By Luciano Aguilera and Felipe Chamorro*
Like most Latin American countries (and other emerging markets), the corporate structure in Chile presents high ownership concentration characterized by the presence of family-owned conglomerates.1 This structure could eventually create in some cases conflicts of interest between the controlling shareholder and minority shareholders. The controlling shareholder usually obtains control through the acquisition of the majority of the company’s shares, and in other cases in order to maintain control of the firms that are part of the business conglomerate it uses pyramidal schemes and dual class stocks. Considering the foregoing, minority shareholders may eventually be affected if the controlling shareholder benefits from asymmetry of information or discrepancies between the controlling shareholder and minority shareholders necessarily lead to the prevailing interests of the latter.
Global and local corporate and accounting scandals have shown related party transactions (RPT) to be a major corporate governance problem. In 1997, the Chilean market was affected by a scandal that consisted in the takeover of a large listed energy company, where several of its key executives were found to have acted with a serious conflict of interest by cutting sweat deals for themselves to the detriment of the company’s minority shareholders. Since then, Congress has passed several corporate governance laws in view of strengthening minority shareholder rights. In 2010, the Corporate Governance Law (Law No. 20,382) came into force, and made substantial improvements strengthening the corporate governance regime, and included, among other things, the addition of an entirely new chapter on RPTs for listed companies to the Corporations Act (Law No. 18,046).
In this article, we shed light on corporate mergers in Chile and its interplay with the RPT rules. In particular, we examine a recent Court of Appeals’ resolution that has provided a guideline on how mergers between related companies must be treated.
Related Party Transactions under the Corporations Act
Legal definition of RPT
In Chile, Chapter XVI of the Corporations Act is the law of RPTs of listed companies and their subsidiaries. Article 146 of the Corporations Act defines RPTs as any negotiation, act, agreement or transaction entered into by a listed company with any of the following persons: (i) one or more related persons of such listed company, as such term is defined by article 100 of the Securities Market Act (Law No. 18,045)2; (ii) board members, managers, executive officers or liquidators of the listed company, as applicable, whether acting directly or on behalf of any third party, or their respective spouses or relatives up to the second degree of consanguinity or affinity; (iii) the legal entities of which any of the abovementioned persons are direct or indirect owners of 10% or more of its capital, or are board members, managers or key executives; (iv) those persons established in the public corporation’s bylaws, or which have been especially determined by the board committee as such; and (v) any legal entity in which a board member, manager, executive officer or liquidator of the public corporation has served as a board member, manager, main executive or liquidator, during the last 18 months.
Approval test for RPTs
Article 147 of the Corporations Act provides that listed companies can only enter into RPTs provided that the purpose of the transaction contributes to the corporate interest3, the transaction is conduct at arm’s length as to its price, terms and conditions, and the following requirements are satisfied:
(i) The interested directors/managers/administrators/executive officers/liquidators must immediately disclose their ‘interest’ to the board of directors or the board’s designated person. A violation to this obligation carries joint and several liability for all damages caused to company and shareholders.
(ii) A RPT must be approved by the absolute majority of board members, without counting the votes of the interested directors/liquidators. The interested directors must record their opinion of the transaction in the board minutes, if requested. Likewise, the board minutes must provide details as to the reasons for approving the transaction and excluding the interested directors.
(iii) The board resolutions that approve a RPT must be informed in the next shareholders meeting.
(iv) If the absolute majority of the board members are interested, the transaction can only be approved by either the unanimous vote of the disinterested directors or by two thirds of the outstanding voting shares at a special shareholders meeting.
(v) If the transaction is subject to the shareholders’ approval, the board must appoint, at least, one independent appraiser to inform the shareholders of the transaction’s condition, effect and potential impact on the company. The independent appraiser’s report must also address any other matter requested by the board committee.
(vi) In case of discrepancies on the appointment of the independent appraiser, the disinterested directors may appoint an additional independent appraiser.
(vii) The independent appraisers’ reports must be made available to the shareholders as from the following business day the board has received them and for a period of at least 15 business days. The listed company must notify the shareholders that the reports are available through a material event notice. Within 5 business days from the date on which the board of directors received the last appraiser’s report, the directors must provide their opinion as to the convenience of the RPT for the ‘corporate interest’ of the company
Breaches to the above-mentioned requirements will not void the transaction but will entitle the company and its shareholders to disgorge any profits obtained by the perpetrator plus claim applicable damages. Disgorged profits must be surrendered to the company.
Transactions exempted from the approval test
Under Article 147 of the Corporations Act, the following RPTs are exempted from the approval test: (i) transactions that involve an immaterial amount4; (ii) transactions that are deemed to be ordinary considering the corporate purpose, according to general policies on regular transactions determined by the board; and (iii) transactions between legal entities in which the company owns directly or indirectly at least 95% of the property of its counterparty.
Corporate Mergers as RPTs
2015 featured a reorganization of a group of related listed energy companies, which sought to simplify the corporate structure of the group by separating the power generation and distribution activities in Chile from the other Latin American countries. Pension funds that owned stakes in these companies opposed the plan considering it detrimental to minority shareholder interests and subsequently filed claims with the Chilean authorities.
The pension funds initially submitted a list of queries to the SVS, which included a specific request to clarify whether a spinoff and merger among the related entities would be considered RPTs, and thus subject to the stricter scrutiny for approval provided under Chapter XVI of the Corporations Act. The SVS held that although the mergers involved in the reorganization qualified as RPTs, the merger approval was not governed by Chapter XVI of the Corporations Act but rather by the specific merger rules contained in the Corporations Act.
The pension funds subsequently filed a claim before the Courts of Appeal of Santiago requesting the court to quality the mergers involved in the reorganization as a RPT, and thus determine the application of Chapter XVI of the Corporations Act. The court held that the SVS’s ruling incorrectly applied the law, stating that the respective mergers were in fact subject to Chapter XVI of the Corporations Act, and thus, required these transactions to go through the stringent process applicable to RPTs of listed companies.
In conclusion, the recent judicial ruling has provided a guideline for future mergers between related companies, making them subject to the stricter regulations provided under Chapter XVI of the Corporations Act. This has certainly strengthened corporate governance standards towards protecting minority shareholders’ rights, but has also raised questions among practitioners as to how to adequately combine the specific merger approval rules contained under Chapter IX of the Corporations Act with the RPT provisions provided under Chapter XVI.
1 A study performed in 2000 showed that approximately 70% of the listed non-financial entities were controlled by a conglomerate, representing 91% of the assets of non-financial Chilean listed companies. See FERNANDO LEFORT & EDUARDO WALKER, Ownership and Capital Structure of Chilean Conglomerates: Facts and Hypotheses of Governance, ABANTE 3(1), at 15-16 (2000).
2 The following persons are considered related to a company: (i) the entities that belong to the same business group of such company; (ii) legal entities that are a parent company, an affiliated company or subsidiary company of such company; (iii) the directors, managers, executive officers or liquidators of such company, and their spouses or their relatives up to the second degree of consanguinity, as well as any legal entity directly or indirectly controlled by these persons; and (iv) any person who either individually or jointly with others acting through a joint participation agreement, are able to appoint at least one member of the management of such company or control at least 10% of its voting shares. Notwithstanding the foregoing, the Securities and Insurance Commission (SVS) may determine that any individual or legal entity is related to a company if, because of relationships of equity, management, kinship, responsibility or subordination, it may be presumed that: (a) individually or jointly with others acting through a joint participation agreement, said person has sufficient voting power to influence in the company’s management; (b) his/her business with the company creates conflicts of interest; (c) its management is influenced by the company, if it is a legal entity; or (d) if he/she is an employee or has a position that can have access to company’s information and its business that has not been disclosed to the market, which is capable of influencing the value of the company’s securities. A person shall not be considered to be related to the company by the mere fact of holding up to 5% of the voting shares, or if he/she is only a company employee that lacks management responsibilities.
3 Although Chilean law does not contemplate a legal definition of ‘corporate interest’, the Supreme Court has held that corporate interest is the common interest among shareholders (as opposed to their individual interest), which must always relate to the company’s purpose, whose primary goal is obtaining and distributing profit among shareholders. See Cuneo et al v. Superintendencia de Valores y Seguros, Supreme Court, Case No. 3,389 (2015).
4 Any act or agreement that exceeds 1% of the corporation’s equity is deemed a material amount, provided that the act or contract surpasses 2,000 Unidades de Fomento (approximately US$80,000 as of March 30, 2017) and, in any case, when it surpasses 20,000 Unidades de Fomento (approximately US$800,000 as of March 30, 2017). Transactions consummated within a 12 consecutive month period through one or more similar or complementary acts that have party identity, including related persons or purpose, are deemed a single transaction.
* Luciano Aguilera is a senior associate and Felipe Chamorro is an associate in the Corporate M&A/Capital Markets group of Carey. Mr. Aguilera can be contacted at email@example.com and Mr. Chamorro at firstname.lastname@example.org