The sale of Shin Corporation by the family of ex-Thai Prime Minister Thaksin Shinawatra (the Shin Deal) created a storm of political protest that ultimately led to a bloodless coup on September 20 2006.
The Thai Ministry of Commerce investigation that was compelled by the protest threatens the viability of a capital structure foreign investors have traditionally used to maintain effective ownership and control of businesses that Thai laws require to be majority-owned by Thai nationals.
Why are foreign investors in Thailand nervous?
Who is a "foreigner"?
A wide variety of businesses in Thailand are subject to foreign ownership restrictions pursuant to various laws. The broadest- reaching of the restrictions are in the Foreign Business Act (FBA), effective March 4 2000, because it restricts foreign nationals from engaging in a significant variety of businesses in broad categories.1 The FBA replaced the Alien Business Law (ABL), which had been in place since 1972; the FBA and the ABL are administered by the Thai Ministry of Commerce (MOC).
The FBA is of critical importance because it contains a definition of "foreigner" that is relied on more generally in testing whether a business is complying with foreign ownership restrictions. Thus, the Telecommunications Act (2001) requires majority Thai ownership of telecommunications businesses, with nationality determined under the FBA's tests. Likewise, the land department has generally applied the FBA's definition in evaluating whether an entity is foreign and thus not entitled to own land, except under special circumstances.2
Under the FBA, the following persons or entities are considered foreign:
(i) natural persons who are not Thai nationals;
(ii) juristic persons not established under the laws of Thailand;
(iii) juristic persons established under the laws of Thailand having the following characteristics:
(a) a juristic person with half or more of the shares constituting its capital held by a person under (i) or (ii), or a juristic person in which a person under (i) or (ii) invests half or more of the total capital of such juristic person;
(b) a limited partnership or a registered ordinary partnership whose managing partner or manager is a person under (i), and
(iv) a juristic person registered in Thailand in which half or more of the shares constituting its capital is held by a person in (i), (ii) or (iii) or a juristic person in which a person under (i) or (ii) or (iii) invests half or more of the total capital of such juristic person.
As described below, Items 3 and 4 create preference share structures.
So long as Thai national investors hold more than 50% of the shares and those shares represent more than 50% of the paid in capital, a company will be considered to have Thai nationality, and thus not be subject to any restrictions on the types of businesses it is entitled to conduct in Thailand.
There is no requirement that Thai nationals control more than 50% of the voting rights attached to the shares or that the shares held by Thai nationals have an equivalent economic interest in the profitability of the company's business.
Two examples of preference share structures
Under the FBA's definition of "foreigner" (and also the definition in the predecessor ABL), a Thai company may be structured such that:
(i) a foreign national has voting control of the company and a predominant economic interest in the dividends and/or distribution of its assets on a dissolution or winding-up, while
(ii) the company is considered to have Thai nationality because Thai national investors hold a numerical majority of the total number of shares (in all classes) issued by the company.
This is done through a simple mechanism of having one class of ordinary shares and one class of preference shares, whose rights may be stipulated in the company's Articles of Association.
Here is one possibility:
In this example, the Thai national investor holds preference shares. The preference shares represent a numerical majority of the total number of shares issued (60 of 100), but are assigned 1 vote per 10 shares and a preferential, but nominal, capped dividend. The foreign national holds ordinary shares, which carry one vote per share and are entitled to participate in dividends pro rata (after payment of any preferential dividend). Although the number of ordinary shares is less than the number of preference shares, the foreign investor is entitled to over 75% of the total share votes (40 out of 46) and thus has full control of the company.
Alternatively, the preference shares could be given greater weight:
In this example, the foreign investor holds the preference shares. The preference shares represent a numerical minority of the total number of shares issued (40 of 100), but are assigned 10 votes per 1 share and a preferential dividend that would represent either a substantial annual return. The Thai national holds ordinary shares, which carry one vote per share and are entitled to participate in dividends pro rata (after payment of the substantial preferential dividend to the foreign investor). Although the number of ordinary shares is more than the number of preference shares, the foreign investor is entitled to over 75% of the total share votes (400 of 460) and thus has full control of the company.
Many large multinationals with established global brands insist on having majority control of their businesses and, absent that possibility, might well not invest in Thailand. Thus, there is little doubt that the availability of structures of this type encourages foreign investment in Thailand.
Are preference share structures legal?
Why would a legal system impose majority-Thai ownership requirements on one hand, but permit a capital structure whose effect is to reserve full control voting control and substantially all of the economic return for a foreign investor?
There is such an obvious contradiction in purpose here that one is tempted to conclude that preference share structures could not possibly be legal.
However, that inference cannot be squared with Thailand's historical acceptance of these structures.
Consider the following:
(i) When an application to establish a company is submitted to the MOC, the MOC will reject the application if the intended business of the company is restricted and Thai nationals do not own a majority of the total shares of the company. The MOC does not review or compare the rights attaching to different classes of shares.
(ii) As mentioned, the test for nationality under the ABL is similar in pertinent respects to the test in the FBA. When the FBA was being drafted, one proposal that was considered and rejected was to introduce a voting control test for Thai nationality. The proposal, which would have rendered preference share structures ineffective, was rejected, which implies the government did not intend preference share structures to be outlawed.
(iii) The nationality of shareholders of private companies and the capital structure of companies in Thailand is a matter of public record. The use of preference share structures by foreign investors has never been hidden from public view, and until the outcry concerning the Shin Deal no attention was paid to widespread use of preference share structures.
Accordingly, the Thai government quite clearly has never regarded preference share structures as per se inconsistent with the restrictions on foreign ownership.
The FBA's anti-avoidance provisions
Although not directed against any particular capital structure, the FBA does contain provisions that criminalize the use of nominee or agency relationships to avoid foreign ownership restrictions:
(i) Section 36 of the FBA provides that a Thai national who "holds shares on behalf of" a foreign national for purposes of "evading or violating" the provisions of the FBA, as well as a foreign national who "allows" the Thai national to commit such an offense, may be subject to a fine of between Bht100,000 and Bht1,000,000 and/or a term of imprisonment not exceeding three years.
(ii) Section 37 of the FBA provides that a foreign national that engages in a restricted business in violation of the FBA may be sentenced to imprisonment for a maximum term of three years and/or a fine from Bht100,000 to Bht1,000,000. A Thai Court can also require divestiture or for the business to cease operations.
These provisions are generally understood as making it illegal for Thai nationals to hold shares as a nominee of a foreign investor so that the company will not be subject to foreign ownership restrictions. Similar provisions existed in the ABL.
However, since the enactment of the ABL over 30 years ago, the MOC has not issued any regulations or notifications concerning the interpretation of these provisions, or what evidence would be relevant to determining whether or not a Thai national was acting as a nominee of the foreign investor.
Likewise, even though Thailand is not a common law jurisdiction, there have been no judicial decisions since the enactment of the ABL that have identified factors relevant to evaluating whether or not a person is acting as a nominee in violation of Section 36 of the FBA.
Notwithstanding the absence of regulations and the absence of any history of enforcement, those that attack the "legality" of the Shin Deal rely primarily on these abstract provisions against the use of Thai nationals as nominees.
One point that should be emphasized is this: although it is undeniable that foreign investors often establish preference share companies in order to assure that the company will have "Thai" nationality and not be subject to foreign ownership restrictions, that does not compel the conclusion that any Thai national holding shares in the company must therefore be holding shares as a nominee of the foreign investor.
The attack on Kularb Kaew
Almost immediately after the closing of the Shin Deal, the Thai press began reporting numerous attacks on the "legality" of its investment structure. The primary object of the attacks was Kularb Kaew Company and the Thai national investors in it.
Kularb Kaew, together with Siam Commercial Bank, holds a majority of shares in Cedar Holdings Company. The balance of the shares are held by Cypress Holdings Company. Cedar was one of the companies that acquired shares in Shin Corporation in the Shin Deal.
At the time of the Shin Deal, 51% of Kularb Kaew's total shares were preference shares and were held by Thai nationals; 49% were held, through a subsidiary, by the principal Singaporean investor. Under the relevant definitions of the FBA, Kularb Kaew was not a foreign national.
The attacks were based on the allegation that the Thai nationals hold their shares in Cedar as nominees, directly or indirectly, of a foreign national in violation of Section 36 of the FBA.
If this were true, so the arguments went, (a) Kularb Kaew would in reality be majority foreign-owned, which would result in (b) Cedar would in reality being majority foreign-owned, which would result in (c) Shin Corporation in reality being majority foreign-owned, which would mean (d) Shin Corporation was in violation of various laws and concessions that require majority Thai ownership of its telecommunications business and certain other of its businesses.3
The points that were made included the following:
(i) The preference shares held by the original Thai national shareholders in Kularb Kaew had limited voting rights.
(ii) The dividends payable in respect of the preference shares held by the original Thai nationals are capped.
(iii) In light of the substantial capital commitment, the preference shares do not offer a return that would be acceptable to a reasonable investor.
(iv) The Thai investors could not have funded an investment of this magnitude.
(v) The funds for the investment were beyond the means of the Thai national investors.
There are two underlying themes here. The first is that no reasonable investor would have made an investment of this magnitude without receiving a far more significant interest in the management and economic performance of the Company. The second is that a single investment of this magnitude is simply not suitable to a similarly situated individual investor.
The inference in each case is intended to be that the only possible explanation for the shareholding is that the Thai national is holding the shares as a nominee, not on his or her own behalf.
Whatever one may think of this logic, the MOC, as the relevant regulatory body, never promulgated any regulations or notifications that establish a "reasonable investor" test or a "suitability" test for evaluating potential violations of Section 36 of the FBA.
Finally, it should be noted that the structure of Kularb Kaew has long since changed. A Thai individual now owns a majority of the ordinary shares of Kularb Kaew. That individual has declared publicly that he is not a nominee of the foreign investor and that he purchased his shares with funds from his own businesses.4 The principal foreign investor has made similar statements.5 Unless the MOC has some basis to question these declarations, it is difficult to see any theory on which this individual could be thought to be acting as a nominee.
Implications
Quite surprisingly, it is only in the last two weeks that reports in the press have concentrated on the "what if?" of a determination negative to Shin Corporation.
After months of investigating only the Shin Deal and the role of Thai national shareholders in it, and the rumored existence of an 800-page report on the investigation, it has just recently been reported that the MOC will "extend the scope of its nominee probe to cover 16 more companies," on grounds of "fairness" following a complaint by counsel to the principal Thai national investor in Kularb Kaew.6
A 13 September 2006 article in the Bangkok Post, entitled "Shin probe generates panic (local law firms flooded with queries)," reports that: "A survey of a dozen of the country's most prominent foreign investors, including Tesco, Holcim, Carrefour and others, showed a widespread use of multiple share classes, different voting rights, nominee structures and other techniques to bypass the 49% restriction." 7
The article included structure diagrams for the holdings of preference and ordinary shares in the investments of Carrefour, Tesco, Holcim and Cemex, all of which are readily producible from information that is publicly available from the MOC.
A different article on the same day in the Bangkok Post, entitled "DTAC could face probe of shareholding," included a structure chart showing Telenor's investment in UCOM, this too readily producible from information that is publicly available from the MOC. The Telenor acquisition is particularly significant in that it preceded the Shin deal, is in the telecommunications sector, and was not challenged as being "illegal."
Conclusion
The greater ramifications of the intense scrutiny of the Shin Deal are now receiving broader attention in the press. This is of critical importance.
The conduct of the investors in the Shin Deal cannot fairly be challenged without challenging years and years of foreign investment practices involving some of Thailand's most significant foreign investors.
In light of Thailand's history with the ABL and FBA, foreign investment in Thailand, and the rule of law for which it is respected, will suffer a severe blow if the MOC, in response to the politically motivated protests against the Shin Deal, were to change the rules, makes them effective retrospectively, and issue a ruling adverse to Shin Corporation and its investors.
Endnotes
1 The restricted businesses, in summary are segregated as follows:
• Businesses which are restricted for "special reasons" and include media, farming, fishing, herbal medicines, trading in cultural objects and real estate trading (List 1).
• Businesses which include businesses relating to national safety and security (armaments and transportation), Thai customs and culture, and national resources (aList 2).
• Businesses which are characterized as "businesses in which Thai nationals are not ready to compete," and include service businesses (accounting, law, architecture, engineering, and "other services"), construction, certain broker or agent businesses, retail and wholesale businesses (if capitalization is below specified minimums), advertising, hotels, and food and beverage sales (List 3).
Lists 1 and 2 are the most restrictive. A foreigner may engage in a List 2 or List 3 businesses if the foreigner is granted investment incentives from Thailand's Board of Investment.
2 Thailand's Board of Investment may grant a foreign national permission to own land to engage in a promoted business and the Industrial Estate Authority of Thailand may grant permission to own land on certain industrial estates.
3 As an example, see "Ruling Awaited on Subsidiaries," Bangkok Post, 27 Feb 2006, page B1.
4 See "Temasek certain Shin Deal is legal," Bangkok Post, 14 Sep 2006, page A1.
5 Id.
6 "Nominee Probe at 16 more firms," The Nation, 14 Sep 06, p. 1A.
7 The reference to "nominee structures" in this sentence is unfortunate. The issue is the absence of legal standards to determine whether a shareholder is acting as a nominee. The concern, of course, is that a standard or test will be announced by the MOC for the very first time, and will be applied retrospectively.
About the authors
Stephen Bennett is a partner in the Bangkok office of Hunton & Williams where he specializes in M&A, capital markets and structured finance. Before joining Hunton & Williams, Bennett was a partner with Freshfields Bruckhaus Deringer.
In the last 12 months, Bennett has advised the purchasers on their US$ 3.6 billion acquisition and subsequent public tender offer of 96% of the shares in Shin Corporation, which controls Thailand's largest mobile phone operator, AIS. This is the largest acquisition of a Thai public company in the country's history. Bennett also advised Telenor Asia on its $700 million acquisition and subsequent tender offer 61% of shares in United Communication Industry, Thailand's second largest mobile phone operator.
Richard Savage has been practicing in Thailand since 1996. His work focuses largely on transactions in the power and energy sector, but has also included corporate transactions, joint ventures and dispute resolution. Savage is an American lawyer, licensed by the New York State Bar and admitted to practice before several United States District and Appeal Courts. He received a Bachelor's degree with honours in philosophy from Princeton University in 1981 and a JD degree from New York University School of Law in 1986. Prior to moving to Thailand, he worked for over six years as a commercial litigator in a major New York law firm.