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【Business Law】Fights over Corporate Control - Series 1 - Lessons from the Fights between Soft-World ..

2024-01-31 Attorney Alice Lee

 
Tips:
◆ Share exchange is a common approach for quickly bringing in an investor.
◆ Bringing a (friendly) new investor into a target company through issuing new shares of the target company requires that the target company must have sufficient authorized shares (specified in the target company's articles of incorporation) that have not yet been issued.
◆ The share exchange ratio should be reasonable.
◆ Are you bringing in a “white knight” or a “black knight”? - Pick your partner wisely.

　　When shareholders controlling the incumbent management of a target company (the “Controlling Shareholders”) are short of funds but face a hostile takeover launched by a hostile acquirer with an aim to gain corporate control over the target company, bringing a third-party investor who is friendly to the Controlling Shareholders (a white knight or a white squire) into the target company is a strategy available to the Controlling Shareholders to fend off the said hostile acquirer. Bringing a friendly investor into a target company by having the said investor acquire certain shares of the target company helps the Controlling Shareholders increase the amount of the target company's shares in support of the Controlling Shareholders and thus keep the control of the target company in the hands of the Controlling Shareholders. Recently, the Controlling Shareholders of Soft-World International Corporation (“Soft-World”) employed the same strategy by bringing Gloria Material Technology Corp. (“GMTC”) into Soft-World as a shareholder of Soft-World when facing a hostile takeover launched by Wanin International Visual Enterprise, Ltd. (“Wanin”).

　　What would be a better way to bring a friendly new investor into a target company? Having a friendly investor acquire shares of a target company from the market is a less attractive option because this option not only increases the cost of acquiring shares of the target company but also is too slow to be effective. Alternatively, bringing a friendly investor into a target company by having the said investor acquire new shares issued by the target company is a common approach nowadays. If a target company and a friendly investor (also a corporation) opt to adopt the abovementioned common approach, each of the target company and the said friendly investor shall first, pursuant to a resolution adopted by its respective board of directors, issue new shares (authorized shares specified in each of their respective articles of incorporation that have not yet issued) as the consideration payable by itself for exchange of new shares of the other (Article 156-3 of the Company Act). Next, the target company and the said friendly investor exchange their newly issued shares with each other as the consideration for the acquisition of the other's newly issued shares. In the recent fight between Soft-World and Wanin over the corporate control of Soft-World, Soft-World adopted this approach and brought in GMTC to fend off Wanin.


● There are several reasons why the exchange of newly issued shares has become the most common approach for bringing a friendly investor into a target company:
  1. Disadvantages of the new share subscription approach (issuing new shares for subscription by particular parties):
The law requires that a company must reserve five percent (5%) to fifteen percent (15%) of the said company's newly issued shares for subscription by the said company's employees when issuing new shares of the said company (Article 267, Paragraph 1, of the Company Act). As to those newly issued shares of the said company that have not been subscribed by the said company’s employees, the original shareholders of the said company have the right to subscribe for those remaining newly issued shares in accordance with the proportion of their original shareholdings (Article 267, Paragraph 3, of the Company Act). In the event that a hostile acquirer is a shareholder of a target company while the Company Act allows shareholders to transfer newly issued shares of the target company, this new share subscription approach comes with unpredictable variables without the certainty of fending off a hostile acquirer and of bringing a friendly investor into the target company. Moreover, subscribing to newly issued shares of a company will likely put a friendly investor under the pressure of funding.
 
  1. Disadvantages of the private placement approach (issuing new shares for subscription by private placement):
A public company may carry out a private placement of the said company's newly issued shares. This approach requires no reservation of a company's newly issued shares for subscription by employees or original shareholders of the said company and also guarantees that a friendly investor will directly acquire sufficient newly issued shares of the said company. However, the law (Article 43-6 of the Securities and Exchange Act) requires that there must be a special resolution adopted by a meeting of shareholders of a public company (i.e., a resolution adopted by at least two-thirds of the votes of the said company's shareholders present at a meeting of shareholders who represent a majority of the total number of issued shares of the said company) before the said public company carries out a private placement of the said public company's newly issued shares. Despite the fact that this private placement approach comes with many unpredictable variables (such as the convention of a meeting of shareholders or seeking the support of shareholders), this approach is likely less attractive to a friendly investor since there are many restrictions on the transfer of shares acquired through private placement (such as Article 43-8 of the Securities and Exchange Act). Furthermore, the Controlling Shareholders of a public company will not likely consider this approach to bring a friendly investor into the said company when the said Controlling Shareholders have the support of shareholders with so many voting rights in the hands of the Controlling Shareholders. This approach is (considered) impractical as it often fails to meet the needs in reality.
  1. Advantages of the share exchange approach (issuing new shares for exchange of shares of another company):
(1) Under the Company Act (Article 156-3 of the Company Act), carrying out a share exchange between two companies requires only the board of directors of each company to adopt a special resolution (i.e., a resolution adopted by a majority vote of a meeting of the board of directors of a company attended by two-thirds or more of all the directors of the said company), without any need to go through a meeting of shareholders of each of the said two companies.
(2) The law (Article 156-3 of the Company Act) explicitly states that the requirement of reserving newly issued shares of a company for subscription by the said company's employees and original shareholders does not apply (to this share exchange approach).
(3) Bringing a friendly investor into a company through this (share exchange) approach requires no capital contribution in cash from the said friendly investor. Rather, this (share exchange) approach only requires that the target company and the friendly investor issue their new shares for exchange. This (share exchange) approach reduces a friendly investor's burden on the said investor's capital contribution to a target company.
(4) Under this (share exchange) approach, the issue of new shares of a target company will reduce a hostile acquirer's shareholding in the target company.
 
● Points to note regarding the share exchange approach

Bringing a friendly investor into a target company through the share exchange approach is a critical anti-takeover defense strategy available to the Controlling Shareholders of the target company when facing a hostile takeover launched by a hostile acquirer. However, there are certain points to note for the consideration of someone who wishes to adopt this share exchange approach (this article does not cover some other points to note regarding a share exchange conducted by a public company):
 
  1. There must be sufficient authorized shares specified in a target company's articles of incorporation that have not yet been issued so that the target company may issue sufficient new shares (of the target company) for share exchange (with a friendly investor):
Under the Company Act, a company may issue its authorized shares specified in its articles of incorporation in installments rather than issuing all of its authorized shares at once. The issue of new shares (authorized shares that have not yet been issued) of a company requires only a resolution adopted by a majority vote at a meeting attended by over two-thirds of the directors of the said company (Article 156, Paragraph 4, and Article 266 of the Company Act). On the other hand, if a company wishes to issue new shares that exceed the maximum number of authorized shares specified in the said company's articles of incorporation, the issue of such new shares requires a special resolution adopted by a meeting of shareholders of the said company to amend the said company's articles of incorporation and increase the authorized share capital of the said company before the said company can issue any such new shares. In view of the foregoing, bringing a friendly investor into a target company by adopting the share exchange approach to fend off a hostile takeover will not be an easy task when the target company does not have sufficient authorized shares that have not yet been issued. Moreover, a friendly investor will have to convene a meeting of its shareholders to increase its authorized share capital if the said investor does not have sufficient authorized shares that have not yet been issued. However, more unpredictable variables may arise under such circumstances when the aforesaid takes more time than expected or when the hostile acquirer becomes aware of the aforesaid.
 
  1. The share exchange ratio should be reasonable:
The law requires a director of a company to exercise his due care as a good administrator and fulfill his duty of loyalty without causing any detriment to the company he serves when conducting any business operation of the said company (Article 23 of the Company Act). In addition, the competent authority requires that the transaction price of shares of a public company for share exchange with shares of others should be reasonable. Therefore, when the Controlling Shareholders of a company opt to bring a friendly investor into the company by adopting the share exchange approach, the share exchange ratio should be reasonable without causing any detriment to the said company.
 
Otherwise, it is possible that a hostile acquirer will apply to a court for an injunction maintaining a temporary status quo with regard to the legal relation in dispute (a “Status Quo Maintenance Injunction”). The granting of a Status Quo Maintenance Injunction by the court will likely result in no share exchange (between the target company and a friendly investor) or no exercise of voting rights (attached to the exchanged shares of the target company) by the friendly investor before the outcome of a litigation filed by the hostile acquirer becomes final. In addition, it is possible that directors of a target company will be subject to civil and criminal liabilities for causing detriment to the target company (this article does not cover the legal consequences of an illegal share exchange, what kind of litigation may be filed under such circumstance, under such circumstance whether one may and how to apply for a Status Quo Maintenance Injunction, or how to determine the liability of a director of a target company in connection with any such transaction).
 
  1. Pick your partner wisely:
Bringing a friend investor (a white knight or white squire) into a target company may be an option available to the Controlling Shareholders of the target company for quickly fending off a hostile acquirer when the said Controlling Shareholders face a hostile takeover launched by the said hostile acquirer. However, the Controlling Shareholders of a target company should nonetheless pick their partner(s) wisely and be aware that such an option is a “palliative” rather than a cure. Let us take the fight over corporate control of Taisun Enterprise Co., Ltd. (“Taisun”) as an example. When the former Controlling Shareholders of Taisun faced a hostile takeover launched by a hostile acquirer a few years ago with an aim to gain corporate control over Taisun, the former Controlling Shareholders of Taisun brought in Long Bon International Co., Ltd. (“Long Bon”) as a white squire to fend off the hostile acquirer and keep the control of Taisun in the hands of the former Controlling Shareholders of Taisun. However, as time passed, Long Bon (who was a white squire) later fought against the former Controlling Shareholders of Taisun and took over the control of Taisun from the former Controlling Shareholders. On the other hand, when a friendly investor acquires shares of a target company through the share exchange approach, the target company also becomes a shareholder of the said friendly investor. Thus, it is worth a friendly investor to consider, before exchanging any share with another company, whether its corporate control will be taken over by another company someday.

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Alice LEE 
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