Several commentators believe that bidders in UK takeovers have gradually developed a tactical advantage over targets in recent years. Some view the highly-publicised takeover of Cadbury plc by Kraft Foods Inc as a high-profile example of the weakened tactical position of offerees in public M&A deals.
In response to these concerns, in October 2010, the UK Takeover Panel unveiled a series of planned reforms to the Takeover Code. In addition to redressing the perceived tactical mismatch between offerors and offerees, the proposed reforms seek to increase transparency and strengthen the protection of target company employees. This article examines the main reform proposals and their potential impact on the UK M&A market.
According to a number of M&A market participants, in recent years, offerors (www.practicallaw.com/3-202-3215) in UK public M&A transactions have gradually gained an undue tactical advantage over offerees (www.practicallaw.com/8-202-3133). Kraft's landmark takeover of Cadbury in February 2010 is a high-profile example of the existing power imbalance between bidders and targets.
In response to these concerns, on 1 June 2010, the Code Committee of the Takeover Panel (www.practicallaw.com/1-106-4788) (Committee) issued Public Consultation Paper 2010/2: Review of certain aspects of the regulation of takeover bids (PCP 2010/2). The objective of the Panel's consultation was to examine possible amendments to the Takeover Code (www.practicallaw.com/0-107-7362) (Code) with a view to creating a more even playing field for targets.
On 21 October 2010, the Committee published its response statement (www.practicallaw.com/6-503-6864) to PCP 2010/2 in which it proposed several reforms to the Code. These include:
Requiring potential bidders to clarify their intentions towards a target within four weeks of making a possible offer announcement.
Banning deal protection measures.
Improving disclosure of financial information about the bidder and requiring disclosure of offer-related fees.
Improving the quality of disclosure about a bidder's intentions for the target company and its employees, and improving the ability for employee representatives to give their views on the offer.
Several leading lawyers believe that, if implemented, these proposals could significantly alter the tactical dynamics of public M&A transactions in the UK.
This article examines the potential impact of the proposed changes to the Code based on:
Interviews with leading public M&A practitioners.
An analysis of deal terms in recent takeovers using data from PLC What's Market .
For an analysis of the Kraft-Cadbury deal and its influence on the proposed changes to the Code, see What's Market, Kraft Foods Inc. offer for Cadbury plc and Articles, Cadbury takeover: a krafty manoeuvre (www.practicallaw.com/1-501-5227) and Takeover Code changes after Cadbury: a grittier road ahead? (www.practicallaw.com/8-504-0596).
For further background on the proposed changes to the Code, see Legal update, Takeover Code: response to consultation on review of certain aspects of takeover regulation (www.practicallaw.com/6-503-6802).
"two things should be borne in mind before trying to predict the impact of these reforms. First, we are still not certain about the precise scope of each proposal. The Panel will publish additional consultation papers containing the details of each reform during 2011, which is giving stakeholders the chance to comment on and potentially modify the most controversial proposals.
Secondly, when you make changes of this nature, the law of unintended consequences often kicks in. We can make an informed guess as to what may happen, but the practical effect of the proposals will not become apparent until after their implementation. All we can conclude with any degree of certainty at this point is that the reforms will alter the alignment of the playing field for targets, especially in hostile bid scenarios".
Under Rule 2.4(b) of the Code, the Panel can issue a "put-up or shut-up" (PUSU) statement at the request of the target company at any time following the announcement of a possible offer (provided the potential bidder has been publicly named) and before the bidder has notified a firm intention to make an offer.
A PUSU statement requires a potential offeror to clarify its intentions with regard to the target company by either making a Rule 2.5 announcement or declaring its intention not to make an offer (in which case the announcement will be treated as a statement to which Rule 2.8 applies) by a specific date set by the Panel. For further information, see Practice notes, Announcing the offer (www.practicallaw.com/6-107-3610) and Takeover Code know-how: Rule 2 (www.practicallaw.com/7-384-3891).
The Panel can only exercise its authority under Rule 2.4(b) if the offeree requests it to do so. Likewise, the Panel can only intervene if the possible offeror is named in the Rule 2.4(a) announcement, which the Code does not always require.
"Rule 2.4(a) announcements are tactically advantageous for very many bidders. Hostile bidders can issue them to exert pressure on a target (known as a "bear hug" announcement) and friendly bidders have begun using them to gauge the market's likely reaction to a proposed transaction".
As Sarch notes, even target companies are beginning to make non-commitment, pre-bid announcements. For instance, on 17 September 2010, the board of Brit Insurance Holdings NV announced that it had received an indicative proposal by a consortium of private equity bidders (Apollo Global Manangement and CVC Capital Partners) which the board "expected to recommend" subject to certain pre-conditions being promptly satisfied and other terms and conditions being acceptable (Sarch describes this as a possible recommendation announcement). (See Brit Insurance Holdings NV, Possible Offer (www.practicallaw.com/0-503-4702) and What's Market, Apollo Global Management, LLC and CVC Capital Partners offer for Brit Insurance Holdings NV.)
The Panel has responded to the increasing use of lengthy virtual bid periods as a besieging tactic by issuing a number of PUSU statements in recent years. In 2010, the Panel issued PUSU statements in response to seven possible offer announcements. Only two of those potential transactions culminated in successful takeovers:
The Kraft-Cadbury deal.
Babcock International Group plc's acquisition of VT Group (see What's Market, Babcock International Group plc's offer for VT Group plc).
The response statement identified protracted virtual bid periods as one of the factors giving offerors a tactical advantage. In particular, the Panel highlighted the effect of virtual bid periods on the offeree's business, negotiating position and shareholder composition (due to the involvement of hedge funds, merger arbitrageurs and other opportunistic, short-term investors seeking to capitalise on M&A activity).
To strengthen the position of offerees, the Committee proposes to amend Rule 2.4 to:
Make it mandatory to name potential offerors in Rule 2.4 announcements.
Establish an automatic, compulsory PUSU procedure which would give bidders four weeks from the date they are named to clarify their intention towards the target.
The proposal would not apply to situations where the target initiates a public auction sale process. Moreover, the Panel would be able to extend the four-week deadline at the joint request of the offeror and offeree. Although the Panel intends to test parties carefully on their reasons for seeking an extension, and could even ask them to set a proposed date for making the Rule 2.5 announcement in their joint application, Sarch finds it difficult to imagine a scenario where the Panel would refuse to grant an extension.
The proposal does not involve amending the Code to provide for private PUSU deadlines (where both the existence of a possible offer and the deadline would remain confidential). However, the Panel could still consider setting a private PUSU deadline in individual cases under General Principle 6 of the Code (which establishes that a bid for a company's securities must not hinder the conduct of that company's affairs for any longer than is reasonable).
According to Sarch, the mandatory 28-day limit on virtual bids could cause a decline in the number of Rule 2.4 announcements, in particular those made by "opportunistic potential offerors looking to make no commitment bids".
Impact on confidentiality and timing. If the proposal is implemented, any rumours or leaks about a possible takeover would significantly reduce the time an offeror has to prepare and make a Rule 2.5 announcement. Preserving confidentiality prior to an offer announcement would become even more important for offerors than it is at present.
As Godden notes, the shortening of virtual bid periods could also force bidders and their advisers to have a fully prepared bid before initially approaching the target (even informally), which paradoxically would increase the risk of leaks.
"Although the Panel seems to believe that the proposal will not encourage offerees to leak information about unwelcome approaches, it is naive to assume that companies under siege may not resort to this measure".
Godden also believes that potential bidders who fear that their targets may not welcome their offers may find themselves propelled into launching a hostile bid without any prior informal negotiations, which could herald a return to the sort of traditional hostile bids that were common during the 1980s and 1990s.
The Panel has recently expressed concern about the strategic leaking of information by core insiders and is likely to monitor any changes in market practice that could arise as a result of the reform (see Legal update, Market abuse: FSA Market Watch No. 37 on inside information leaks (www.practicallaw.com/2-503-4008)).
Impact on transactions that are highly leveraged or require regulatory approval. Godden and Sarch both believe that the proposal could have a particularly strong impact on certain takeovers. These include:
Deals where the bidder raises substantial amounts of third-party acquisition finance. As Godden explains, the combined effect of the 28-day PUSU deadline and the "certain funds" requirement in General Principle 5 and Rule 2.5(a) of the Code could "alter the tactical dynamics of highly geared transactions".
Transactions requiring domestic or foreign regulatory clearance (for instance, an approved prospectus or, as was the case in the Kraft-Cadbury deal, a US securities filing).
For further background on the certain funds requirement and an overview of common regulatory issues in public M&A deals, see Practice notes, Financing an offer for a public company: the certain funds requirement (www.practicallaw.com/5-370-3957) and Regulatory and competition issues: takeovers (www.practicallaw.com/2-107-3612).
As a result of the proposed reform, offerors in transactions that are highly geared (www.practicallaw.com/0-107-6640), multi-jurisdictional or in heavily regulated sectors could abandon possible offer announcements in favour of pre-conditional offer announcements. Although the response statement does not directly address pre-conditional announcements, Note 1 on Rule 2.4 of the Code requires bidders to consult with the Panel before making such an announcement (see Practice note, Announcing the offer (www.practicallaw.com/6-107-3610)).
Regulation of virtual bids in other jurisdictions. Some jurisdictions, such as the Netherlands, impose time limits on virtual bid periods similar to those envisaged in the response statement, at least in non-mandatory hostile bids. As Hans Beerlage, M&A partner at Clifford Chance's Amsterdam office explains, under Dutch law, non-mandatory hostile bidders must publish a follow-up announcement within four weeks of making an initial public announcement indicating a possible offer, clarifying whether or not they intend to file an offer document for approval with the Dutch regulator and, if so, within which period. The Dutch rules require non-mandatory bidders to file an offer document with the Dutch regulator for approval no later than 12 weeks after the initial announcement.
Deal protection measures are typically undertakings sought by offerors to pre-empt rival offers, discourage offerees from seeking white knights (www.practicallaw.com/9-107-6221) and enhance deal certainty. Although relatively new in the UK (but not in the US), they have become pervasive in takeovers of British companies in recent years. UK bidders tend to draft implementation agreements comprising a suite of deal protection measures, the most common of which include:
Exclusivity agreements (www.practicallaw.com/4-107-6577) (also known as no-shops).
Limitations on the ability of target boards to change a recommendation.
Constraints on a target's ability to supply information to competing bidders.
For further information on deal protection measures in UK takeovers, see Practice note, Break fees (www.practicallaw.com/5-107-4610) and Article, Takeovers: matching rights and deal protection (www.practicallaw.com/5-205-6304).
According to a comparison of the 23 firm offers announced in 2010 for UK public companies listed on the Main Market with a value of at least £100 million, details of which are summarised in PLC What's Market:
Break fees were agreed in 19 transactions.
Non-solicitation undertakings were used in 16 deals.
Matching or bettering rights were used in nine takeovers.
Seven transactions contained all of the above measures.
Conversely, only four takeovers contained no deal protection measures. These include:
Investec's offer for Rensburg Sheppards (see What's Market, Investec plc's offer for Rensburg Sheppards plc).
Emerson Electric's offer for the Chloride Group (see What's Market, Emerson Electric Co's offer for Chloride Group plc).
CH2M HILL Companies' offer for Scott Wilson Group (see What's Market, CH2M HILL Companies, Ltd offer for Scott Wilson Group plc).
Korea National Oil Corporation's offer for Dana Petroleum (see What's Market, Korea National Oil Corporation offer for Dana Petroleum plc).
The circumstances of the transactions that contained no deal protection measures were often quite specific. For instance, in the Investec-Rensburg merger, a recommended takeover structured as a scheme of arrangement (www.practicallaw.com/0-107-7201), the offeror (Investec) had a pre-existing 47% stake in the offeree (Rensburg Sheppards), which meant that a competing offer was highly unlikely. The Emerson Electric-Chloride deal started off as a hostile offer, which became recommended after Emerson outbid a previous recommended offer by ABB Ltd. ABB's ultimately unsuccessful offer contained several deal protection measures including a GBP8.54 million break fee, a non-solicitation undertaking and matching rights. Interestingly, in this instance, deal protection measures failed to dissuade Emerson from making a higher competing bid (see What's Market, ABB Ltd offer for Chloride Group plc).
The response statement highlighted the detrimental impact of deal protection measures on offerees, in particular their deterrent effect on competing bidders. The statement also acknowledged that although bidders could legitimately request certain undertakings, such as confidentiality or non-solicitation, allowing them to seek additional undertakings would gradually lead to a return to excessive market practices. Consequently, the Panel intends to prohibit most forms of deal protection including break fees, matching or topping rights and no-shops.
As is the case with the proposed changes to the virtual bid regime, the proposed prohibition would not extend to sales by public auction. Moreover, to ensure that the prohibition does not disrupt takeovers structured as a scheme of arrangement, the Committee plans to amend the Code to provide that, where the target agrees to proceed with a recommended offer by way of a scheme, it would need to implement the scheme according to a pre-agreed timetable to be published in the scheme circular.
According to Sarch, although market practice has arguably moved too far in favour of ever more complex deal protection, the proposed ban on these measures is too draconian. He believes that the Code already gives offerees enough protection against the abusive use of break fees by offerors (plus, no offeree board needs to agree such terms). For instance, Rule 21.2 of the Code establishes that any break fee is to be de minimis (which means no more than 1% of the offer value). This 1% cap is also consistent with the approach in other jurisdictions, such as Australia, where break fees with a value lower than or equal to 1% of the target's equity value are generally acceptable in the absence of certain other factors (such as coercive triggers) (see Country Q&A, Mergers and Acquisitions (public): Australia: Question 10 (www.practicallaw.com/0-501-4520)).
"the use of deal protection measures has become absurd in recent years. While I understand the counter-arguments made by those opposing the ban, the Panel has made a sensible case for their abolition. It could even be argued that the current reliance on these measures runs counter to the General Principles (especially General Principle 3) and the spirit of the Code".
"Before the crisis, when it was common for five or six bidders to approach a listed company, it could have been argued that break fees undermined the ability of competing offerors to enter the fray. However, due to the downturn's effect on take-private activity and the corresponding reduction in the average number of bidders chasing a single target, one could question whether break fees are as detrimental (for the offeree) as they used to be".
There were seven take-privates during 2010 that met PLC's criteria (www.practicallaw.com/8-383-6376) for inclusion in the PLC What's Market database (five of those were Main Market deals and two were on AIM). Break fees were used in all seven deals, non-solicitation undertakings in four and matching or bettering rights in two. One transaction, BMG and KKR's offer for Chrysalis, contained all three deal protection measures (see What's Market, BMG and KKR's offer for Chrysalis plc).
"What private equity bidders primarily want is the privacy to undertake due diligence, arrange finance and negotiate a recommended deal. The changes to the PUSU regime are therefore more likely to deter private equity sponsors than the ban on deal protection measures".
"deal protection measures are relatively new in UK M&A deals. Transactions used to be negotiated without them until five or six years ago and will continue being successfully completed if they are banned. Moreover, although lawyers spend considerable time negotiating and drafting break fees and other deal protection clauses, these provisions do not ultimately affect the final offer price. Some principals and financial advisers may even be glad to see them banned".
Impact on the contractual bid versus scheme of arrangement debate. Schemes of arrangement have become a popular mechanism for effecting UK takeovers in recent years at the expense of traditional contractual bids. Six out of the seven take-privates mentioned above were structured as schemes of arrangement. The only exception was the Brit Insurance deal, which used a contractual offer structure because the target was a Dutch NV, not capable of being wound up under the Companies Act 2006 and therefore not capable of proposing a scheme of arrangement. Takeovers in the Netherlands can be structured as offers or mergers. In the case of Brit Insurance, the chosen structure was an offer under English contract law. However, if successful, the offer will confer on the bidder the right to squeeze out minority shareholders (once it has acquired 95% of the target's shares). For further information on public M&A transactions in the Netherlands, see Country Q&A, Mergers and Acquisitions (public): The Netherlands (www.practicallaw.com/3-502-0666).
The removal of deal protection measures could indirectly allow contractual bids to regain some of the popularity they have lost to schemes in recent years, by boosting the strategic importance of other ways of improving deal certainty, such as stakebuilding (www.practicallaw.com/8-107-7301). Stakebuilding tends not to take place in takeovers structured as a scheme because market purchases of target shares during the scheme period cannot influence its outcome.
In addition, the proposed reform could also make bidders place greater emphasis on irrevocable undertakings (www.practicallaw.com/3-107-6304). Although irrevocables are used in takeovers structured as a scheme of arrangement, there is uncertainty as to whether shareholders who give irrevocables ought to constitute a separate class for the purposes of voting on the scheme.
For a comparison of the advantages and disadvantages of offers versus schemes of arrangement in takeovers, see Practice note, Takeover offer or scheme of arrangement? (www.practicallaw.com/1-208-6992). For further information on stakebuilding and irrevocable undertakings, see Practice notes, Stakebuilding (www.practicallaw.com/0-107-3608) and Takeover Code know-how: Irrevocable commitments (www.practicallaw.com/6-500-5551).
One of the objectives of the Panel's response is improving the quantity and quality of disclosure. As Sarch explains, these proposals are rooted in the belief that "more disclosure is better than less".
According to Godden, although greater disclosure will make the documentation process more burdensome for bidders and their advisers, it is unlikely to have a big practical impact.
The objectives of the Panel's proposals regarding disclosure are to:
Require disclosure of offer-related fees.
Ensure that bidders disclose the same level of information about their financial position and the financing of the offer, regardless of whether the main form of consideration for the offer is cash or securities.
Although the Code does not forbid conditional fee arrangements, Note 3 on Rule 3.3 of the Code states that certain fee arrangements between a target and its adviser, such as a conditional fee arrangement where the adviser only gets paid if the offer fails, can create conflicts of interest. These conflicts can render the adviser ineligible to give independent advice to the offeree.
Proposed changes. To enhance disclosure and improve early detection of potential conflicts, the Panel proposes to make disclosure of the following information compulsory:
The minimum and maximum amounts payable as a result of any success, incentive or ratchet mechanism. The Panel will want to ensure that this information can be disclosed without jeopardising commercially sensitive information about the offer.
Both parties' estimated aggregate fees, which should be disclosed in the offer document or the initial target board circular.
The estimated fees of each party's advisers (including lawyers, accountants, brokers, financial advisers and PR advisers), which should be disclosed separately by category of adviser.
Fees in relation to the financing of the acquisition, such as underwriting fees, which should be disclosed separately from advisory fees.
Material changes to any fee arrangements, which must be promptly disclosed.
Potential impact. Practitioners generally believe that the practical impact of this reform will be negligible. According to Sarch, apart from minor reservations by some financial institutions about having to disclose underwriting, syndicating and hedging fees, advisors are not hugely concerned about this proposal.
Sarch also believes that this proposal could stimulate a move towards further success fee arrangements for M&A advisers. While this may initially sound unappealing, he thinks that incentivising advisers to align their interests with investors could benefit the M&A market as a whole. Moreover, Sarch states that greater transparency would not necessarily lead to lower fees. Indeed, as the experience in the US suggests, overall fees can actually increase as a result of more granular disclosure.
The Code's current approach to the disclosure of financial information and the financing of the offer is to impose more onerous disclosure requirements on bidders who choose securities as the main or only form of consideration (such as securities exchange offers). In contrast, the disclosure requirements for cash offers are less extensive (see Rule 24.2(a) and (b) and Note 6 on Rule 24.2).
Proposed changes. The response statement highlighted that, in addition to the target's shareholders, other stakeholders such as creditors, directors and employees may also be interested in the bidder's financial position. Consequently, the Committee intends to require bidders to disclose the same amount of financial information regardless of the main form of consideration for the offer, which would involve deleting Rule 24.2(b) and Note 6 on Rule 24.2.
The proposed amendment of Rule 24.2 would also require the inclusion of a pro forma balance sheet of the combined group in offer documents and details of the ratings given to the bidder by rating agencies (as well as any changes to those ratings as a result of the offer), in cases where the offer is material (a term which the Panel is yet to define).
In addition, the Panel proposes greater disclosure of the debt facilities and other forms of acquisition finance raised by the bidder, regardless of whether the payment of interest, principal or the granting of security under these facilities depends on the target's business to any significant degree.
"The Code used to require bidders to disclose the same amount of financial information regardless of whether the consideration for the offer was cash or securities. I always viewed the old requirement as somewhat unnecessary in cash offers, seeing as in those offers target shareholders generally want to just take the money and run. In fact, during my time as a member of the Panel, I argued in favour of the inclusion of what became Rule 24.2(b)".
Rule 24.1 of the Code already requires bidders to disclose details of any plans regarding the target's employees, locations of business and fixed assets. However, partly as a result of certain events that took place in the course of the Kraft-Cadbury deal, the effectiveness of this provision as a means of informing target company employees has been questioned.
Before its acquisition by Kraft, Cadbury announced its intention to close one of its facilities in Somerdale. Throughout the offer period, Kraft repeatedly noted that it believed it would be in a position to keep the Somerdale facility open. However, on 9 February 2010, seven days after Kraft's offer had become unconditional, Kraft announced that it would proceed with Cadbury's plan to close the Somerdale facility.
On 26 May 2010, the Panel Executive issued a statement of public criticism of Kraft for failing to meet the standards required under Rule 19.1 of the Code in connection with its statements regarding the Somerdale facility (see Legal update, Takeover Panel statement: criticism of Kraft Foods Inc. for breach of Rule 19.1 (www.practicallaw.com/9-502-3916)).
The response statement recommended amending the Code to:
Include a requirement for bidders to make negative statements if there are no plans regarding the target company's employees, locations of business and fixed assets.
Clarify that, except with the Panel's consent, statements made in offer documents about a bidder's intentions for the target company, its employees, locations of business and fixed assets (or the absence of any such plans) should remain true for at least one year after the offer becomes or has been declared wholly unconditional.
As Godden explains, it is not common practice for bidders to ignore their undertakings in relation to employees. However, "every few years, there is a high profile transaction that causes particular furore and is subject to high levels of public scrutiny". Godden also believes that, while upholding the principle enshrined in Rule 19.1 of the Code is important, the proposed one-year rule is somewhat arbitrary.
The response statement also outlined several measures to improve the provision of information to, and participation of, target company employees in UK takeovers. The proposals include:
Clarifying that the Code does not bar the provision of information to employee representatives in confidence during the offer period.
Requiring the target's board to inform employee representatives at the earliest opportunity of their right to circulate an opinion on the effects of the offer on employment.
Emphasising that it is the target board's responsibility to publish the employee representatives' opinion at the company's expense.
Requiring that the target company reimburses employee representatives for any costs incurred in obtaining advice needed to verify the information in their opinion.
As Sarch explains, most measures dealing with employee protection in EU takeovers have been around since the implementation of Directive 2004/25/EC of the European Parliament and of the Council on Takeover Bids (Takeover Directive). The current proposals merely seek to align UK practice more closely with other EU jurisdictions where employee representatives can play a prominent role in takeovers. For instance, in Belgium, the target company's works council can request a hearing with a representative of the bidder. Failure to attend the hearing will result in the loss of any voting rights that the bidder may have acquired during the course of the offer (see Country Q&A, Mergers and Acquisitions (public): Belgium: Question 15 (www.practicallaw.com/4-502-0642)).
Practitioners believe that the proposals will not alter the fundamental drivers of public M&A activity, but could affect the strategic planning and execution of transactions in the future.
Godden believes that some of the proposed reforms could have a much more significant impact than others. The proposals relating to disclosure and employee participation are unlikely to achieve anything beyond making the documentation process slightly more burdensome. Some market participants are likely to vocally oppose the ban on deal protection measures but, if the ban is ultimately implemented, it will not in itself discourage M&A activity.
"It is unclear how the proposed rule will operate in certain circumstances, such as in the event of a competing offer, or rumours of a competing offer".
Sarch believes that the Panel has done a good job in deterring unwelcome bidders without being too protectionist. The response statement addresses perceived problems with speculative, opportunistic offerors successfully. Although the proposals will require practitioners to amend and update their toolkit, he is confident that the proposals will not have a significant impact on the resurgence of M&A activity in the UK.