Report of the High Level Group of Company Law Experts on issues related to takeover bids

After the European Parliament rejected the draft for a Directive on Takeover Bids in July 2001, the European Commission set up a group of company law experts (the "Group") to provide independent advice in the first instance on issues related to pan-European rules for takeover bids and subsequently on key priorities for modernising company law in the European Union. Three issues were considered:

• How to ensure there is a level playing field in the EU concerning the equal treatment of shareholders across all Member States
• The definition of the notion of an "equitable" price to be offered in mandatory bids
• The right for a majority shareholder to buy out minority shareholders after a takeover bid (the "squeeze out")

The Group felt that ‘Takeovers are a means to create wealth by exploiting synergies and to discipline the management of listed companies'. The recommendations are therefore broadly designed to encourage takeovers.

1. Takeover Bids: the need for a level playing field The Group advised that any European regulation aimed at creating a level playing field for takeover bids across all Member States should be guided by two principles:

Shareholder decision - making: the shareholders rather than the boards of companies should make the ultimate decision of whether a takeover bid is successful or not. The Group took the view that the boards of companies are often faced with a significant conflict of interests which results in costly defensive mechanisms being employed which are not in the best interests of the shareholders. A takeover should therefore go ahead if the majority of the shareholders are in favour and shareholders should have access to the information they need to be able to make an informed decision.

Proportionality between risk-bearing capital and control: on the subject of how shareholders should be entitled to vote, the Group was more controversial. They argued that there should be proportionality between holding risk-bearing capital and having control. Although ‘risk-bearing capital' is not clearly defined in the report, the Group suggested that the holders of shares which carry an unlimited right to participate in the profits of the company, or in the residue on liquidation, and only the holders of such shares should normally carry control rights in proportion to the risk carried. These principles led the Group to make several important recommendations:

Full disclosure: listed companies would be required to disclose complete information about their capital and control structures and continuously to update this information.

Shareholders' authorisation to frustrate the bid: after announcement of a takeover bid, the board of the target company would only be permitted to take actions frustrating a bid with the authorisation of the general meeting of shareholders, given after the bid has been announced.

Authorisation on basis of proportionality: such authorisation by the general meeting would be given by a majority of votes exercised by holders of the proportionate majority of risk-bearing capital of the company, regardless of pre-existing voting rights.

Break-through of defensive mechanisms by bidder acquiring 75per cent or more of risk-bearing capital: a rule would be introduced allowing a bidder who has acquired a certain threshold percentage of risk-bearing capital in the company after completion of a general takeover bid, immediately to break-through any mechanisms and structures in the offeree company's constitutional documents which may frustrate the exercise of control by the bidder. Such a bidder would be able to exercise voting rights in a general meeting of shareholders in proportion to his holding of risk-bearing capital and to determine the composition of the board and the constitution of the company. The Group felt that Member States should not set the threshold percentage higher than 75per cent of the risk-bearing capital of the company.

Also applicable to golden shares: the break-through rule would also apply to golden shares carrying special control rights held by Member States. Member States that wish to retain control over a company would have to do so by legislation which is subject to public rather than company law principles.

No compensation: the Group felt that the bidder should not be required to offer compensation to those holders of shares who had lost voting rights as a result of the breakthrough rule.

Non-transferability provisions not enforceable against bidder: provisions in a company's constitutional documents restricting the transferability of risk-bearing shares would not be enforceable against the bidder who makes a general takeover bid for the risk-bearing capital of the company. Pre-existing contractual blocks to a takeover were felt to be too complicated to be overridden, but the Group did recommend that the Commission should review whether clauses in shareholder agreements which prohibit the transfer of shares to a bidder should be unenforceable.

Pyramid structures and cross- and circular shareholdings to be reviewed: the Group felt that certain pyramid structures allowed minority shareholders in the target company to have disproportionate control in the outcome of a takeover. Despite this, the Group could not see a way to change this without incurring excessive complications. They recommended instead that the Commission should review whether pyramid structures and cross- and circular shareholdings should be regulated generally and what adequate measures of protection for minority shareholders should be enforced in all Member States.

2. The equitable price to be offered in mandatory bids The previous draft Takeover Directive, whilst requiring a party acquiring a controlling stake in a company to make a mandatory bid for all the shares at an equitable price, contained no definition of equitable price, leaving it up to Member States to produce their own rules that could differ widely. The Group felt that a harmonised approach should be introduced which allowed the bidder to predict, and ideally determine, the equitable price they would have to pay in a mandatory bid. This would be achieved by the application of a common rule relating to the timing of the mandatory bid and the price to be offered. Although these common rules would provide certainty, the Group recognised that flexibility might be needed in particular circumstances.

The Group recommended the following:

30 day limit: the bidder would be required to make the mandatory bid within a short period after having acquired control of the company. This would set by the Member State at a maximum of 30 days.

Equitable price is highest price paid: the price to be offered in the mandatory bid would normally be equal to the highest price paid by the bidder, on and off the market, in a certain period up to and including acquiring control. Member States would be free to set this period between 6 and 12 months.

Exceptions possible if unfair price would result: flexibility would be available to allow a bidder to pay a lower price if the bidder could prove that to pay the highest price would be plainly unfair.

3. The squeeze-out and sell-out rights after a takeover bid The last area the Group considered was the right, following a successful takeover bid, of the bidder to compel minority shareholders to sell their shares to him at an appropriate price (squeeze-out right) and for minority shareholders to compel the bidder to purchase their shares at an appropriate price (sell-out right). Many Member States already have a squeeze-out right and the Group thought both that right and the sell-out right were justified and that they should be put into effect at EU level, while allowing Member States flexibility to take into account the peculiarities of particular markets.

The Group recommended the following:

Threshold for squeeze-out: this would be set by reference to the capital held by the bidder after the bid, in which case it would be between 90per cent and 95per cent. Alternatively it could be set by reference to the number of acceptances in the offer, in which case it would be set at a minimum of 90per cent of the share capital for which the offer was made.

Squeeze-out price: the price offered in the takeover should be presumed to be a fair price if 90per cent or more of the shareholders accepted the bid. In a mandatory bid the bid price would be assumed to be fair.

Sell-out threshold and price: the threshold for a sell-out would be set by reference to the capital held by the bidder after the bid, in which case it would be between 90per cent and 95per cent. The same presumption of the bid price as a fair price would apply.

Next Steps: The report has been presented to the European Commission and the Financial Services Policy Group (which comprises personal representations of EU Finance Ministers). The Commission has said that it would carefully examine the recommendations of the Group with a view to submitting a revised proposal for a Takeover Directive in April or May.

For further information on this topic, please contact Nick Callister-Radcliffe at nick.callister-radcliffe@cms-cmck.com or on +44 (0)20 7367 2394.