In October 2012, the Hong Kong Stock Exchange (“HKEx”) published two guidance letters on Pre-IPO investments and Pre-IPO investment in convertible instrument respectively. The purpose of the two guidance letters is to consolidate previous HKEx’s listing decisions on Pre-IPO investments and to set out its current practice when dealing with convertible instruments issued to Pre-IPO investors.
Applicable listing rules, regulations and principles relating to Pre-IPO investment
The Main Board Listing Rule 2.03(2) requires the issue and marketing of securities to be conducted in a fair and orderly manner and the Main Board Listing Rule 2.03(4) requires that all holders of listed securities be treated fairly and equally.
The Guidance Letter HKEx-GL29-12 published in January 2012 requires, except in very exceptional circumstances, that pre-IPO investments be completed either (a) at least 28 clear days before the date of the first submission of the first listing application form or (b) 180 clear days before the first day of trading of the applicant’s securities.
In this eNews, we will summarize (A) the common special rights offered to Pre-IPO investors (excluding other shareholders) which the HKEx may allow or disallow to survive listing and (B) HKEx’s current practice in dealing with convertible instruments issued to Pre-IPO investors.
(A) Summary of general principles relating to special rights attached to Pre-IPO Investments
In general, atypical special rights or other rights which do not extend to all shareholders will not survive listing on the basis that all shareholders should be treated equally. The following are some general principles regarding treatment of special rights created prior to IPO at Pre-IPO investments :-
(1) Any price adjustment provisions which effectively create two different prices for the same securities for Pre-IPO investors and other shareholders at the time of listing are not allowed.
(2) All put or exit options granted to Pre-IPO investors to put back the investments to the applicant or its controlling shareholder are not allowed unless the applicant’s listing does not take place.
(3) Any contractual right of a Pre-IPO investor to nominate a director is not allowed to survive after listing.
(4) Any contractual right of a Pre-IPO investor to exercise veto power over the applicant’s major corporate actions such as winding up or change of business should be terminated upon listing.
(5) Anti-dilution rights of a Pre-IPO investor to purchase additional securities to be issued by the applicant to maintain its percentage of shareholding in the applicant should be extinguished upon listing. However, the exercise of such anti-dilution rights at the time of listing at the offer price of the IPO offering in order to give effect to the pre-existing contractual rights of a Pre-IPO investor will be considered permissible if the exercise has been fully disclosed in the IPO prospectus and the allotment results announcement.
(6) Profit guarantee is only allowed if the compensation is settled by a shareholder instead of the applicant and is not linked to the market price or capitalization of the shares.
(7) Negative pledges should be removed before listing unless they are widely accepted provisions in loan agreements, are not egregious and do not contravene the fairness principle under Rule 2.03 of the Main Board Listing Rules. Negative pledges will be considered as widely accepted provisions in loan agreements if they do not :-
(i) create or effect any mortgage, charge, pledge, lien or other security interest
on an applicant’s assets and revenues; and
(ii) dispose of any interest in the economic rights or entitlements of a share
which the controlling shareholder owns or controls to any person.
The HKEx may require the sponsor to confirm that the negative pledges which remain after listing are in line with normal terms of debt issues.
(8) Prior consent of a Pre-IPO investor for (i) certain corporate actions such as declaration of dividend, sale of substantial assets or change in executive directors and (ii) change of the applicant’s constitutional documents is not allowed unless they are not egregious and do not contravene the Listing Rules.
(9) Exclusivity rights and no more favourable terms in a Pre-IPO investment agreement that require the applicant not to issue or offer any shares, options, warrants and rights to any direct competitor of the Pre-IPO investor or to other investors on terms more favourable than the terms on which the shares are issued to the Pre-IPO investor are not allowed to survive after listing unless an explicit “fiduciary out” clause is included in the Pre-IPO investment agreement to allow the directors to ignore such terms if complying with the said terms would constitute a breach of their fiduciary duties.
(10) Information rights of a Pre-IPO investor are not allowed unless the information is made available to the general public at the same time.
(11) Contractual rights of a Pre-IPO investor to nominate senior management and committee representative are, in normal circumstances, allowed to survive after listing. However, such nomination pursuant to contractual rights is subject to the decision of the board of directors who are not contractually obligated to approve such nomination.
(12) Right of first refusal and tag-along rights granted by the controlling shareholder to a Pre-IPO investor which intend to contractually prohibit the controlling shareholder from selling its shares to other parties are allowed to survive after listing.
(13) A term in an investment agreement which compensates a Pre-IPO investor in a case where the applicant does not achieve a qualified IPO within a specific period of time is allowed if the amount to be compensated is set out in the investment agreement or can be derived from the compensation provisions under the investment agreement.
(B) Summary of HKEx’s current practice in dealing with convertible instruments issued to Pre-IPO investors
(1) The conversion price for the convertible or exchangeable bonds, notes or loans and convertible preference shares (collectively “CBs”) must be at a fixed dollar amount or at the IPO price. The conversion price should not be based on a guaranteed discount to the applicant’s IPO price nor should the conversion be linked to market capitalization.
(2) Any conversion price reset mechanism of the CBs such as a mechanism which is based on the lower of a fixed price and a floating market price must be removed.
(3) Partial conversion of CBs is not allowed if all atypical special rights are not terminated after listing.
(4) The option granted to bondholders of CBs to redeem early the outstanding CBs at a price which would enable the bondholders to receive a fixed internal rate of return on the principal amount of the CBs being redeemed is allowed.
(5) Additional information should be disclosed in (i) the “Financial Information” and “Risk Factors” sections of the prospectus to explain the impact of the CBs on the applicant and (ii) the applicant’s interim and annual reports to enable investors to be aware of the dilution impact on the applicant’s shares in the event all outstanding CBs were converted as at the relevant year end or period end.
Experienced lawyers in our Corporate and Securities Department regularly advise on pre-IPO and post-IPO mergers and acquisitions, regulatory, compliance and company law issues. If you have any question on the above eNews, please do not hesitate to contact us.