Takeover Defences under PRC Law (Part II)

A publicly-listed company is typically managed or controlled by a board of directors. The success of a hostile takeover largely depends on whether an unsolicited acquirer is able to gain control of a target company's board of directors, by electing new directors to replace the incumbent directors who are against the unsolicited takeover bid. As a tactic to delay the acquirer's ability to gain control of the board, the target company may structure its board in such a way that the directors are divided into multiple classes - usually three classes - with the directors in each class serving three-year terms and only one class elected annually. This board structure is commonly known as 'classified' or 'staggered'. The terms of a staggered board of directors make it difficult for the acquirer to seize immediate control of the target company. Although a majority of the target company's shares is acquired or controlled by way of a majority shareholders' voting power, the acquirer may only replace a part (usually one-third) of the directors on an annual basis. Hence, it will generally take the acquirer at least a year (providing the acquisition took place just before the shareholders' meeting) to gain control of a classified board of directors after holding elections of directors at two shareholders' meetings. Such a lengthy delay may pose a significant deterrence for potential acquirers who need to obtain immediate control of the target company for commercial or other reasons.

The PRC Company Law (Company Law)(中华人民共和国公司法) sets out the basic statutory requirements regarding the structure of a PRC company's board of directors. Articles 46 and 109 of Company Law provide that a director may serve for a term of up to three years. However, the Company Law is silent as to whether a directors' term may be staggered. The Guidelines for the Articles of Association of Listed Companies (Guidelines), as amended by the China Securities Regulatory Commission (CSRC) on March 16 2006, may provide some guidance on this point. Except as indicated otherwise, a PRC listed company is required by the CSRC to adopt in its articles of association all the provisions of the Guidelines. Under Article 96 of the Guidelines, a director's term commences from the date on which he or she takes office and ends on the date on which the term of the current board of directors expires. This provision suggests that all directors' terms will end upon the expiration of the term of the current board of directors and the entire board of directors will be subjected to re-election at the same shareholders' meeting, which may be construed as precluding a PRC listed company from staggering its directors' term.

Even without a staggered board of directors, the long term of office for directors under the Company Law may have a substantial anti-takeover effect. A PRC company usually has a board with a term of three years and elects its directors triennially, unless there are vacancies resulting from situations such as resignation or death of directors. Depending on when an unsolicited acquirer launches its takeover bid, it may have to wait up to three years to replace the target company's incumbent board of directors. For instance, if the acquirer launches its bid just before the annual shareholders' meeting of a target company for election of directors, there will be no substantial delay in gaining control of the target company's board. However, if the acquirer launches a bid immediately after such a meeting, it will have to wait almost three years for the opportunity to gain control of the target company's board.

A board with a long term of office that is used as an anti-takeover defence is also susceptible to anti-defence tactics. For example, an acquirer may seek to reduce directors' term of office or create vacancies on the board by increasing the size of the board so that it can elect new directors to fill such vacancies and control a majority of the enlarged board. Given that the size and term of the board are usually provided for in a company's organizational documents (for example, an articles of association), an acquirer can only achieve such purposes by amending the target company's organizational documents. In order to restrict the acquirer's ability to amend the organizational documents, the company may provide in its organizational documents that any such amendments require a supermajority vote of shareholders. The Company Law provides this protection for PRC companies by specifying that any amendment to a PRC company's articles of association requires approval by more than two-thirds of the shareholders present at a shareholders' meeting (Articles 44 and 104 of the Company Law). However, such statutory provisions also restrict a PRC company's flexibility to require a greater vote (for example, a three-quarter vote) for amendment to its articles of association. Furthermore, under Article 109, a PRC listed company is permitted to have no more than 19 directors, who will serve as a restraint on an acquirer's flexibility to increase a target company's board size, even if it controls sufficient shareholders' votes required for amendment to the articles of association.

Additionally, a board with a long term of office is vulnerable where a director may be removed for no cause. However, Article 96 of the Guidelines expressly provides that a director may not be removed by a shareholders' meeting for no cause before his or her term expires. When adopting this provision into its articles of association, a PRC listed company may consider further clarifying and limiting the circumstances that may give rise to a cause for removal, such as fraud and criminal acts, in order to minimize any ambiguity that may be taken advantage of by a potential acquirer.