note: This article has been updated to reflect that the Singapore court also has the power to waive the headcount test.