Balance of power to be shifted towards takeover targets

Companies that find themselves the subject of unwanted takeover speculation will have their hand strengthened by changes to be made to the Takeover Code next year. In particular, break fees, and other “deal protection” measures that are commonly sought by bidders, will generally be prohibited, and potential bidders will usually have to “put up or shut up” within four weeks of being publicly named.

The changes were announced by the Panel on 21 October 2010, after the closure of a consultation it initiated following the takeover of Cadbury plc by Kraft Foods Inc earlier this year. The Panel has also decided that:

• the minimum acceptance condition should not be raised from 50% plus one;
• shares that are acquired during an offer period (e.g. by hedge funds and merger arbitrageurs) should not be disenfranchised;
• shareholders in the bidder should not be required to approve a takeover offer unless it is a reverse takeover; and
• the minimum and maximum amounts payable under any success fee arrangement with an adviser to the bidder or target should be disclosed in the offer document or defence circular.

The Panel’s Response Statement sets out only in broad terms the areas in which the Code will (and will not) be amended. Further consultation about the exact wording of the proposed amendments will be published in due course. The changes are therefore likely to come into force some time next year.

Background

In February 2010 the Panel announced that it would consult about whether the Code should be changed in light of widespread comment and public discussion after the takeover of Cadbury plc by Kraft Foods Inc. in the first quarter of the year. In particular, concerns were expressed that it has become too easy for a “hostile” bidder (i.e. a bidder whose offer is not recommended by the board of the target company) to obtain control of more than 50% of the voting rights of a target company; and that the outcomes of takeover bids, particularly hostile offers, are unduly influenced by the actions of “short-term” investors (for example, persons who become interested in the shares of the target company only after the possibility of an offer has been publicly announced).

In June, the Panel published Public Consultation Paper PCP 2010/2, entitled “Review of certain aspects of the regulation of takeover bids”, in which it asked for views on a large number of significant issues, including whether:

• the minimum acceptance condition should be raised from 50% plus one;
• shares that are acquired during an offer period should be disenfranchised;
• there should be additional restrictions on a target agreeing to pay an inducement (break) fee or to other “deal protection” measures that are often found in implementation agreements;
• target shareholders should be provided with independent advice about the merits of the offer which is separate to that given to the target board;
• there should be greater regulation of virtual bids and “possible offer” announcements; and
• the Panel should reintroduce restrictions on the speed with which a potential bidder can acquire target shares (similar to the old Substantial Acquisitions Rules, which were abolished in May 2006).

Panel response

After receiving an “unprecedented” number of responses to its consultation, on 21 October 2010 the Panel published Response Statement 2010/22, setting out in broad terms the areas in which the Code will, and will not, be amended.

Aspects of bid regulation that will not be changed

The Panel has decided not to:

• Raise the acceptance condition threshold above ‘50% plus one’. Some commentators had suggested it be increased to, say, two-thirds of the voting rights in the target company, in order to reduce the influence of short-term investors who buy shares in the target after it is put into play. However, setting the minimum acceptance threshold at a level higher than the threshold for obtaining statutory control of a company would create significant commercial and regulatory difficulties, and unsurprisingly the Panel has decided not to make this change.
• Disenfranchise shares that are acquired during an offer period, or to introduce a qualifying period before votes can be exercised (or weighted voting rights for shareholders who have held their shares for a particular period). These options had also been suggested as ways to reduce the influence of short-term investors, but implementing and policing a workable regime would be difficult, and the Panel has decided not to do so.
• Require shareholders in the bidder to approve a takeover offer, unless it is a reverse takeover (which currently requires shareholder approval).
• Require the target to obtain advice on the merits of the offer that is separate from the advice given by the target’s Rule 3 adviser.
• Reduce the maximum 28 day period between the announcement of a firm intention to make an offer (Rule 2.5 announcement) and the publication of an offer document.
• Reintroduce restrictions on the speed with which a potential bidder can acquire target shares (similar to the old Substantial Acquisitions Rules, which were abolished in May 2006). The Panel notes that market raids occur relative rarely, and their frequency has not increased markedly since the abolition of the SARs; and the arguments for abolishing the SARs still hold good.
• Reduce from 1% to 0.5% the threshold for disclosing dealings and positions in relevant securities under Rule 8.

Changes that will be made

But the Panel has concluded that “hostile offerors have, in recent times, been able to obtain a tactical advantage over the offeree company to the detriment of the offeree company and its shareholders”. For example:

• “the announcement of a “possible offer” can have a destabilising effect on the offeree company and often leads to significant changes in the composition of the shareholder register, with certain shareholders selling some or all of their shares and merger arbitrageurs acquiring interests in shares in the offeree company;
• the “virtual bid” period (i.e. the period between the commencement of an offer period and the announcement of a firm offer) can be long and drawn-out and this can adversely affect the conduct of the offeree company’s business and the offeree company board’s negotiating position with an offeror;
• after the commencement of an offer period, an offeror is able, in effect, to bypass the offeree company board and engage directly with offeree company shareholders generally in discussions regarding the merits of a possible offer and the price at which any such offer might be made without having to commit to making a formal offer;
• the cost to a potential offeror of making an approach to an offeree company or publishing a possible offer announcement is not significant (for example, the offeror does not need to have incurred financing costs or undertaken any preparatory due diligence work) and, in making such an approach or announcement, an offeror receives the benefit of the protections afforded by Rule 21.1 in restraining the offeree company from taking any action that might frustrate an offer;
• offeree company boards are often reluctant to request that the Panel should impose a ‘put up or shut up’ deadline under Rule 2.4(b) in respect of a potential offeror whose identity has been publicly announced, since such action might be perceived to be self-serving or defensive, particularly at an early stage in an offer period; and
• there has been an increasing trend for offerors and their advisers to persuade the offeree company board to enter into a comprehensive package of deal protection measures (including agreeing an inducement fee at the maximum permitted level) that is designed to deter competing offerors and, in practice, restricts the ability of the offeree company board to engage with potential competing offerors in a way that is detrimental to the interests of offeree company shareholders.”

To redress the balance, it will in due course propose amendments to the Code to:

• Increase the protection for target companies against protracted “virtual bid” periods by requiring potential bidders to clarify their position within a short period of time. In particular, (in broad terms) a publicly-named potential bidder will, unless the target or Panel agrees otherwise, always have to put up or shut up within four weeks of being named.
• Except in certain limited cases, prohibit (i) inducement fees; and (ii) undertakings by the target to implement a particular bid or not to do anything that might facilitate a competing bid. For recommended schemes of arrangement, the target will have to abide by a timetable that is agreed with the Panel and published in the scheme circular. These changes are especially significant as it has become standard practice for bidders to seek an inducement fee (mainly to cover costs they incur in doing due diligence on the target and in preparing for the bid), and common, even in contractual offers, for the bidder to ask for other undertakings and restrictions that are designed to protect its bid and deter rival bidders. Although most respondents believed that the Code should continue to permit inducement fees that are de minimis (usually no more than 1% of the value of the target calculated by reference to the offer price), the Panel has concluded that “in many cases, it is difficult either to regard the deal protection measures included in implementation and other agreements as the result of an arm’s length negotiation or to believe that inducement fee agreements, in practice, actually induce offerors to make an offer”. Bidders are therefore likely to consider other ways of reducing the “lost” expenses if their bid fails. It will remain possible for bidders to request undertakings from the target board in relation to, for example: the confidentiality of information provided to the target during the course of the offer;the non-solicitation of the bidder’s employees or customers; andthe provision of information that is required in order to satisfy the conditions to the offer or obtain regulatory approvals.
• Require the disclosure of the minimum and maximum amounts payable under any success fee arrangement with an adviser to the bidder or target. But such arrangements will not be prohibited (except to the extent currently provided in the Code). In addition, the offer document or defence circular (as applicable) will have to include: the estimated aggregate fees payable by each party;the estimated fees of all advisers to each party, by category of adviser; and(separately) the fees in respect of the financing provided to a party.
• Make clear that the price offered does not need to be regarded by the target board as the determining factor in deciding whether to recommend a bid.
• Require the disclosure of financial information relating to the bidder, the financing of an offer, and its impact on the balance sheet of the bidder, even if the offer is solely in cash. This is designed partly to enable target shareholders to scrutinise the bidder’s financing arrangements to assess whether there is any scope for the offer to be increased; and target directors to assess the implications of the bid for the target and its employees going forward.
• Require bidders to give more information in the offer document about their intentions regarding the target’s employees. In particular, statements in offer documents regarding an offeror’s intentions in relation to the offeree company and, in particular, the offeree company’s employees, locations of business and fixed assets (or the absence of any such plans), will be expected to hold true for a period of at least one year following the offer becoming or being declared wholly unconditional (except where another period is stated).
• Improve the ability of employee representatives to make known their views on the offer and its impact on the target; in particular, by requiring the target board to inform employee representatives at the earliest opportunity of their right to circulate an opinion on the offer (at the target’s expense).

Source materials

Public Consultation Paper PCP 2010/2
Response Statement RS 2010/22