Does the tender offer rule apply to indirect acquisitions?

In these days of mergers and acquisitions, minority shareholders often find themselves “orphaned” when the majority or controlling shareholders of their company sell their equity stake to a stranger.

Fortunately, the Securities Regulation Code (SRC) has put in place a mechanism to protect minority shareholders of a public company (like a listed company) in such an event.

Tender offer

One such mechanism is the mandatory tender offer rule under the SRC.

In layman’s terms, a tender offer is a bid by a third party to acquire a substantial percentage of a company’s stock, generally at a price above the market price, for the purpose of taking over the company.

If the shareholding exceeds a certain threshold (at least 35 percent or even under 35 percent if the resulting ownership by the acquirer is more than 51 percent under our present rules), the law makes it mandatory for the acquiring person to offer to buy the shares of the other shareholders.

The tender offer rule gives minority shareholders the chance to exit a public company by selling their shares at the same price (usually at a premium) as those of the majority or controlling shareholders in case they are not comfortable with the new shareholder or group of shareholders taking over their company.

The rule is not as simple as it appears, though. There is a multitude of questions that can arise from it. For example, does it apply when the object of the takeover attempt is the parent company of the listed company and not the listed company itself?

Confusion

The confusion has arisen because the governing legal provision, Section 19.1 of the SRC, gives the impression that the rule applies only when what are to be acquired are the shares of the public company.

Legal scholars and even people at the regulators’ level disagreed on how to interpret the SRC.

Not so anymore.

In Cemco Holdings, Inc. vs. National Life Insurance Company of the Philippines Inc., G.R. No. 171815 (Aug. 7, 2007), Union Cement Corp. (UCC), a publicly listed company, has two principal stockholders—Union Cement Holdings Corp. (UCHC), a non-listed company, with shares amounting to 60.51 percent, and Cemco Holdings Inc. (Cemco) with 17.03 percent.  The majority of UCHC’s stocks were owned by Bacnotan Consolidated Industries Inc. (BCI) with 21.31 percent and Atlas Cement Corp. (ACC) with 29.69 percent. Cemco, on the other hand, directly owned 9 percent of UCHC stocks.

BCI and its subsidiary, ACC, sold their 21.31 percent and 29.69 percent shareholdings in the holding company (UCHC) to Cemco. As a result of the acquisition, Cemco’s total beneficial ownership, direct and indirect, in UCC increased by 36 percent, thereby resulting into at least 53 percent ownership of the shares of UCC.

A minority stockholder of UCC, the National Life Insurance Co. of the Philippines Inc., sought to nullify the sale for failure of Cemco to comply with the mandatory tender offer rule.

Cemco argued that, based on the plain wording of Section 19.1 of the SRC as confirmed by the SEC En Banc before the transaction was consummated, the “tender offer rule applied only to a direct acquisition of the shares of the listed company and did not extend to an indirect acquisition arising from the purchase of the shares of a holding company of the listed firm.”

The issue before the Supreme Court was whether the mandatory offer rule under the SRC applies only to direct acquisition of shares in the public company.

Legislative intent

The Supreme Court ruled that the mandatory tender offer rule applies to both direct and indirect acquisition, holding that the legislative intent of Section 19 of the SRC is to regulate activities relating to the acquisition of control of a public company. Whatever may be the method by which control of the company is obtained, either through the direct purchase of its stocks or through an indirect means, mandatory tender offer applies.

The bottom line of the law is to give the shareholders of the public company the opportunity to decide whether or not to sell their shares in connection with the transfer of control.

The Cemco case resolves a major issue on tender offers. But there are still issues that are of interest to the market—investors, issuers, investment bankers, lawyers and even the regulators.

For example, can the SEC raise the threshold to 35 percent when the basic law (SRC) fixed the threshold at 15 percent for one-time acquisition and 30 percent for creeping acquisition? Can the SEC provide exceptions to the tender offer rule when none is provided by the basic law? Without going into the validity of the SEC rules, does the tender offer rule apply to reverse acquisitions? Does it apply when what is given to the acquiring person is only an option to purchase the shares but he takes over the management of the company pending the exercise of the option?  If so, at what point in time should the tender offer to the public be made—is it before the takeover or before the option is actually exercised?

These are interesting questions, to say the least. To be frank about the matter, however, I have not yet given serious thought about them. In the meantime, I’m glad to be able to provide the answer to a basic question that has been asked of me time and again by some market players.

(The author, former president and CEO of the Philippine Stock Exchange, is now the co-managing partner and the head of the corporate and special projects department of Accralaw. He may be contacted at [email protected].)