Comment: Co-operative becomes a fiction in Silver Fern Farms deal

OPINION

The information to shareholders about the Silver Fern Farms partnership with Shanghai Maling does not clearly explain the practical implications of some of the key aspects or identify or address some important matters.

Two of the main advantages are the continuance of the farmer co-operative and that the transaction will be implemented through a 50:50 partnership. 

While factually correct, it does not automatically follow that either of these will result in benefits to shareholders or that Shanghai Maling does not obtain effective control. The co-operative becomes no more than a holding company. It will hold 50% of the shares in the partnership, appoint five of the 10 directors and receive and distribute any dividends. 

When instructed by the partnership, the co-operative must notionally buy stock as directed, including at the price specified (and paid) by the partnership. In reality, though, the partnership, not the co-operative, is responsible for all stock procurement. 

Given this, and the lack of control retained by the co-operative, it is difficult to see any real advantage to shareholders retaining the co-operative other than it being a convenient vehicle through which they can indirectly participate in the new venture. If this is the position, why did the directors decide to reject “proposals which may have challenged our co-operative status?”

Practical implications
The information pack sets down the governance arrangements and voting rights held by the directors appointed by both shareholders. However, it does not clearly explain their practical implications. 

These include:

• The chairman appointed by Shanghai Maling has a casting vote, meaning it can pass the most important board resolutions even if all of the co-operative’s directors vote against them.  These resolutions include approval of the annual business plan, budget and financial statements, the appointment and remuneration of the chief executive and the dividend policy and amount to be paid.  It is unlikely any of these decisions will include any of the “reserved matters ” that require approval from seven of the 10 directors;
• The co-operative cannot pass any shareholder resolution unless Shanghai Maling also approves it;
• Directors appointed by the co-operative cannot pass any directors’ resolution unless they are supported by at least one director appointed by Shanghai Maling; and
• A “deadlock” will exist and nothing will happen: 

1) If, at the shareholder level, the shareholders do not agree; 

or 2) At the board level, unless at least one director appointed by a shareholder votes with all of the directors appointed by the other shareholder (which is unlikely), or unless the resolution involves a “casting vote matter” and then the Shanghai Maling chairman has the casting vote.

‘Overseas person’ status
Nowhere are shareholders told the partnership will become an “overseas person” and regulated by the Overseas Investment Act. As an “overseas person” the partnership will need to obtain Overseas Investment Office consent before it can enter into certain transactions. It may also deter some third parties from joint venturing with it, not wanting, through association, to also come within the ambit of the act. 

Given the importance of exports to Silver Fern Farms, it is surprising its directors do not say if the proposed partnership will continue to obtain the benefit of the New Zealand quota and free trade arrangements that are so important to gain access to major markets.

Neither do the directors address the increased political and related trade risk resulting from partnering with a Chinese company effectively controlled by Bright Foods Group, a company owned by the Shanghai city government. 

For example, if any of New Zealand’s major markets impose trade sanctions on China, similar to those recently imposed on Russia, would the partnership be locked out of those markets?

Competition covenant
Shanghai Maling Hong Kong, a subsidiary of Shanghai Maling, is the party to the shareholders agreement. A number of important provisions in this contract include the covenant by Shanghai Maling Hong Kong not to compete against Silver Fern Farms in New Zealand. It is not clear if both Shanghai Maling and Bright Foods have given the same undertaking. If they haven’t it raises the question of the effectiveness of this restraint.

Special and ordinary resolutions
Another area of uncertainty is why Silver Fern Farms has submitted an ordinary resolution to shareholders to approve the Shanghai Maling transaction.  The Companies Act and Silver Fern Farms’ constitution clearly require the board to manage the co-operative’s business and affairs. 

The only exception to that is a major transaction for which approval by a special resolution of shareholders is required. From the information provided by Silver Fern Farms, it is not clear why the proposed transaction does not require a special resolution. 

Nor has Silver Fern Farms explained why, if it is not a major transaction, it is seeking shareholder approval by ordinary resolution when such a resolution appears unnecessary and arguably not in conformity with the constitution.

Remaining doubts
Irrespective of whether Silver Fern Farms clarifies all outstanding matters, many shareholders will still be left with some lingering doubts. They will question how effective control of a New Zealand agricultural sector business owned by a farmer co-operative company, with approximately 16,000 shareholders and a “code company” regulated by the Takeovers Act, can pass to an overseas person without any meaningful shareholder involvement. 

There may be sensible reasons why the transaction has been structured as it has but higher thresholds apply to control changing transactions effected in other ways, such as takeovers, amalgamations or schemes of arrangement.

The transaction has been structured as a business transfer by the co-operative and share subscription by Shanghai Maling.  This does not appear to require any shareholder approval, assuming the business transfer is not a major transaction as defined by the Companies Act. 

The board has decided to seek shareholder approval anyway but at the ordinary resolution level.  Shareholders might reasonably have expected for such a “game changing” transaction the Board would seek approval from shareholders by special resolution, as for a major transaction.

The fact that a special resolution is not required and that none of the other shareholder protections applicable to control changing transactions effected in the other ways apply, might give cause for concern to the regulators who have strived over the past 20 years or so to ensure that shareholders have meaningful rights and protections in control changing transactions of this nature.

David Boswell is an adviser on the legal process for major commercial transactions and has a farming interest that supplies Silver Fern Farms