Stephen Layburn

It seems appropriate that Paul Glass (see New Zealand Herald, 8 October  http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=11930836 ) should make use of annual reporting season to raise some serious questions about the need for a fresh look at the thorny issue of executive remuneration.  Institutional investors have a key role to play in shaping market expectations about a range of performance issues affecting corporate New Zealand.  And raising serious questions about executive remuneration is in keeping with the work to date by the Corporate Governance Forum, to promote good corporate governance in NZ companies.

Nonetheless, using a metaphor that seems appropriate this week, some care needs to be taken to ensure that the key issues underpinning calls to address issues such as the need to improve the transparency of remuneration arrangements and performance targets do not descend into a form of dog-whistle politics (small “p”).

Importantly, Paul’s article concludes with a call to introduce a form of Australia’s ‘two strikes law’ into our market.  The Australian model is a very different approach to most other attempts at a “say on pay” regime.  Tellingly, the Australian model focuses on the board of directors and its approval of remuneration policies – not what the individual manager/s are paid.

In a nutshell, the two strikes law holds the board of a listed company accountable, so that if two years in a row, shareholders refuse to endorse the board’s remuneration policy, the shareholders can force the board to be “spilled” (an Australian phrase that seems to have been over-used in relation to events in Canberra in recent years).

Shareholders of listed companies now have to vote on whether to spill all board positions if 25% or more votes cast are not in favour of adopting the remuneration report at two successive AGMs.  A spill resolution must then be put to a vote at a second AGM and, if passed with 50% or more of eligible votes cast, requires a spill meeting within 90 days to elect directors.

There has been a mix of feedback in Australia for the two strikes law since it was implemented in 2011.  Some critics argue it duplicates existing avenues already available to shareholders to register their unhappiness with remuneration.  The rule is also criticised because the hurdle for shareholders to force a first strike is low, but effecting real change (a board spill) remains difficult.

Interestingly, initial studies across the Tasman indicate that shareholders are not as upset by executive pay as the media suggests.  Instead, an overwhelming majority of remuneration reports have been approved, and only a small handful of companies have been the focus of discontent – and of those an even smaller number were the subject of board spills.  And, where there was a spill, less than a dozen directors were not returned following the spill (although the spills have also triggered resignations).

Where the two strikes law seems to be effective is because:

• It is seen to operate as a shaming measure – creating a setting where the board is (publicly) accountable rather than at actual risk of removal. That risk of reputational damage, and consequently, fewer board roles is seen to be effective.
• After a first strike, companies are seen to make more effort communicating with shareholders.
• (It is claimed) the impacts of a first strike and a hit to the company’s share price have also been seen to impact on CEO pay (particularly).

Institutional investors, and industry groups such as the Corporate Governance Forum, are well-placed to generate the sort of empirical analysis needed for a serious debate about issues of fairness to shareholders and value for money – and whether the seemingly endless upward spiral of executive remuneration overseas translates into a New Zealand context.  This also seems to be an issue for unlisted companies – and may even translate into some public sector appointments.

Similarly, a well-founded series of conclusions (based on sound research) could greatly assist the commentary about the apparent anomaly of rewarding ostensibly poor-performers as they exit.  Again, this seems to be an issue for a wider range of situations than just the listed company sector.

Finally, it is important that the issue of shareholders having a greater say on executive remuneration is linked to issues of performance and productivity.  It would not be helpful if this issue became blurred in a broader political debate, as seems to be the case in many countries at present, over issues such as pay inequality or even the living wage conundrum.  In this regard, the Australian model seems to have achieved an outcome that has de-coupled what should be an objective benchmarking process from wider issues based on calls such as those for a need to improve equality.  At least in the short term, a kneejerk reaction may have the negative impact of limiting the ability to foster home-grown management talent.  Longer-term impacts await further data.

Late last month, Fujitsu received a substantial fine as a result of the first ever penalty decision under section 12A of the Fair Trading Act 1993 as a result of being found by the District Court to have made unsubstantiated representations about the efficiency of its heat pumps.

The decision was made on the basis of a series of representative charges (essentially one for each unsubstantiated claim) for advertising on Fujitsu’s website and in other forms of advertising.

The focus of the Commerce Commission’s (and therefore the Court’s) attention was Fujitsu’s claims that:

• it had “New Zealand’s most energy effective/efficient heat pump range”
• the e3 range delivers almost five times the heat of the amount of energy used
• its e3 range of heat pumps were the most efficient systems ever – and delivered “$4.92 heat for a $1 power”

The ComCom alleged that these representations were unsubstantiated (and breached both section 12A and 13(e) of the Fair Trading Act) because Fujitsu did not have reasonable grounds for making them – because the performance cited by Fujitsu was achieved only under laboratory conditions and was not likely to be achievable by consumers in real-world conditions.

Fujitsu submitted that the claims (representations) of energy efficiency were evidence-based and were not a complete departure from the truth – and that the offending was inadvertent or careless (not deliberate).  Also, that publication of the representations was relatively small – and that there was no demonstrable prejudice to consumers or profit to the company as a result.

It also appeared that the representations were based on Fujitsu having been awarded more energy stars by the Energy Efficiency and Conservation Authority than any other brand of heat pump in New Zealand – albeit that Fujitsu accepted that the number of stars could not (of itself) substantiate the representations.

Finding

The District Court held that, in the circumstances, the offending that arose due to the unsubstantiated representations was less serious than the more specific representations that had been made in breach of section 13(e) of the Fair Trading Act (that the e3 heat pump delivered $4.92 of heat for $1 of power).  The unsubstantiated claims were largely made in general terms, and were exaggeration, and therefore less likely to influence buyers than the misleading claims (such as that for the e3 heat pump).

However, the dissemination of information was found to be significant and significantly inaccurate – and that all the facts must have been known to Fujitsu including the limitation of the test results.

In sentencing, the District Court took into account:

• the objectives of the Fair Trading Act
• the seriousness of the offending
• whether the offending was deliberate or careless)
• the impact of the offending on consumers – including the need for deterrence

The District Court held that Fujitsu’s management had been careless in making claims based on the energy star ratings – and that the claim that the range could deliver five times more efficiency was approaching gross negligence.

The decision resulted in Fujitsu being fined $25,000 for each of the five (representative) charges for the unsubstantiated representations – plus court costs for a total fine of $310,000.

Lessons

After the decision, the ComCom noted that the conduct involved bold claims about superiority and energy efficiency, made in persuasive terms by a well-known and reputable manufacturer.  Such claims are important to consumers who may be cost-conscious but also concerned about the environment.  Consumers could not verify the accuracy of these claims for themselves, but had to take them on trust.

The Fujitsu case marks a step up from the ComCom’s previous approach of issuing warnings – such as that in an earlier example involving therapeutic claims in relation to amber products.  As a result, the case is a timely reminder to all businesses to make sure they have reasonable grounds at the time they make any claim in relation to any goods or services.  A breach may result in fines of up to $600,000.

The Commerce Commission has published tips for businesses, including:

• Don’t make claims that you don’t have reasonable grounds for believing to be true
• Rely on facts, figures and credible sources of information, not guesses and unsupported opinions
• Keep documentation or other information that you have gathered in the process of sourcing or researching a good or service
• You must have reasonable grounds for claims at the time they are made, substantiating a claim after it was made may not get you off the hook.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.

Today’s announcements by the Commerce Commission about its investigation into a range of issues affecting the sale of steel mesh, including the 29 charges filed against Steel and Tube for making false and misleading representations about their steel mesh product known as SE62 – makes for interesting reading. I suspect that the Steel and Tube matter is likely to be quite fact-specific.

Perhaps of wider interest will be the outcome of the charges filed by Comcom earlier this year against two other distributors in relation to false and misleading representations about steel mesh – in which guilty pleas have been entered.

In the meantime, the Commerce Commission has recently published an open letter to retailers (copy attached), highlighting pricing practices which might breach the law.

The letter includes a one-page summary of tips for retailers to consider when planning price promotions, including:
• ensure discounts are taken off the usual selling price
• don’t use fine print to hide important information like extra charges
• a ‘sale’ is a brief and limited opportunity to buy at a reduced price
• ‘clearance’ sales are only for clearing goods
• don’t exaggerate savings to be made or the range of goods available at a discounted price
• be careful with claims like “lowest” and “cheapest” prices.

If you require further information about the ComCom’s view on such issues – including access to the open letter and Comcom fact sheets on pricing and fine print, please do not hesitate to contact me.

Introduction

The Contract and Commercial Law Act 2017 (C & C Act), another omnibus act implementing changes to a laundry list of pieces of legislation, was passed in early May and comes into force on 1 September 2017. The C & C Act will bring about a number of small, but significant, changes as well as making minor changes to a long list of contract and commercial laws.

The primary aim of the C & C Act is modernisation, not substantive amendment. These changes will occur in the areas of:

• contract law;
• the law affecting the sale of goods;
• laws affecting electronic transactions;
• the law affecting the carriage of goods; and
• a range of other commercial matters.

It is important to note that some familiar, and quite old, statutes will be repealed – in which case a range of transitional measures will apply. A list of the repealed statutes is set out below. As a result, a range of businesses should take this opportunity to review their trading terms and other standard (template) contracts in order to being them up to date as a result of the changes heralded by the C & C Act.

The C & C Act makes use of a process of “revision” contemplated by the Legislation Act 2012 – with the result that the repealed/replaced statues are consolidated within the C & C Act and drafting changes made, where necessary, to clarify the original drafting and/or tidy up inconsistencies.

Impact on pre / post-1 September 2017 contracts

The prevailing (new) provisions in the C & C Act are intended to apply to contracts entered into from 1 September 2017. However, the transitional provisions tackle this issue in a two-part approach:

• the substantive changes will be deemed to apply – regardless of whether the relevant contract was entered before or after 1 September 2017; and
• in the case of the minor updates – a reference to an old statutory provision will continue to mean that the old law (prior to updating by the C & C Act) will continue to be relevant. As a result, the effect of the law as expressed in those old enactments continues to apply in relation to those matters.

In the case of contracts entered into after 1 September 2017 – the modernised provision contained in the C & C Ac will apply in full.

The C & C Act contains a detailed schedule which can be used as a reference table to determine the impact of an affected statute on existing contracts. By its nature, the list of minor changes (to clarify Parliament’s intent or reconcile inconsistencies) is an extensive one.

Action points

Businesses and their advisers should take this opportunity to review their trading terms and standard contracts and make sure that, particularly, references to the statutory provisions in the list of substantive changes are updated – ready for the 1 September 2017 start date.

The most common changes are likely to be those relating to:

• carriage of goods;
• privity of contract; and
• electronic transactions.

However, because of the nature of the C & C Act (as a revision statute), I think it unlikely that substantive changes will be required to existing contracts – other than updating the reference to the relevant statutory provision. Nonetheless, it is a truism that such a review provides a good opportunity to ensure that standard term (template/boilerplate) provisions remain up-to—date and relevant.

For lawyers, this might also provide a good opportunity to brush up on the impact of the Contractual Remedies Act 1979 (which is being carried across as Part 2, subpart 3 of the C & C Act).

List of repealed statutes

The following contract and commercial statutes are repealed and consolidated by the C & C Act:

• Carriage of Goods Act 1979;
• Contracts (Privity) Act 1982;
• Contractual Mistakes Act 1977;
• Contractual Remedies Act 1979;
• Electronic Transactions Act 2002;
• Frustrated Contracts Act 1944;
• Illegal Contracts Act 1970;
• Mercantile Law Act 1908 (with one carve-out);
• Minors’ Contracts Act 1969;
• Sale of Goods Act 1908; and
• Sale of Goods (United Nations Convention) Act 1994.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.

Introduction

Yesterday, the FMA used one of the new tools in its regulatory toolkit to designate newly-issued shares in investment companies as managed investment products. With effect from 19 May 2017, shares will fall within the designation if:

• they are issued by an investment company; and
• there are reduced powers for shareholders and/or entrenched key service provider arrangements.

The effect of this use of the FMA’s designation power under the Financial Markets Act 2013 is that the investment company issuing those shares will be regulated as managed investment schemes (“MIS”). As a result, it will also need to:

• obtain a license from the FMA to act as an MIS manager;
• appoint a licensed supervisor; and
• comply with additional governance and (assuming that a PDS is required for the offer) disclosure obligations.

A three-step test

The designation applies where a three-step test is met:

• The shares are issued by an investment company; and
• There are reduced powers of shareholders and/or “unreasonably” entrenched key service provider arrangements; and
• The shares are not quoted on the NZX main board.

What is an investment company?

An investment company is a company:

• whose principal business consists of investing in investment property; and/or
• that holds itself out as being a company whose principal business consists of investing in investment property.

Investment property is broadly defined and covers a range of asset usually held by MISs, including financial products, commodities, foreign currencies and real estate. It may be a single asset or a portfolio of assets. There is no distinction between active and passive investment strategies or direct investment and indirect investment strategies – for example, holding the assets through an SPV (although the FMA notes that in some cases, such a SPV may be treated as an investment company in its own right). The FMA also notes that companies whose principal business is not investment will not be caught – and gives the example of a farm operation that owns land for the purpose of farming.

Reduced powers of shareholders

The designation specifies three bright line tests for when there will be reduced powers of shareholders:

• the shares do not confer on the holder all of the rights set out in section 36(1)(a) of the Companies Act 1993;
• a director of the investment company can be appointed / removed other than by a resolution of shareholders; and
• the shareholder’s rights to vote on the appointment / removal of directors are disproportionate to the amount to be paid for the shares.

And then the FMA adds that, even where none of the bright-line tests are triggered, it may consider individually designating shares as MIPs when:

• An investor’s ability to exercise the rights and powers attached to their shares is restricted (as compared to sections 104-109 of the Companies Act), making it more difficult for them to vote on the appointment / removal of a director.
• An issuer structures the terms of its share offer in a manner which avoids the shares being classed as disproportionate immediately after the issue of those shares, but raises concerns that investor voting rights will be disproportionate when a vote on director appointments / removals is held.

Entrenched key service provider arrangements

A number of bright line tests are also used to determine whether there are “unreasonably” entrenched key service provider arrangements. A key service provider is an asset manager, investment manager, or investment adviser. The tests focus on the terms in which key service provider arrangements are entered into- and include:

• the key service provider owns or controls assets material to the operation of the investment company’s business, the benefit of which the company could not reasonably obtain for materially similar cost on arm’s-length terms if the services agreement is terminated;
• the services agreement is on more favourable terms to the key service provider than arm’s-length terms;
• the services agreement is, or will be for a term longer than 3 years, and cannot be terminated by the investment company without cause under the terms of the agreement; and
• the services agreement requires the investment company (or associated person such as a subsidiary) to pay a termination fee (i.e. a break fee) for terminating the services agreement which is more than the lesser of:
o 30% of the payments for the entire term of the agreement; and
o 50% of the payments for the remaining term of the agreement.

Exclusion for NZX main board shares

This exclusion applies because the voting, quorum and other governance requirements that apply to NZX main board listed companies mean that these shares should retain equity-like characteristics (and not in economic substance be MIPs).

Designation to prevent use of crowd funding exclusion

The FMA notes that shares designated as MIPs should not be offered through an equity crowd funding platform.

The other exclusions in Schedule 1 of the FMC Act remain available, if they apply.

The mischief the FMA is trying to prevent

The MIS regime imposes a higher regulatory burden than that for offers of equity securities.

As a result, the FMA is responding to concerns from the managed funds industry about investment companies they believe are operating like MISs (and issuing MIP-like shares), but avoiding the MIS compliance burden. This is being done by offering shares, using a company structure (that are no different in substance to an MIS) as a loophole without having to be licensed or comply with MIS regime requirements.

Also, during its PDS review process, the FMA has seen examples of share offers with terms that make the economic substance of the shares offered less like equity securities and more like MIPs. And whilst the FMA thinks an investment company can be used as a legitimate alternative collective investment structure to a MIS – in some cases the proposed terms did not confer shareholder rights (such as equity voting rights). In other cases, founding shareholders have entrenched themselves as key service providers to such a degree that it is impossible or impractical remove them.

Companies inadvertently caught

The FMA suggests that anyone who believe their shares will be inadvertently caught by the designation to approach them – (e.g. those who believe they are an ‘ordinary’ company but are caught by the definition of ‘investment company’ or the offer terms, company constitution or services agreement technically triggers one of the bright-line tests, but they don’t think the offer breaches the key principles underlying those tests).

Further information

If you would like more information about any of the matters discussed in this note, please contact me.

NZX Corporate Governance Code – updated

This week the NZX has published an updated version of its Corporate Governance Code.

The NZX Code will replace the existing Best Practice Code (applicable to the NZX Listing Rules for the main board and debt market) – to take effect from 1 October 2017 so that it must be reported against for reporting periods ending 31 December 2017 and beyond.

The release of the NZX Code was greeted by statement from the FMA that the NZX Code is “well aligned” to the principles in the FMA’s Corporate Governance Handbook – and helps to ensure New Zealand’s listed companies are in line with international standards of corporate governance.

It should also be noted that NZX intends to do further work in this area, including looking at the proportion of independent directors required for listed companies, during their broader review of the Listing Rules.

The NZX Code covers eight principles, which are intended to protect the interests of and provide long term value to shareholders while also seeking to reduce the cost of capital for issuers. Each principle contains specific recommendations and explanatory commentary that NZX listed issuers are encouraged to adopt.

Comply or explain (aka if not, why not)

The NZX Listing Rules encourage issuers to adopt the NZX Code but do not force them to do so.  If the Board considers that a recommendation is not appropriate because it does not fit the issuer’s circumstances, it is entitled not to adopt it – but it must explain why not.

Application

NZX has provided a useful diagram to illustrate the hierarchy of the ‘comply or explain’ regime and how each (Main Board / Debt) issuer should interpret the principles, recommendations and commentary.

Reporting against the NZX Code

 

The disclosure of an issuer’s compliance with the NZX Code is intended to be flexible so that disclosure can either be:

• in its annual report – NZX recommends that any statement and any related disclosures appear in a clearly labelled corporate governance section; or
• on its website – in which case disclosures should be clearly presented and centrally located / accessible (in a category such as ‘About Us’ or ‘Investor Centre’); or
• a combination of both.

Disclosing that a recommendation is not followed

If the issuer has not followed a recommendation for any part of the reporting period, its statement must separately identify that recommendation and what (if any) corporate governance arrangements it has adopted in lieu.

An issuer’s corporate governance statement must specify the date at which it is current (i.e. balance date or a later date specified by the issuer and approved by the Board).

A ‘why not’ statement should:

• be reasonably detailed and informative;
• disclose the alternative practices (if any) used in lieu – and explain why they are more appropriate; and
• avoid being short / uninformative, without analysis and unhelpful to investors.

Eight principles

A brief summary of the eight principles and highlights of the key points in the NZX Code is set out below.

1. Code of ethical behaviour: Directors should set high standards of ethical behaviour, model this behaviour and hold management accountable for these standards being followed throughout the organisation.

2. Board composition and performance: To ensure an effective board, there should be a balance of independence, skills, knowledge, experience and perspectives. Of particular note is the recommendation that:

An issuer should have a written diversity policy which includes requirements for the board or a relevant committee of the board to set measurable objectives for achieving diversity (which, at a minimum, should address gender diversity) and to assess annually both the objectives and the entity’s progress in achieving them. The issuer should disclose the policy or a summary of it.

3. Board committees: The Board should use committees where this will enhance its effectiveness in key areas, while still retaining board responsibility.

4. Reporting and disclosure: The Board should demand integrity in financial and non-financial reporting and in the timeliness and balance of corporate disclosures.  The recommendations include:

• The Board should have a written continuous disclosure policy.
• Non-financial disclosure should be provided at least annually, including considering material exposure to environmental, economic and social sustainability risks and other key risks (including how the issuer plans to manage those risks and how operational or non-financial targets are measured).

5. Remuneration: The remuneration of directors and executives should be transparent, fair and reasonable.  Here, the recommendations include:

• Actual director remuneration should be clearly disclosed in the annual report.
• CEO remuneration arrangements should be disclosed in the annual report – including disclosure of the base salary, short term incentives and long term incentives and the performance criteria used to determine performance based payments.

6. Risk management: Directors should have a sound understanding of the material risks faced by the issuer and how to manage them.  The Board should regularly verify that the issuer has appropriate processes that identify and manage potential and material risks.  The recommendations include that:

An issuer should disclose how it manages its health and safety risks and should report on their health and safety risks, performance and management.

7. Auditors: The Board should ensure the quality and independence of the external audit process.

8. Shareholder rights and relations: The Board should respect the rights of shareholders and foster relationships with shareholders that encourage them to engage with the issuer.  The recommendations include:

• Each person who invests money in a company should have one vote per share of the company they own equally with other shareholders. There are one or two examples of NZX listed issuers with some tranches of unlisted, non-voting, shares but they are not common.
• The board should ensure that the annual shareholders notice of meeting is posted on the issuer’s website as soon as possible and at least 28 days prior to the meeting (c.f. the 10 working day notice period).

Next steps –Listing Rule review

The NZX regulatory agenda published in February indicates that a wider review of the Listing Rules has commenced.  And the NZX Code notes that the topic of independent directors is included in that review.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.

 

Yesterday, the Government introduced the Dairy Industry Restructuring Amendment Bill (“DIRA Amendment Bill”).

The Bill makes changes to the Dairy Industry Restructuring Act 2001 (“DIRA”), which provides some of the cornerstone regulatory architecture affecting New Zealand’s dairy industry.

When Fonterra was formed in 2001 and became, from the date of its foundation, the dominant market player, a number of the key features of DIRA were implemented in to ensure an efficient and innovative dairy industry to promote the long-term interests of farmers and consumers.

A report from the Commerce Commission last year found that competition is not yet sufficient to warrant de-regulation at this point.  It is expected that, once there is sufficient competition in place, competitive pressure, rather than the DIRA regulatory provisions, should drive the efficiency of New Zealand dairy markets.

The DIRA Amendment Bill has been introduced after a period of consultation on the Government’s proposals to amend DIRA.  Primary Industries Minister, Nathan Guy, said yesterday that these were split between those who wanted further deregulation of Fonterra and those who said Fonterra was still in a dominant position.

The DIRA Amendment Bill will introduce a number of changes to the DIRA regulatory regime.  The primary changes are:

 

• Retain the DIRA regime for the time being, by preventing it from expiring;
• Require a review of the need for the DIRA legislation during 2020/21;
• Allow Fonterra discretion to accept applications to become shareholders from new dairy conversions from 2018/19; and
• Make other technical changes unrelated to the review of the state of competition.

Supply of DIRA milk

The need for the DIRA regulatory provisions on Fonterra in subparts 5 and 5A of Part 2 is contingent on sufficient competition developing in New Zealand dairy markets.  If or when sufficient competition develops, competitive pressure will drive the efficiency of New Zealand dairy markets, removing the need for the DIRA regulatory provisions to do the same.

An automatic expiry of key provisions in subpart 5 and all of subpart 5A in the South Island was triggered in 2015.  A statutorily required report on the state of competition, undertaken by the Commerce Commission, found that competition is not yet sufficient and that subparts 5 and 5A should remain in place for the time being.  The report also recommended that any transition pathway to deregulation should take a staged approach and initially involve removing elements of the regulatory regime that contribute least to efficiency and contestability.

In the interim, as a result of Cabinet decisions announced in October 2016, whilst the DIRA regulatory regime is being retained for the time being, some changes are to be made to the regime to smooth the pathway towards future deregulation.

Specifically, the changes:

 

• prevent parts of the DIRA from expiring in the South Island, and require that the next review of the state of competition in the New Zealand dairy industry begin during the 2020/21 dairy season
• alter who is eligible for regulated milk from Fonterra, and the terms that it is available on – in particular:
  • Fonterra will no longer be required to sell regulated milk to large, export-focused processors from the start of the 2019/20 season.
  • All processors purchasing regulated milk will have reduced flexibility in forecasting the volume of regulated milk they intend to purchase from Fonterra from the start of the 2018/19 season.

The requirement for Fonterra to supply regulated milk to processors other than large, export-focused processors is not being changed at this time, although these processors will be subject to the changes in forecasting flexibility.

Allowing Fonterra discretion to accept supply from new dairy conversions

The DIRA Amendment Bill requires entering farmers, who are not already Fonterra suppliers, to provide evidence that their farm is not a new dairy conversion.

DIRA requires Fonterra to accept all applications to become a shareholding farmer (with limited exceptions that relate to minimum volume to be supplied and transport costs).  This is the “open entry” provision.  The “open exit” provisions of the DIRA require that Fonterra must allow shareholding farmers to withdraw without unreasonable restrictions or penalties.

The open entry and exit provisions reduce farmers’ switching costs and risks by enabling them to freely enter and exit Fonterra.  This lowers the barriers to entry for independent processors by enabling farmers to leave Fonterra and supply someone else, with the confidence of being able to return to Fonterra in the future.  In turn, this ensures contestability of the market for farmers’ milk and simulates the competitive pressures that Fonterra would face in a competitive market.

The DIRA Amendment Bill establishes an exception to open entry, which allows Fonterra discretion to accept applications that relate to new dairy conversions.  This exception applies only where an application relates to a new collection point that has not been used to supply milk in the 5 years immediately prior to the application being made to Fonterra.  (In some situations, a new collection point may be established on existing dairy land – which is not captured by the new exception).

The effect of the exception is that Fonterra has discretion to accept an application to become a shareholding farmer that relates to a new collection point if less than 50% of the land used to supply milk to that point has been used as dairy land in the previous 5 years.  The exception allows for existing dairy farms to expand and the references to 5 years allow for land use to change over time to the most efficient use.

Concluding comments

Minister Guy noted that the consultation process provided new information about risks of some of the originally proposed changes to regulated milk – particularly for downstream markets and consumers.  As a result, he said that the Government is deferring the consideration of those potential changes to regulated milk for Goodman Fielder and small or domestically focused processors – pending further work by MPI officials to understand the complexities in this area and any outcomes will inform the next review.

The next review will commence in the 2020/21 season – 20 years since DIRA was created.  The scope of this review will be wider than just competition policy to take into account any impacts from the work on downstream milk markets.

The changes affecting Fonterra’s obligation to accept supply from new dairy conversions probably manage the risk of Fonterra having to build more capacity for dairy conversions in (seemingly) more-and-more marginal areas.

However, the changes affecting the ability of “large, export-focused processors” to source DIRA milk from Fonterra from the start of the 2019/20 season – are likely to lead to further concerns about the risk of stifling competition in the added-value sector.  Will this stifle the prospect of another Lewis Road being developed?

Next steps

As noted above, MPI has already undertaken consultation – but this may not stop the Select Committee process being interesting.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.

1 December 2016 heralds the end of the transition period and the start of the brave new world of financial market regulation under the Financial Markets Conduct Act 2013.  As a result, the root and branch reform that began with Rob Cameron’s Capital Markets Development Taskforce in 2008 has generated a new regime (and a new regulator) for the oversight of financial markets activity.

The new regime under the FMA has seen the introduction of licensing of a variety of participants in the financial services sector during the course of the transition period which began in 2014 – including trustees, supervisors, platform providers (such as equity crowdfunding platforms and peer-to-peer lenders) and managers of managed investment schemes.

In its recent public statements, it is clear that the FMA will seek to use its powers to bring about what it sees as a transformation in the financial services sector by seeking to embed high standards of conduct on the part of financial service providers.

The FMA says that the process of standard setting (and lifting) has imposed significant challenges for some parts of the sector.  At the same time, the FMA notes that it has tried hard to impose additional compliance and other burdens only where it saw a clear benefit to investors and the markets – as well as avoiding unnecessary barriers to entry for new players.  In this regard, the FMA has also undertaken stakeholder surveys which, it says, show that the industry understands the new regulatory framework is designed to maintain market integrity – and not just impose a thicket of new compliance obligations.

However, as well as providing the framework for the FMA’s ‘conduct lens’ for evaluating the activities of participants – the FMC Act brings the regulations of some financial market activities into the 21^st century and providers both clarity and wider scope for fund-raising activities, particularly by SMEs.  This is achieved without some of the uncertainties or unnecessary elements that made such activities uncertain or uneconomic under the old regime.  The challenge now is for business to utilise the opportunities presented by new regime, whilst managing the expectations of stakeholders and (where relevant) those of a regulator with a much greater role and much more extensive powers.

Over night the UK Prime Minister, Theresa May, has delivered a speech at the Confederation of British Industry (CBI) annual conference about the forthcoming Green Paper on corporate governance, in particular the Government’s position on worker representation on boards.

Worker representation (in terms of direct appointment of a worker or trade union representative to the board) – will not be mandatory.

The key points from the speech appear to be:

• Business needs to change its approach to restore its “bruised” reputation with some parts of the community – as a result of the behaviour of a few businesses and business figures who appear to game the system and work to a different set of rules. The speech referred to the need to recognise that when the social contract between business and society fails – and the reputation of business as a whole is undermined (which I suggest means such hot button issues as zero-hours contracts and the Sports Direct and BHS scandals).

• So just, as government must open its mind to a new approach, the business community must too. That is why the UK government will shortly publish its plans to reform corporate governance, including executive pay and accountability to shareholders, and proposals to ensure the voice of employees is heard in the Boardroom.

• The UK has a strong reputation for corporate governance –which have made it a prime location for listing and headquartering. But it can’t stand still – and must continue to make improvements where these result in better companies and improved confidence in business on the part of investors and the public.

• Much can be done by voluntary improvements in practice – in the representation of women on Boards and in senior positions for example, or in broadening diversity. But where there is a need to go, the Government will do.

• The Green Paper, later in the autumn, will address executive pay and accountability to shareholders, and how to ensure the employee voice is heard in the Boardroom. This will be followed by genuine consultation – to work with the grain of business and to draw from what works but also deliver results.

• Importantly:

o While it is important that the voices of workers and consumers should be represented, this will not be about mandating works councils, or the direct appointment of workers or trade union representatives on Boards. Some companies may find that these models work best for them – but there are other routes that use existing Board structures, complemented or supplemented by advisory councils or panels, to ensure all those with a stake in the company are properly represented.

o This is not about creating German-style layers of governance which separate the running of the company from the inputs of shareholders, employees, customers or suppliers. The existing Board / governance works well and will be maintained. But it is about ensuring employees’ voices are properly represented in Board deliberations, and that business maintains and – where necessary – regains the trust of the public.

Perhaps typically, the speech has been characterised by some in the UK press as a policy U-Turn. And some commentators have suggested that (mandated) worker representation would have been cost-free to the taxpayer but brought with it the potential to increase innovation, and provide fairer and better pay for workers, and more successful businesses overall.

Perhaps inevitably, the line is drawn by some commentators to the sea change occurring as a result of the Brexit vote and now the US Presidential election, and claims about the gulf between the “elite” and those who are “ordinary workers”.

Whether such comparisons are valid in the case of New Zealand, where SMEs with less than 20 workers make up such a significant part of the economy, is an interesting issue. Nonetheless, the latest developments in corporate governance from the UK will be viewed with interest.

The High Court has upheld civil claims brought by NZX against the former owners of Clear Grain Exchange (an Australian on-line grain trading business) the assets of which NZX purchased in 2009.

The outcome is a sort of nil-all draw as Dobson J. also upheld one of the vendors’ counterclaims against NZX.

NZX claimed the vendors had misrepresented the growth potential of Clear Grain Exchange in the Australian grain sales market and that aspects of the transaction breached the Fair Trading Act.

In response, the vendors made a series of counterclaims, including that NZX had breached its own contractual obligations by failing to adequately resource the business – after its acquisition.

After a lengthy hearing, Dobson J. found the NZX had proven four out of its 5 alleged misrepresentation claims against the vendors – but found no compensation was payable to NZX because it could not demonstrate losses flowing from its reliance on those  misrepresentations.

On the other side of the draw, although the vendors succeeded in their claim that NZX had not met its contractual obligations with respect to resourcing, no damages were awarded because the vendors had been unable to demonstrate that better resourcing would have meant that the vendors would have been able to meet their earn-out targets.

Of particular note in the judgment (and accompanying media release) is the statement from Dobson J. that:

Both sides were exceptionally keen to consummate the deal.  It was a case of a very willing seller, and a very willing buyer.  This probably contributed to both sides materially overstating their position in pro-contractual dealings with the other.

Costs lie where they fall

On the question of costs, Justice Dobson expressed the provisional view that costs ought to lie where they fall, given the outcome on damages (i.e. the nil-all draw).

Background

 At the time the transaction took place the assets acquired by NZX comprised two businesses:

 

• Clear Interactive – which employed an IT team with expertise in designing and writing software for applications such as the operation of an electronic market for buying and selling commodities; and
• Clear Commodities – an embryonic electronic grain exchange.

The fallout from the purchase and the subsequent litigation was obviously fairly willing and has been the subject of some fairly breathless reporting by the mainstream media.

From the buyer’s perspective, the judgment notes that NZX’s CEO, envisaged the grain exchange as at cornerstone of a much larger new venture for NZX in the provision of data and facilitation of trading in agricultural commodities.

Central to NZX’s claims was the allegation that the vendors had misrepresented the prospects for the grain exchange to increase the volume of grain that could be traded on it.  The Court found misrepresentations relating to:

 

• the volume of grain that the vendors represented were likely to be traded on the exchange in the ensuing season;
• the extent of support the grain exchange enjoyed in the Australian grain industry;
• the positive features of an alliance that had been entered into with a company dominant on the Australian east coast in the bulk-handling of grain; and
• representations on the level of expenses likely to be incurred by the businesses in the current financial year,

had been proven by NZX.

 

NZX also alleged that the some complaints amounted to misleading and deceptive conduct under the Fair Trading Act, and breaches of contractual warranties.

 

NZX also sued a group of directors and shareholders of the vendor under personal guarantees in the SPA (as well as a wider group of shareholder/employees – as assignees of the benefits provided for in the SPA).

 

The vendors pursued counterclaims against NZX alleging breaches of contractual obligations under the SPA as to how NZX would resource and finance the businesses, post-acquisition.  The SPA provided for a substantial earn-out, in the event that the businesses reached certain targets.  The vendors claimed that NZX’s breach of the resourcing obligation caused loss to the extent of the earn-outs that were not triggered, or alternatively the loss of the chance to qualify for those payments.

 

The vendors also claimed that NZX made pre-contractual representations about the extent of resources it would commit to the businesses – on the basis that they constituted misrepresentations under the Contractual Remedies Act and misleading and deceptive conduct under the Fair Trading Act.

 

In addition, counterclaims were also pursued against the ZNX’s CEO in his capacity as CEO and a director of NZX attributed with personal responsibility for the financing and resourcing decisions of the businesses once they were owned by NZX.

 

Dobson J. found that NZX breached its contractual obligation to consider the resources required to commit to the businesses in order to provide them with a reasonable opportunity of achieving the targets which would trigger the earn-outs.  None of the other causes of action under the counterclaims against NZX or its CEO were made out.

 

Counterclaims against the CEO

 

Regrettably, the mainstream media seems to have taken some sort of delight in the fallout in the personalities in this case.  Clearly the fallout was personal in the sense that the primary directors and shareholders of the vendors were the founders of the business and the CEO of NZX drove the acquisition and oversaw aspects of the post-acquisition steps.

 However, it is important to note that the vendors’ counterclaim again the CEO (alleging either being knowingly involved or aiding and abetting the making of representations which contravened the Fair Trading Act) failed.  The vendors also alleged that the CEO’s “participation” rendered him a sort-of joint action, with NZX, in respect of the alleged negligent misrepresentations.

 

This cause of action depended on the vendors making out its counterclaims (against NZX) for misleading and deceptive conduct, or negligent misrepresentations – which the vendors failed to do.  As a result, the (dependent) claim of “knowing involvement” against the CEO also failed.

 

Despite this, Dobson J. did not accept that the inclusion of the CEO in his personal capacity was entirely misconceived.  Whilst the judge had the benefit of hearing all of the evidence and submissions, his reasons for this (ultimately discomforting) conclusion are a little on the skinny side.  He notes that, as matters unfolded at trial, NZX made no attempt to distance itself from any of the CEO’s acts or omissions – but the vendors could not be certain of NZX’s stance on the point when the counterclaims were pleaded.  From where I sit, I think that there would need to be something much more concrete to point to a concern (that ultimately the company would literally – “throw its CEO under the bus” and seek to distance itself from either or both of the acquisition or the post-acquisition integration) to sustain a personal claim against a CEO in these circumstances.

 

As a result, I am left with the concern that would-be claimants might take this as a signal that it is a suitable litigation strategy to seek to apply pressure to the CEO to settle by suing them in their personal capacity.

 

For this reason, I am left puzzled about the statements about costs.  Dobson J. effectively said that if the CEO was indemnified by NZX then his provisional view is that NZX should also absorb the CEO’s defence costs as part of a larger nil-all draw.  Surely this question was an integral part of any decisions to allow a separate claim against the CEO?  Again, from where I sit, only where there was a (serious) question about an absence of such an indemnity should a separate counterclaim against the CEO have been allowed to proceed.

 

Further information

 

If you would like more information about any of the matters discussed in this note, please contact me.