Buying a supplier from the chairman's sister's husband: connected transaction ratios and approvals
A Main Board listed issuer (market capitalisation HK$6.0 billion, total assets HK$8.0 billion, revenue HK$5.0 billion, net profit HK$600 million) proposes to acquire 100% of a raw-material supplier from a holding company owned 60% by the chairman's sister's husband and 40% by an unrelated private equity fund. The consideration is HK$420 million. The target's total assets are HK$300 million, revenue HK$250 million and net profit HK$18 million. The target currently supplies 12% of the issuer's raw materials. The board wants to sign the sale and purchase agreement on 20 May, announce on 21 May, and complete after an independent shareholders' meeting on 10 July. The chairman says no shareholders' approval is needed because the consideration is only 7% of market capitalisation and the deal is "below 25%". The CFO says a circular is needed only if a ratio exceeds 5%, and that the chairman can vote because he is not the seller.
1. Classify the transaction under the Listing Rules and explain whether the chairman and the CFO are right.
Read the worked answer
The percentage ratios are calculated against the issuer's figures:
- Consideration ratio: 420 / 6,000 = 7.0%
- Assets ratio: the higher of 420 / 8,000 = 5.25% and 300 / 8,000 = 3.75%, so 5.25%
- Revenue ratio: 250 / 5,000 = 5.0%
- Profits ratio: 18 / 600 = 3.0%
No ratio reaches 25%, so this is not a major transaction. But the chairman's "below 25%" point is irrelevant to the connected transaction regime. Because the seller is a connected person, Chapter 14A applies and the relevant threshold is 5%. The consideration ratio (7.0%), assets ratio (5.25%) and revenue ratio (5.0%) all reach or exceed 5%, so the transaction requires an announcement, a circular to shareholders, and independent shareholders' approval. The CFO is right that a ratio exceeds 5%, but wrong to suggest the chairman can vote.
2. Who is a connected person here, and what voting and procedural safeguards apply?
Read the worked answer
The chairman is a director and therefore a connected person. His sister's husband is the spouse of his sister, which brings him within the definition of a close associate. The holding company is 60% owned by that close associate, so it is controlled by a connected person and is itself a connected person. The target is a company controlled by the holding company, so it is also a connected person. The transaction is therefore a connected transaction notwithstanding that the chairman is not the legal seller.
Procedurally:
- The chairman must abstain from voting on the board resolution approving the acquisition, because he has a material interest in the transaction.
- The board should establish an independent board committee of all independent non-executive directors to consider the transaction and to recommend how independent shareholders should vote.
- The issuer must appoint an independent financial adviser to advise the independent shareholders, and the IFA must be independent of the issuer, the chairman and the seller.
- At the EGM, the chairman and his associates cannot vote. Approval must be by poll of independent shareholders.
- The announcement must be made as soon as practicable after the terms are agreed, and the circular must contain the SPA, the valuation, the IFA's advice, the independent board committee's recommendation, and the reasons for the transaction.
3. What must the announcement and circular contain, and does the target's supply relationship create any additional issue?
Read the worked answer
The announcement must identify the parties and the connected relationship, state the consideration and how it is satisfied, set out the percentage ratios, explain the reasons for the transaction, confirm that it is on normal commercial terms and fair and reasonable, identify the independent board committee and the IFA, and state that independent shareholders' approval will be sought. The circular must give fuller disclosure: the SPA, the target's financial information, the basis of the consideration, the valuation, the IFA letter, the independent board committee's recommendation, the interests of directors, and the voting restrictions.
The 12% supply relationship needs analysis. On completion the target becomes a subsidiary of the issuer, so supplies from the target to the group become intra-group and are not a continuing connected transaction. But if the seller or the chairman retains any supply or distribution arrangement with the group after completion, that arrangement could be a continuing connected transaction requiring a written agreement, annual caps, announcement, reporting and annual independent shareholders' approval if the caps exceed the thresholds. The prospectus/circular should also address whether the group will continue to depend on the seller's network and whether the transaction is truly on arm's-length terms.