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Breach of special deal rule would invalidate a whitewash waiver

The Takeovers and Mergers Panel ("Takeovers Panel") recently ruled that Alibaba Group Holding Limited (together with its subsidiaries or any of them, "Alibaba Group") breached Rule 25 (Special deals with favourable conditions) of the Takeovers Code in its subscription of shares representing a majority stake in CITIC 21CN Company Limited ("CITIC 21CN") (now known as Alibaba Health Information Technology Limited) (Stock Code: 241) in 2014.

Special deal without the Takeovers Executive’s consent

According to its written decision dated 17 May 2016, the Takeovers Panel found that on the date that CITIC 21CN, Ms Chen Xiao Ying ("Ms Chen", the then executive director and vice chairman of CITIC 21CN, who then held an approximately 21% interest in CITIC 21CN) and Alibaba Group entered into the subscription agreement (the “Subscription Agreement”) and on the date that the subscription was completed, Alibaba Group entered into certain agreements (the “OpCo Agreements”) with Mr Chen Wen Xin (who is Ms Chen's younger brother and also a shareholder of CITIC 21CN) to, among others, acquire a company owned by him (“OpCo”).

The Takeovers Panel ruled that the OpCo Agreements constituted a special deal with favourable conditions which were not extended to all shareholders falling within the ambit of Rule 25 (See note below) taking into account the following:

  • the Takeovers Panel considered that the OpCo Agreements constituted an important element of a proposal by Alibaba Group which included the acquisition of a majority shareholding in CITIC 21CN (which is principally engaged in the development of product identification, authentication and tracking system for the healthcare and other industries) because OpCo held a permit which was seen as essential for the development of Alibaba Group’s over-the-counter drug online platform; and
  • both the Subscription Agreement and the OpCo Agreements were negotiated largely by the same people who were employees of CITIC 21CN or consultants only for Ms Chen and on occasion Ms Chen herself, and they were negotiated at the same time.

Note: Rule 25 (Special deals with favourable conditions) provides that “Except with the consent of the Executive, neither the offeror nor any person acting in concert with it may make any arrangements with shareholders or enter into arrangements to purchase or sell securities of the offeree company, or which involve acceptance of an offer, either during an offer or when an offer is reasonably in contemplation or for 6 months after the close of such offer if such arrangements have favourable conditions which are not to be extended to all shareholders.”

The Takeovers Executive was not consulted about the special deal between Alibaba Group and Mr Chen at the time it processed and granted the whitewash waiver from the mandatory general offer obligation which would otherwise result from the subscription.  The Takeovers Panel found that there was a clear breach of Rule 25 of the Takeovers Code.

Whitewash waiver invalidated as a result of breach of the special deal rule

The Takeovers Panel noted that as the whitewash waiver was granted subject to, among other things, compliance with Rule 25, Alibaba Group's breach of Rule 25 would invalidate the waiver, and it would follow that a mandatory general offer obligation has been triggered unless waived. 

However, in light of the difficulties in placing a precise value on the favourable conditions received by Mr Chen, and the prevailing market price CITIC 21CN’s shares since the subscription was announced, the Takeovers Panel noted that any additional value to the subscription price Alibaba Group paid to acquire a majority interest in CITIC 21CN was most unlikely to be material in the context, and therefore waived the mandatory general offer obligation.

Useful points on the rules governing special deals and whitewash transactions

The written decision contains some useful discussion on the rules governing special deals and whitewash transactions of which practitioners and persons who propose to take-over Hong Kong listed companies should take note:

  • The underlying purpose of Rule 25 is derived from a fundamental principle in the Takeovers Code – General Principle 1 – that all shareholders should be treated equally. Rule 25 is a major concession to the strict operation of General Principle 1. The consent of the Takeovers Executive to a special deal, particularly one which is not specifically covered by the Notes to the Rule, is not a foregone conclusion.
  • Transactions that Rule 25 seeks to address go much wider than those in which a shareholder is induced to accept or promote an offer or whitewash transaction. It is unnecessary for the Takeovers Executive or the Takeovers Panel to show that inducement was the underlying purpose of the arrangement.
  • The Hong Kong legal advisers for Alibaba Group argued that neither they nor Alibaba knew that Mr Chen was a shareholder of CITIC 21CN.  In this regard, the Takeovers Panel suggested that given the proximity of the relationship between siblings, the Hong Kong legal advisers should have been concerned that the OpCo Agreements may have fallen within the ambit of General Principle 1 and Rule 25, even if Mr Chen was not a shareholder, and should have consulted the Takeovers Executive.
  • Alibaba Group argued that a favourable condition should only be one that gave a greater value to an asset than could be obtained from another party. The Takeovers Panel rejected this argument.  It considered that a favourable condition in the context of Rule 25 is one in which a positive value or benefit is received by the shareholder under an arrangement with the offeror and it is not necessary to be a consideration which exceeds the market price for an asset or service involved in the arrangement.
  • In normal circumstances, a breach of a rule to which a whitewash waiver is subject, should result in the whitewash waiver being invalidated. This will place a discipline on successful applicants for a whitewash waiver to adhere strictly to the conditions under which the whitewash waiver is granted.

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