In late August Justice Farrell of the Federal Court handed down her much anticipated judgment in the MYOB case. The decision did not make new law, but it did lay bare inherent weaknesses that exist in common sell-side auction processes and in doing so, it also highlighted some important issues that need to be managed by those who participate in those processes.
Funds managed by Archer were the majority shareholders of accounting software developer MYOB. In early 2011, Archer commenced a competitive auction process to sell MYOB and 3 private equity sponsors (Bain Capital, KKR and Hellman & Friedman) and Sage participated in the process. Sage is a UK software company listed on the London Stock Exchange.
Following a period of due diligence and negotiation (but not finalisation) of a Share Sale Agreement, Sage sent a letter addressed to the directors of MYOB headed “Sage Final Offer to acquire MYOB”. The Final Offer stated it was “subject to contract” and confirmed, relevantly, that the offer conditions included FIRB approval, review of black box due diligence, finalisation of due diligence reports and agreement on the Share Sale Agreement.
Sage had previously informed Archer’s advisers that if the MYOB acquisition was a “class 1” transaction under the UK Listing Rules (class 1 classification depends on purchase price as a function of market capitalisation), it would require Sage shareholder approval. Sage and its advisers had been looking for workarounds to eliminate the need for shareholder approval and had informed Archer’s advisers of that endeavour. There was a clear disconnect between Archer and Sage on this point. Archer and its advisers had incorrectly assumed that the issue had been resolved as it was not specifically referenced in the Final Offer.
On the day following submission of Sage’s Final Offer and following some further negotiation, Archer confirmed by email to Sage’s financial advisers that “Archer has decided to appoint Sage as sole preferred bidder”. Soon after, senior executives of Archer and Sage shook hands at an informal meeting in a building foyer.
Two days later Sage’s CEO advised Archer that Sage would not buy MYOB unless the price was reduced by $175m or the transaction was conditional on Sage shareholder approval. Archer refused to proceed with Sage on this basis and 2 days later signed with Bain Capital to sell MYOB for $1.045bn.
Archer argued there was a legally binding contract between Archer and Sage for the sale of the MYOB shares by virtue of: Sage’s Final Offer, Archer having accepted the offer by appointing Sage as the sole “preferred bidder” and representatives of Sage and Archer having shook hands at the meeting on the same day. According to Archer, Sage’s subsequent conduct amounted to repudiation of the contract.
Archer did not claim that the Final Offer was the complete and definitive document between the parties, but rather that it gave rise to a legally binding “interim” agreement. Neither party was free to withdraw from the interim agreement for reasons outside of those set out in the Final Offer.
Archer also claimed that Sage had engaged in misleading and deceptive conduct in making representations that it would purchase MYOB on the terms set out in the Final Offer when it did not reasonably believe that it would do so (because, among other things, it knew it would likely need shareholder approval for the transaction).
The Court rejected Archer’s claims. It found that the Final Offer was not an offer to enter into a legally-binding contract which Archer could accept as such. Rather, it set out a process for the next stage of bid negotiations. The Court also found that Sage had not made actionable misrepresentations.
Lessons for sellers
Is the preferred bidder contractually bound to negotiate final documents?
The fact that an ‘offer’ forms part of a competitive process and contains limited conditions will not, of itself, be enough to make it a binding interim agreement.
A seller’s decision to appoint a bidder as the ‘preferred bidder’ is not conclusive of any particular legal relationship. This remains the case even where the seller has incurred the competitive detriment of stopping or suspending negotiations with other bidders.
There is no presumption to create legal relations in an auction context. While appointing a party as a preferred bidder “was a significant milestone and it may dampen the enthusiasm of other bidders”, that does not create a legally enforceable obligation on the preferred bidder to proceed.
Better document any intended interim agreement
The conclusion above may be confronting for those who have conducted or managed auction processes. Comforting legal and commercial assumptions some may have drawn around the final, but critical, phase of an auction process have been skewered.
The question now becomes whether there is a better way for sellers to enter the final phase of the auction process recognising the risks that they run by standing down other interested bidders.
One possible alternative worth considering is to require the preferred bidder to sign a short deed poll in favour of the sellers:
- committing to negotiate the formal transaction documentation in good faith consistent with the terms of the final offer letter; and
- confirming that there are no other matters (beyond those in the final offer letter and any final transaction document mark-up) that go to affect material matters including price and conditions.
Or require that an executable Share Purchase Agreement is submitted with a final offer
The alternative to an interim agreement is to ensure that, as far as possible, the sellers have settled each of the full form transaction documents ahead of the final bid date with each prospective bidder. That requires advance work on the part of sellers and their lawyers to negotiate and settle the transaction documents in the lead up period so the definitive documentation submitted with the final bid can be signed without any further negotiation.
Whilst past practice has differed on this, there may in the future be greater emphasis placed on finalising the full documents with bidders as part of the penultimate phase of the bid process.
Fluid auction processes come at a cost...
As part of the Court’s overall analysis it looked at features of the wider auction process. The Court highlighted the tight and somewhat ill-defined deadlines imposed on bidders during the process and the general lack of visibility given to them on the process.
Embedded within the analysis is the suggestion that auction vendors may increase the prospects of generating legally-binding offers by ensuring:
- there are clearly defined deadlines and processes which are respected;
- there is sufficient due diligence information provided to bidders ahead of the final bid date to allow them to submit final binding offers; and
- bidders clearly understand the status of their offers and their obligations as bidders at each stage, including what it means to be anointed as the ‘preferred bidder’.
The small details matter if you want that final offer to be binding...
Sage’s Final Offer was addressed to the directors of MYOB rather than the relevant sellers (i.e. the MYOB shareholders). This proved to be significant. The Court found that it was never an offer to the MYOB shareholders which they could accept - irrespective of what the Final Offer did or did not say and whether it was or was not a contractual offer. The reason for this is that Archer lacked the authority to accept an offer on behalf of the minority shareholders (see below for more on this point).
Auction process letters need to clearly set out the specific requirements of any final offer to be made. For sellers who choose to ignore or simply mistakenly overlook these requirements, there may well be a price to pay in terms of legal certainty. The time to insist on observance of sell-side requirements is at the time final bids are submitted. If necessary, prompt action to require a refreshed conforming bid may be prudent if doubt exists.
Lessons for bidders
If you don’t intend to be bound, make sure your final offer letter has the right language
The Court saw as significant that the Final Offer was expressed to be “subject to contract” and did not contain language stating that Sage intended to be legally bound.
The judgment is a reminder of factors which bidders and sellers should consider in drafting an offer or evaluating whether an offer is binding, including whether it:
- contains language affirming an intention of the bidder to be legally bound or, conversely, expressly stating that the offer is not legally-binding and subject to negotiation and/or execution of definitive transaction documentation;
- specifies conditions to definitive transaction documentation being executed;
- specifies a clear method by which the seller may accept the offer to enter into a legally-binding contract;
- contains a governing law clause; and
- is addressed to target shareholders rather than the board of the target.
Lessons for exiting sponsors
If you are managing the exit on behalf of others...
An issue the Court had to consider was whether Archer (as manager of the Archer funds) or MYOB was able to act as agent for the minority MYOB shareholders and bind them legally. The MYOB Shareholders Deed contained customary, sponsor-friendly rights in relation to facilitating an exit transaction, including ‘drag along’ rights and a power of attorney.
The Court found that the Shareholders Deed did not give Archer the required authority and Archer was merely a ‘packager’, negotiating with potential bidders prior to any final agreement. Archer did not have authority it claimed prior to the drag along provisions being formally activated by the issue of exit notices. As a secondary consequence of Archer’s failure to be authorised in this way, the court also found that there was no legally actionable misrepresentation by Sage as, irrespective of whether there had or had not been an actual misrepresentation, Archer was not an authorised party who could receive any misrepresentation and then act on it on behalf of the minority shareholders.
The decision highlights an assumption which has previously been accepted in so many PE exit processes – that the PE investors’ manager has the authority to run the exit process on behalf of all shareholders as a necessary extension of the PE investors’ right to implement an exit.
One approach to mitigate against this risk is for PE sponsors to issue formal exit notices earlier in the process (even before a preferred bidder is selected). While this will depend on the terms of the relevant shareholders deed, it gives PE sponsors considerably more comfort that they have the requisite the authority. There are, however, potential downsides to this approach. It is only possible if the usual pre-requisites for such an exit notice can be specified with any precision at the time (e.g. the sale price). Notifying all shareholders of the process significantly increases the risk of leaks which are almost inevitably counterproductive to achieving the best results. Even more importantly, it can set the wrong tone with management and other minority shareholders – creating the impression that they are bound to sell into a transaction when they may not have much visibility or understanding.
And finally, you can still shake hands, but …
While the act of shaking hands in the context of a transaction may give the principals some comfort that matters are commercially settled, in MYOB the act was found to be just a courtesy in recognition of Sage’s appointment as preferred bidder and not itself conclusive of the parties’ intentions to be legally bound from that point.