corporate restructuring

06 Jan corporate restructuring

What is Corporate Restructuring?

Restructuring is a method of changing the organizational structure in order to achieve the strategic goals of the organization. It involves dramatic changes in an organization. It is not always in the best interests of the company and its shareholders for the company to be wound up. As such, Company Law offers a number of alternatives for companies experiencing financial and other difficulties. These include:

• Reconstructions 
• Amalgamations
• Schemes of arrangement
• Mergers
• Takeover bids

Reconstruction

A reconstruction may be an alteration of the structure of a group of companies or an alteration of the capital structure of a single company. It explains how a company is “built again” or reconstituted. This may be effected through:

• Reduction of capital
• Variation of class rights
• Scheme of arrangements

Amalgamation

This is a transaction whereby two or more companies are combined in some way in united ownership.

Scheme of Arrangement

This is the making of a change in the rights of shareholders or creditors of an existing and continuing company. A scheme of arrangement may be used in many different situations. Essentially it is suitable for making a change in the rights of shareholders or creditors of an existing and continuing company. But it can also be used to effect a take-over or to carry out a reconstruction involving changes of company structure. Arrangement is defined under Section 922 of the 2015 Companies Act to include a reorganization of the company’s share capital by the consolidation of shares of different classes or by the division of shares into shares of different classes, or by both of those methods.

Acquisition

An acquisition is the process in which a company (acquirer) purchases most or all of another company’s(target) shares to gain control of that company. Purchasing more than 50% of a target firm’s stock and other assets allow the acquirer to make decisions about the newly acquired assets without the approval of the company’s other shareholders. Acquisitions, which are very common in business, may occur with the target company’s approval, or in spite of its disapproval. With approval, there is often a no-shop clause during the process.

In an acquisition, the board of directors of an acquired firm agrees to allow another company to control the firm for a certain price. The firm making the acquisition usually agrees to purchase the acquired company’s assets or stock. Purchasing the assets allows the acquiring company to obtain shareholders’ approval. The company desiring to make the acquisition must perform due diligence before the acquisition process begins.

Steps taken during an acquisition

1. developing a strategy and researching the financial benefit of acquiring the target company. Acquiring companies must know the resources needed to purchase another company.
2. identifying and performing a valuation of the target firm. Companies perform valuations by examining financial statements, identifying market positions, researching legal obligations and performing a SWOT analysis on the target firm.
3. determine how much the target company is worth, and the best way to raise the resources needed for the acquisition.
4. agreeing to the terms of the acquisition and meeting all legal requirements.

Section 566 of the companies act no.17 of 2015 provides that an interest in shares may arise from an agreement between two or more interests in a person that includes provision for the acquisition by any particular company one or more of them of interests in shares of a particular public company (the “target company” for that agreement).

Difference Between a Merger and an Acquisition

Although the two terms are often used interchangeably, certain situations are mergers and others are acquisitions, depending on the terms of the business deal. If a company does not wish to be taken over by another, this situation is regarded as an acquisition and may be referred to as a hostile takeover. The difference often presents in the way the employees, board of directors and shareholders learn of the merger or acquisition. Though, many merger and acquisition situations are mutually beneficial and allow companies to grow their presence and expand their reach. Some more differences between them include:

• Business name: In an acquisition, the company acquiring the other company typically maintains its business name, legal structure and operations. In a merger situation, the companies involved may choose a new name that better reflects the vision of the new, joined company, or they may choose to use one of the existing company names to maintain brand awareness and loyalty.
• Legality: From a legal standpoint, the company acquired by another company essentially ceases to exist under its previous name and as its own legal entity. It’s absorbed by the acquiring company, and if the acquired company sold or traded stock, the stock is owned and managed by the acquiring company.

Examples of an Acquisition include: –

1. Cooperative Bank’s recent acquisition Jamii Bora Bank has been renamed to Kingdom Bank Limited and has had a change in its management.
2. Amethis, alongside its partners DEG, MCB Equity Fund and IFC, a member of the World Bank Group, is pleased to announce its partnership with Naivas. The transaction marks the acquisition of a minority equity stake into the Naivas Group. Naivas is the leading mass distributer in Kenya with a 60 stores’ network throughout the country. Thanks to strong fundamentals, the group plans to pursue its expansion strategy nationwide.
3.  On 11th October, 2018, Sokoni acquired Tumaini Self Service Limited (Tumaini), a retailer in Kenya involved in the business of self-service stores, retail supermarkets and wholesale distribution of all kinds of goods and services. Tumaini has 13 outlets located in Nairobi, Kiambu, Kajiado, and Kisumu counties.

Mergers

The term “merger” is defined in section 2 of the Competition Act, 2010 (the Act) as “any acquisition of shares, business or other assets, whether inside or outside of Kenya, resulting in the change of control of a business, part of a business or an asset of a business in Kenya, in any manner and includes a takeover.

Section 41(1) of the Competition Act defines a merger as “occurring when one or more undertaking directly or indirectly acquire or establish direct or indirect control (2nd part) over the whole or part of the business of another undertaking

The Capital Markets (Take-overs and mergers) Regulations, 2002 provides that a merger is an arrangement whereby the assets of two or more companies become vested in or under the control of one company A merger is a voluntary amalgamation of two firms on roughly equal terms into one new legal entity. The decision is usually mutual between the merging companies. Mergers are mostly geared towards enjoying greater economies of scale and increasing a company’s competitiveness in the market.

It means the uniting of two companies through an acquisition by one company of a controlling holding of shares in another. A company may absorb a minority shareholding in its partly owned subsidiary in exchange for cash or shares. A company may seek to alter the rights of its creditors, e.g. by variation of the rights of debenture holders, by mutual agreement.

Under Section 933 of the 2015 Companies Act, a merger occurs where:

1. the assets and liabilities of a public company are to be transferred to another existing public company (merger by absorption)
2. The assets and liabilities of a public company are transferred to a new company (merger by formation of a new company)

Draft Terms of Proposed Merger Scheme

Section 934 of the Companies Act 2015 provides that the directors of the merging companies shall prepare and adopt a draft of the proposed terms of the proposed merger. 

The draft terms shall contain particulars of at least the following matters:

1. in respect of each transferor company and the transferee company:
2. its name,
3. the address of its registered office; and
4. whether it is a company limited by shares or a company limited by guarantee and having a share capital;
5. the share exchange ratio and the amount of any cash payment;
6. the terms relating to the allotment of shares in the transferee company;
7. the date from which the holding of shares in the transferee company will entitle the holders to participate in profits, and any special conditions affecting that entitlement;
8. the date from which the transactions of a transferor company are to be treated for accounting purposes as being those of the transferee company;
9. any rights or restrictions attaching to shares or other securities in the transferee company to be allotted under the scheme to the holders of shares or other securities in a transferor company to which any special rights or restrictions attach, or the measures proposed concerning them;
10. any amount of benefit paid or given or intended to be paid or given to any of the experts or to any director of a merging company, and the consideration for the payment of benefit.

The directors of each of the merging companies have to lodge a copy of the draft terms with the Registrar failing which a default penalty of KES 200,000 applies. The registrar will thereafter publish a notice of the lodgment in the Kenya Gazette.

Approval by Members of Merging Companies

Section 936 of the companies Act No. 17 of 2015 provides that a scheme has no effect unless it is approved by a qualified majority (75%) of members of each class of each of the merging companies.

However, such an approval is not necessary under S.945 if the following conditions are met:

1. If it is a merger by absorption where 95% of the transferor’s company’s shares are held by the transferee company 
2. The draft terms of the proposed merger were published by the Registrar within 1 month
3. The members of the transferee company were able to:
   1. Inspect copies of the merger documents
   1. On request, obtain copies of the same
4. No member(s) holding at least 5% of the transferee company’s shares required a meeting to approve the merger

DUE DILIGENCE

Due diligence is a process of verification, investigation, or audit of a potential deal or investment opportunity to confirm all relevant facts and financial information, and to verify anything else that was brought up during an M&A preliminary negotiation process.

• Diligence covers areas like
  • Financial- balance sheets, financial reports, audit reports
  • Legal- Intellectual Property, contractual obligations, legal encumbrances, legal suits
  • Commercial- Products and services offered, target market

Due diligence process includes;

• Preparation of a checklist
  • Collection of necessary information- meetings, questionnaires, searches
  • Analysis of information collected
  • Preparation and presentation of a due diligence report

Due Diligence Questionnaire

A due diligence questionnaire (DDQ) is a list of frequently asked questions required by the merging companies to effectively undertake the merging process and to mitigate risk. It is a framework to use during initial due diligence work

While the DDQ will vary depending upon the deal type and target company, there are basic categories practitioners have learned to investigate and baseline questions practitioners have learned to ask. While the DDQ does not eliminate all the work and investigation involved in diligence, it can identify early risks and red flags, allowing the buyer to decide if it would be advantageous to proceed.

 A due diligence report is then prepared and is subject to discussions by the executive team who are evaluating the transaction and is a requirement for mergers.

Subsequent Phases of the due diligence process

• ;
• Due Diligence Review and;
• Transactional Due Diligence
• Preliminary Due Diligence -Potential benefits of acquisition are reviewed and publicly available information on target company is collected and estimated. Potential buyer and seller enter into negotiations. Parties could enter in a Term Sheet/Head of Terms/ MOU/ Letter of Intention (LOI).  It sets out the basis of the agreement, basic set up of the deal/what people are looking to buy /any conditions parties may have and lastly gives rise to a period of exclusivity. During preliminary due diligence the managers of the acquiring company become more informed on target company but more than other market participants who are aware of the publicly available information.
• Due Diligence Review- This process begins when the participants start the negotiation process and this gives automatic birth to signing a confidential agreement (Non-Disclosure Agreement NDA).  The acquiring company formulates a comprehensive checklist that consist of thematic areas that cover different areas such as Financial Environment, IP, etc.  The acquiring company should ensure that the checklist has clear format so other party answer directly. Due Diligence process seeks to obtain and evaluate private information on target company which will be applied to decided whether to execute the acquisition.
• Transactional Due Diligence- At the end of transactional due diligence company assumes ownership and control over the target company. As you do your due diligence, the target and acquiring company start drafting a sales agreement. The target company is the one that drafts the sale agreement. By the time one finishes with due diligence process one must also be done with the drafting of the sale agreement. Since information obtained in the due diligence process is also used in drafting of the sales agreement. Target company also drafts a Disclosure letter which contains any information that has not been disclosed. Disclosure Letter should be provided to the acquiring company before signing of the sale agreement.  This assist acquiring company to ascertain whether they are ready to proceed with the acquisition.

General Overview of Merger Process

Step 1: – Research +Expert Analysis on Possible Merging of companies

Step2: – Passing of Resolution to Merge Companies

Step 3: – Letter of Intent sent to target company

Step 4: – Meeting held to disclosethe letter of Intention

Step 5: – Letter of Intention either to reject of accept merging of companies

Step 6: – Submission of further documents within 30days

Step7: – Filing a Notification to Merger

Step8: – Preparation of merger agreement

Step 9: – Disclosers

Step 10: – NDA’s and Exclusivity Agreements Drawn

Step 11: – Consideration of Application by Competitive Authority of Kenya

Step 12: – Approval or Rejection

NO.	DUE-DILIGENCE CHECKLIST	FOCUS OF ENQUIRIES
1.	Legal Information	A list of all litigation or administrative or governmental proceedings, investigation or inquiries pending Any or all decrees judgments orders and settlement agreements to which the company or any subsidiary of the company is a party or is bound.Copies of all material governmental approvals authorizations and licenses required in the conduct of the corporation’s business.All joint venture or partnership agreements to which the corporation is a party
2.	Cooperation Information	Articles of Incorporation Schedules of directors and officers including age term of office and description of dutiesAny partnerships, Joint Ventures or any affiliatesStock ownership and listing of all outstanding options warrants or other rights.
3.	Financial Information	Copies of Companies audited financial statementCopies of Company Income taxDetailed trade accounts receivable (trial balance)Detailed trade accounts payable (trial balance)General Ledger trial balances
4.	Business/Operational Information	Memo describing the company’s history.Sale Activities.Description of product lines and individual business segments.Marketing and advertising activities Names of principal competitors and respective market position Copy of all customer supplier and agreement
5.	Human Resource	Organizational ChartSchedule of all employeesCopy of any employment or consulting contracts and agreementsCopy of all employee benefit plansProvide current pension plan valuation reportProvided or describe the company’s policies regarding vacation and sick pay

Example of a Merger in Kenya

1. Access Bank and Diamond Bank merged on April 1, 2019. In conclusion of its merger with Diamond Bank, Access Bank unveiled its new logo, signaling the commencement of a new enlarged banking entity.
   1. The Competition Authority of Kenya approved the proposed acquisition of 100% of the shares in Quick Mart Limited by Sokoni Retail Kenya Limited unconditionally. The proposed transaction involves the acquisition of 100% of the issued shares in Quick Mart by Sokoni. The transaction therefore qualified as a merger within the meaning of Section 2 and 41 of the Competition Act No.12 of 2010.
   1. The Competition Authority of Kenya (CAK) approved the proposed merger between Commercial Bank of Africa (CBA) and NIC Group Plc. In arriving at the decision, the competition watchdog said it expects the resultant merged entity, with a market share of 10.67 per cent, to still face competition from tier I banks who, together, control 55.32 per cent of the 42-bank market.

Takeover Bids

The Companies Act, under section 584, defines Takeover as making an offer to acquire shares, if such offer includes any of the conditions under section 584 (2) and (3) of the companies Act No. 17 of 2015 which include: –

• First condition- whether the offer is to acquire all the shares in a company, or acquisition of one class or all classes of shares – exclusive of shares that might be held by the offeror.
• Second condition- the terms are consistent to all shares, even when there are different classes, to all respective class of shares.

A takeover offer is defined under the Takeovers and Mergers Regulations as a general offer to acquire all voting shares in the Offeree company (“Target Company”). A reference to a takeover offer includes a takeover scheme.

According to the Capital Markets (take-overs and mergers) Regulations, 2002, a take-over offer means a general offer to acquire all voting shares in the offeree company and includes a takeover scheme. Takeovers can be classified as

• Hostile takeovers– acquiring all or a majority of the company’s shares giving the acquiring company control or ownership of the target company without consent of board of directors or shareholders
  • Friendly takeovers/acquisitions usually occur with the knowledge and consent of the board of the target company. In some cases, it can be negotiated through a consensual process.

The difference between a friendly and hostile takeover is solely in the manner in which the company is taken over. In a friendly takeover, the target company’s management and board of directors approve the takeover proposal and help to implement it. However, in a hostile takeover, the management and board of directors of the targeted company oppose the intended takeover.

Take-over process

The takeover process is governed under the Capital Markets (Take-overs-and-mergers) Regulations-2002 which include; –

• Notice of intention- Under Regulation 4(1), the company (offeror) which intends to acquire the effective control of the listed company (offeree) shall not later than 24 hours of resolving to take over the offeree announce the proposed offer by a notice published in the press and serve a notice of intention, in writing of the take-over scheme, to the offeree, CMA, NSE and Commissioner of Monopolies and Prices.

• Under Regulation 4(4), the offeror shall serve on the offeree its statement of the take-over scheme within 10 days from the date of the notice of intention referred to in Regulation 4(1) which statement shall be approved by the CMA.

• Regulation 6. (1) Upon receiving the offeror’s statement in accordance with Regulation 4(4) the offeree shall inform the relevant securities exchange and the Authority and make an announcement by a press notice of the proposed takeover offer within twenty-four hours of receipt of the offeror’s statement.

•Under Regulation 7(1), the offeror shall within 14 days of service of the offeror statement submit to the CMA for approval the take-over document which CMA is required to approve within 30 days or such time as CMA may determine. The document is required to be served on the offeree within five days of approval by CMA.

• Under Regulation 10 the Board of directors of the offeree shall within fourteen days after the receipt of the take-over offer issue a circular to the holders of voting shares to which the takeover offer relates, indicating whether or not the board of directors of the offeree recommend to holders of the voting shares the acceptance of the take-over offer(s) made by the offeror under the take-over scheme.

• Regulation 18. (1) A take-over offer shall be deemed to close on the last day of the offer period. (2) A holder of the voting shares in the offeree may withdraw acceptance out of his own volition at any time before the closing of the offer.

• Competing bids may be served for up to 10 days before the offer period ends. When competitive bidding ensues, the CMA may vary the timeframes to require all bids and variations to be received within a fixed period.

Principles in the takeover regulations

Disclosure of information which includes: –

• Ensures that the merger is facilitated and not impeded
• Ensures no information is concealed that will impact on the success of the takeover
• Information obligation is placed on the offeror, and on the directors of the target company
• The information includes-
• Shareholding structure
• Liabilities

Equality in treatment of all shareholders which includes: –

• Takeover bids must be circulated by all share and debenture holders
• Bids must be approved by a resolution of members
• Members must be given their right to exercise their preemption rights during takeover

Takeovers must be carried out within a strict and limited timeline to minimize disruption of business.

Duty of Directors of Target Company during takeovers

1. Duty to Circulate offer to all shareholders
2. Duty to prepare and circulate to members their own report on the offer
3. Valuation and assessment of the offer
4. Provide info to the offeror as required
5. Duty to convene a meeting of members to consider the offer
6. Duty not to take any action as to defeat the offer

Duties of the offeror during takeover

1. Disclosing shareholding of the target company and those of his association
2. Disclosure of the purpose of the takeover the offer must be made for a specific legitimate reason
3. Make a precise offer it must not be speculative.

There are two main regimes for takeover regulation globally

UK Model- Non-Interference Model

• The regulations require the board of the target company to cooperate with an offer
• The offeror should not be unnecessarily impended
• The board must facilitate all information to promote the processing of the offer
• Kenya follows this model.

American Model- Poison Pill Model

A poison pill is a defense tactic listed companies use to deter activist investors or acquirers from building large stakes or staging a takeover without the board’s consent, and without paying a premium to all shareholders.

• The board of the target company can take active measures to resist a takeover where in their opinion, that offer is not advantageous to the company including-
• Diluting the shareholding by issuing more shares
• Inflating the price of shares by being active in the market
• Disposing of certain assets to reduce attractiveness of the company

Right of Minorities

In 2019, the Companies Act was amended through the Statute Law (Miscellaneous Amendments) Act no.12 of 2019, to lower the take-over threshold to 50%.  The reduced threshold was also seen to undermine the right of minority shareholders to decline the offer.

The Business Laws Amendment Act 2020 amended the Companies Act to reinstate the threshold for “squeeze-ins” and “sell-outs” to 90%. The previous threshold of 50% was impractical and not in line with the global practice.  “Squeezing-in” permits an investor, to acquire minority shareholdings on a compulsory basis if it has acquired not less than 90% in value of the shares and not less than 90% of the voting rights carried by the shares to which the offer relates.  A “sell out” occurs where minority shareholder requires the offeror to purchase their shares in each case on the same terms as the offer.

Defence takeovers

1. A competing bid from a strategic investor is often the most attractive form of anti-takeover defence.
2. Target companies may also make counter-offers to purchase the shares at a premium this includes a company buying a sizable portion of its own shares, which prevents the acquiring company from purchasing the shares and becoming the majority owner.
3. A target entity may modify its capital structure and force a re-evaluation of the deal’s attractiveness or seek white knight offers from other players in the relevant industry.
4. Further anti-takeover Defences may be prescribed in a listed company’s articles of association.
5. Targets may persuade the existing shareholders to reject the offer based on the independent adviser’s evaluation.
   1. Confidentiality is key to prevent the any counters to the acquisition
   1. Keeping the proposed bid as confidential as possible until it is announced generally assists in protecting the deal. Entering into voting agreements to secure the minimum percentage of shares to be taken up may help encourage a friendly deal.

Reverse Take-Overs (RTO)

A reverse takeover enables a private company to go public without the attached costs and time delay of an initial public offering (IPO). In the RTO a smaller firm will acquire management control of a larger or longer established company and keep its name for the combined entity. This is known as a reverse takeover. Another type of acquisition is reverse merger which enables a private company to get publicly listed in a short period of time. This occurs when a private company that has strong prospects and is eager to raise financing buys a publicly listed shell company, usually one with no business and limited assets. RTOs have often been deemed to be the poor man’s initial public offering (IPO). Sometimes, conversely, the public company is bought by the private company through an asset swap and share issue.

Example of a Reverse Takeover in East Africa 

• June 25, 2013: The first reverse takeover transaction in East Africa was completed when I&M Holdings began trading on the NSE.

Example of a Take-over

1. Competitive Authority of Kenya (CAK) gave nod to KenolKobil takeover by French firm Rubis

ADVANTAGES OF MERGING, ACQUISITION AND TAKEOVER OF A COMPANIES

1. Tax Benefits- sometimes bring tax benefits if the target company is in a strategic industry or a country with a favorable tax regime.
2. Increases market share- When companies merge, the new company gains a larger market share and gets ahead in the competition.
3. Reduces the cost of operations- Companies can achieve economies of scale, such as bulk buying of raw materials, which can result in cost reductions. The investments on assets are now spread out over a larger output, which leads to technical economies.
4. Expands business into new geographic areas- A company seeking to expand its business in a certain geographical area may merge with another similar company operating in the same area to get the business started.
5. Prevents closure of an unprofitable business- Mergers, Acquisition or takeover can save a company from going bankrupt and also save many jobs.

DISADVANTAGE OF MERGING, ACQUISITION AND TAKEOVER OF A COMPANIES

1. Raises prices of products or services- A merger results in reduced competition and a larger -market share. Thus, the new company can gain a monopoly and increase the prices of its products or services.
2.  Creates gaps in communication- The companies that have agreed to merge may have different cultures. It may result in a gap in communication and affect the performance of the employees.
3.  Creates unemployment– In an aggressive merger, a company may opt to eliminate the underperforming assets of the other company. It may result in employees losing their jobs.
4.  Prevents economies of scale- In cases where there is little in common between the companies, it may be difficult to gain synergies. Also, a bigger company may be unable to motivate employees and achieve the same degree of control. Thus, the new company may not be able to achieve economies of scale.