Appraisal Rights in South Africa - Part 3
This article explores appraisal rights in South Africa, with a primary focus on the pertinent principles of share valuation. This article further makes proposals for a faster and more efficient appraisal process for both companies and dissenting shareholders. This is Part 3 of a 3-part series.
South African developments to date
Adam Pike of Pike Law has represented several dissenting shareholders in South Africa. He has provided me with the following summary of legal progress in establishing principles of S164:
- Action vs application
- The Act requires appraisal proceedings to be moved by way of an application (petition), on the papers - (S164 (14) '
A shareholder ...may apply to a court';
S164 (15) 'On an application to the court...'
- Seeking discovery in application proceedings is almost impossible.
- Nevertheless, and on authority pertaining to insolvency petitions, which can be brought by way of an action (trial), dissenting shareholders have initiated three appraisal actions without complaint from defendants.
- Discovery of information
- Given that the rules of procedure require parties to discover evidence in action proceedings, dissenting shareholders now have the benefit of discovery.
- In Breede Coalitions vs Fairvest1, the plaintiff moved an interlocutory
application to compel further and better discovery.
- Defendants claimed that the JSE circular cured information asymmetry, plaintiff disagreed.
- Plaintiff sought underlying documents that justified the valuation assumptions used in the independent expert's fair and reasonable report (included in the circular) and the financial advisor's report to the board informing its offer of fair value to the dissenters.
- Given the settlement of the action, the interlocutory application was not adjudicated.
- The Court in SandGrove vs Distell2 stated obiter that arbitrage may have beneficial consequences. In the US, arbitrageurs from 2007 to 2016, were very successful at obtaining a higher fair value than the merger price, until the Dell and DFC Global cases in 20173. In these cases, there was a proper auction / sale process resulting in merger price less synergies of the merger equating to fair value (a value lower than the typical DCF MVIC4 less debt value). South African mergers are not conducted via auction or 'go-shop' processes which means arbitrage can be successful in achieving a higher value than merger / transaction price.
- The Court in BNS Nominees vs Arrowhead (2023)5 found that arbitrage is permissible and beneficial to the market.
- Most claims settle before proceedings are initiated.
- Others settle after proceedings commence.
- The pressure points for the companies are:
- Reliance on fair and reasonable reports prepared by "independent experts";
- potential allegations of self-dealing by the board.
- The defendant bar:
- Often rely on traded price (market value);
- persist with the view that financial reporting standards (IFRS) should guide the valuation exercise;
- is reluctant to engage with foreign jurisprudence;
- value the shares in the hands of the dissenter (minority valuation) rather than value the company as a going concern, and then determine the pro rata share on the result (control valuation).
- Rozendal vs Capital Appreciation (2019 to 2023) is the first time that an appraiser has undertaken valuation. The matter is pending.
- In BNS Nominees vs Arrowhead (2023) the court attempted a tentative definition of fair value that departs from international case law - see my commentary in Part 2 of this series of articles.
- Interest from trigger event date to payment of fair value
- BNS Nominees vs Arrowhead:
- the determination of the applicable rate of interest is a question of fact, and evidence should be adduced to prove interest;
- alluded to interest other than the legal rate or the market rate.
- Challenges dissenters, companies, and advisors face
- Finding appraisers:
- individuals with the requisite skills are mostly employed by EY, KPMG, Deloitte, PwC, and the second-tier firms such as BDO;
- most are reluctant to accept appointment for fear of subsequent conflicts of interest.
- Non-specialist bench - we do not have a Court of Chancery. Some judges may lack valuation experience;
- Client funding - fund managers pay for the litigation out of their own pockets;
- Client reluctance - also in the USA, where most mergers end in litigation, dissenting shareholder cases are not the norm;
- Institutional investors are non-litigious.
Extracts from Contemporary Company Law, 3rd ed
Process favours the company over the dissenter; uncertainty of a costs order may deter dissenters
The appraisal process is skewed in favour of the company versus the dissenting shareholder. The company suffers no adverse consequences for not complying with the procedural obligations of the Act. It can make an inadequate offer of fair value which forces the dissenter to ask the court for a determination.
The dissenter, once dissented, loses rights to voting and dividends until the fair value has been determined by the court. This is why courts have allowed interest in the interim period. In some countries, the company must pay the fair value determined by it early in the process (either the full amount or largest part) and dissenters have been awarded adequate interest to make the process worthwhile. It's only the difference between final and initial fair value that is paid at the end of the process.
The company can use its deep pockets to frustrate the process, which may pose a challenge of oppressive behaviour, for which there are remedies in the Act. Companies should be cautious not to take such an approach. Directors may be held personally liable, as in the USA. In the Sovereign Foods6 case, the company was found to have engaged in oppressive behaviour (S163 of the Act).
A further limitation relates to the costs of appraisal proceedings where the court may saddle the dissenter with substantial costs.
Advance waiver of appraisal right
A court has yet to rule whether a company can ask shareholders in advance to waive their appraisal rights.
It must be kept in mind that appraisal is an express statutory right designed for the fundamentally important policy purpose of protecting minority shareholders. It does so by providing an exit mechanism and by serving as a distinct counterweight to the liberalisation and leniency of the statutory procedures for fundamental transactions. It is also a vital function as a check on the management of the company.
Proposals for companies
In New Zealand, the parties must first go for arbitration. Considering how slow any process is through the SA courts, the company may propose arbitration - either through such a clause in the Memorandum of Incorporation (MOI); or in the transaction circular.
The arbitrator can be a person experienced in company valuations, not necessarily a legal practitioner, hence the valuation aspects will not pose a challenge for a fair process.
However, S164 is an unalterable provision of the Act. In principle, every company is required to comply with all the unalterable provisions of the Act - unless the company's MOI imposes a higher standard, greater restriction, longer period, or any similarly more onerous requirement, than what would otherwise apply to the company in terms of an unalterable provision7.
In my opinion (and also postulated in Contemporary Company Law 3rd ed), the company may propose an arbitration process to settle a dissenting shareholder matter. Courts should consider this suggestion favourably since arbitration is an accepted alternative dispute resolution mechanism. Such an approach could resolve the matter more efficiently and is highly likely to lower costs to all participants. This would be in the spirit of the Act and New Zealand is a good example of an effective process.
Appoint an expert appraiser knowledgeable in these matters 8
This will ensure the company's determination of fair value is defendable and will lead to a shorter and less costly process. Companies have been inclined to obtain advice from advisors who do not understand statutory fair value; or rely on a fair and reasonable opinion.
Pay the dissenting shareholders the estimation of fair value upfront, as in the USA
This would certainly be in the spirit of S164, and protection of minority rights. The directors will also demonstrate good faith.
Offer interest at a rate acceptable to the company for the period from the special resolution date to final fair value determination date
This will be consistent with the USA and other regimes and will, again, demonstrate good faith. It is in the best interest of the company to know what interest may be due.
The rate may be what the company earns on money market deposits. This will likely be lower than what the dissenter expects but may be a good quid pro quo to settle the matter faster. The dissenter should be happy with this as a substantial part of the fair value would have been received upfront.
The directors of a company are actively engaged in managing the company. The need to pay attention to a dissenting shareholder matter will involve substantial time, effort, and costs. A faster resolution of the matter will benefit the directors and the company.
Proposals for dissenting shareholders for a faster and cost-efficient process
I recommend the following:
- employ a legal team experienced in these matters, including arbitration, should the company propose it.
- propose arbitration to the company at the outset of the process. This will ensure a faster resolution and savings on costs and time.
- appoint a valuation expert, experienced in the theory of dissenting shareholder valuations.
- engage the valuation expert at the outset and present the company with the expert's high-level valuation report, including foreign legal precedent and textbook theory, the day after the special resolution date. This will assist the directors of the company to gain a brief understanding of the legal terrain and the dissenter's expectation of fair value. The company may make an adequate offer at the outset, based on the expert valuation report.
- A court or arbitrator will likely view such a proactive approach in a good light. This approach may play a role in obtaining a fair value acceptable to all parties. It may also lead to a shorter timeframe for resolution and lower costs for participants. Additionally, it could potentially result in a favourable cost order, should this route be pursued.
1 BNS Nominees (Pty) Ltd and Breede Coalitions (Pty) Ltd vs Fairvest
Property Holdings Ltd (2022)
2 Sand Grove Opportunities Master Fund Ltd and Others v Distell Group Holdings Ltd and Others (2022) JDR 0821 (WCC)
3 Dell Inc. v. Magnetar Global Event Driven Master Fund Ltd, C.A. No 9322 (Dec. 14, 2017), reversing In Re Appraisal of Dell Inc., C.A. No. 9322 (Del. Ch. May 31, 2016); DFC Global Corp. v. Muirfield Value Partners, L.P., C.A. No. 10107 (Del. 2017), reversing In Re Appraisal of DFC Global Corp., 2016 C.A. No. 10107 (Del. Ch. 2016); modified, C.A. No. 10107 (Del. Ch. Sept. 14, 2016) [unpublished].
4 Discounted Cash Flow / Market Value of Invested Capital
5 BNS Nominees (RF) (Proprietary) Limited and Another (Breede Coalitions) v Arrowhead Properties Limited and Others (19/39482)  ZAGPJHC 848; 2023 (1) SA 478 (GJ) (2022)
6 Juspoint Nominees (Pty) Ltd v Sovereign Food Investments Ltd (BNS Nominees (Pty) Ltd Intervening) (2016)
7 S15(2)(a)(iii) of the Act
8 In BNS Nominees and Breede Coalitions vs Arrowhead, the court lamented that the appellants did not employ an expert as the respondent had, and hence, regarding fair value, the court ruled in favour of the respondent, Arrowhead