The Takeovers Panel's Guidance Note
The Normandy Mining Takeover
The Ballarat Goldfields Restructuring
The Ausdoc Takeover
Arrangements to pay break fees (also known as termination or reimbursement fees) have been a common feature in M&A transactions in the United States for some time. However, until recently it was relatively unusual to see a break fee in Australian-based transactions.
As the Australian market becomes more competitive, deals are more vigorously pursued and cost protection in the event of the failure of a deal is of growing importance. To address these commercial demands, companies are increasingly seeking break fees.
Typically, a break fee transfers the risk of paying some or all of the advisory and other costs if the deal does not proceed. In addition, break fees may assist the bidder by discouraging targets from considering other proposals and discouraging counter bidders - if they are successful they may effectively have to make the payment under the break fee.
Given the anti-competitive effect that a large break fee can have, the validity and enforceability of break fees was for some time treated cautiously in Australia. The Takeovers Panel (the primary dispute resolution forum in Australia for takeovers) has provided an indication of its position with regard to break fees in the form of a guidance note. The panel has recently considered the reasonableness of break fees in the contested takeover battle for the control of Normandy Mining, the proposed reconstruction of Ballarat Goldfields and the recomended bid by ABN AMRO for Ausdoc.
The Takeovers Panel's Guidance Note
The Corporations Act gives the panel wide powers to make orders if it finds that "unacceptable circumstances" exist in relation to a takeover bid or other control transactions. For example, in the takeover the panel ordered that the break fee should not be paid.
On December 2001 the panel published a guidance note, which sets out the principles it will apply when determining whether break fees in takeovers are acceptable.
The panel's main concern with break fees is that they have the potential to run counter to a key policy objective of the Corporations Act's takeover provisions, which is that the acquisition of corporate control takes place in an efficient, competitive and informed market. A break fee is likely to be unacceptable where its size puts pressure on shareholders to accept a bid. To that end the panel will consider a number of factors when looking at a specific break fee arrangement, including:
- whether the break fee was negotiated on an arm's length basis;
- what bids were expected or likely at the time;
- whether the bids known or expected were reasonably regarded by the target board as inadequate;
- whether the bid that a break fee induces will offer shareholders special value for their holdings;
- whether the target sought out other prospective bidders;
- who made the initial approach;
- the effect of the fee on the conduct of the counterparty and any other bidders;
- the value of the fee or the significance of the agreement and its likely effect on any current, or any possible future, rival bid;
- whether the fee has a clear dollar or percentage cap;
- whether the target board considers that it is in the best interests of shareholders to promote a particular bid;
- any restrictions on the target board from dealing with a rival bidder, particularly if the rival bid is on better terms;
- whether the target board is explicitly allowed to fulfil its obligations to its shareholders; and
- any other matters it consider relevant.
A break fee agreed with a major shareholder of a target company as part of an arrangement for that shareholder to sell all or part of its holding to the bidder (either directly or by accepting the bid) gives rise to some additional considerations. In such a case the panel will still have to assess the effect of a break fee on competition for control of the target, considering all of the principles outlined above.
However, the panel will also be concerned to ensure that the arrangement does not defeat the purpose of Section 606 of the Corporations Act by allowing the bidder effectively to control the disposal of shares above the 20% threshold, unless one of the exceptions listed in Section 611 of the Corporations Act applies (eg, if the target must pay a fee if shareholders do not accept the bid, shareholders may have an economic incentive to accept that bid even if a higher rival bid emerges).
Break fees generally give rise to two key issues - the nature of the costs and outgoings that can be properly paid under a break fee, and the amount of the payment.
As to the first issue, a break fee should usually only consist of a reimbursement of:
- reasonable third-party costs (eg, financial, legal and tax advisers);
- reasonable internal costs; and
- in appropriate circumstances, the bidder's reasonable opportunity costs in connection with the bid.
The existence of a break fee cap (in the form of either a dollar or percentage limit) and an arbitration provision in any fee arrangement will help to demonstrate the reasonableness of the third-party costs.
The panel states that reimbursement of a third-party adviser's success fees would be unacceptable. Although this may be reasonable on the basis that a success fee would not usually be payable if a deal is not completed, it is not uncommon for some success fees to be payable, for example, on the announcement of the intention to make an offer.
The panel is aware of the difficulty in quantifying opportunity costs and therefore provides that any allowance for opportunity costs should be included in the agreed break fee cap. Opportunity costs will not be reasonable if they constitute a reimbursement for profit expected on the proposed bid. However, no definition is given to what the panel means by 'profit'. If this is given a broad meaning it will give rise to the question of whether essentially all benefits arising to a bidder from the bid will be excluded from break fees.
As to the amount of the break fee, the panel has stated that it considers that 1% of the value of the bid is a useful guideline as to what amount is reasonable. In low-value bids the costs may reasonably exceed 1%, whereas in high-value bids a fee of 1% may be excessive. However, the panel provides no guidance as to what should be considered a low or high-value bid.
The panel requires immediate disclosure of the existence and nature of a break fee by means of an announcement to the respective home exchanges of the bidder and target. The bidder's and target's statement should fully disclose the terms of the break fee. The directors of the target should explain why they have entered into the agreement, with regard to its effect on competition for control of the company.
In September 2001 AngloGold announced a scrip bid for Normandy valuing the target at approximately A$3.2 billion. The AngloGold bid was at that time neither recommended nor rejected by the Normandy board. On November 14 2001 Newmont announced a competing cash and scrip bid for Normandy worth A$4 billion, and entered into a deed with Normandy containing a break fee of A$38.33 million. This became payable to Newmont if either (i) another bidder acquired more than 50% of Normandy, or (ii) the Normandy board failed to recommend Newmont's bid or recommended or supported a competing bid. On the same date Newmont also announced a merger with Franco-Nevada. Franco-Nevada held 19.9% of the shares in Normandy and had granted Newmont a call option over those shares. Franco-Nevada also agreed to pay Newmont a break fee of US$20 million, payable primarily (i) where a rival bidder acquired 50% or more of Normandy, or if (ii) the Normandy board failed to recommend Newmont's bid or supported a competing bid. Two further offer increases by both AngloGold and Newmont followed.
After announcing its revised offer, AngloGold sought a declaration of unacceptable circumstances from the panel in relation to the break fees associated with the Newmont bid. In essence, AngloGold argued that the two break fees needed to be aggregated, given that they would most likely be payable in the same circumstances. AngloGold submitted that the total break fees would be approximately 2.3% of the value of Newmont's bid, well in excess of the 1% set out in the panel's guidance note. AngloGold also argued that, notwithstanding the Franco-Nevada break fee, the Newmont bid for Normandy was a 'large bid' and therefore the 1% Normandy break fee was excessive.
The panel rejected AngloGold's arguments and decided that the break fee did not have any anti-competitive effects, as evidenced by AngloGold's higher counter offers. The panel's decision relied heavily on the fact that AngloGold made a higher offer for Normandy subsequent to the Newmont bid. This allowed the panel to conclude that the break fee did not prevent a competitive auction for Normandy. Further, AngloGold produced no evidence that the Normandy break fee might have deterred other rival bidders. The panel did not find it necessary to decide whether the Franco-Nevada break fee should be aggregated with the Normandy break fee. Further, while assessing the Normandy break fee on its own, although the panel agreed that the bid was a 'large bid', it felt comfortable in not following its own policy as set out in the guidance note that a break fee of 1% in high-value bids may be excessive.
If the panel is going to concentrate on the anti-competitive effects of a break fee as it appears to have done in this instance, the problem arises that there may not always be a higher offer to rely upon. Further, it will be nearly impossible to know if other bidders have been deterred by the break fee, as most potential bidders are reluctant to show their hands until they are ready to proceed. In cases where a counter bidder does not emerge, the question arises as to whether it is reasonable for a bidder to obtain a sizeable break fee from both the target and a major shareholder of the target.
The Ballarat Goldfields Restructuring
On August 3 2001 the board of Ballarat Goldfields entered into an agreement for the sale of its gold assets to Rexadis. The sale was subject to Ballarat Goldfields shareholder approval. On December 6 2001 RFC Corporate Finance communicated an offer to Ballarat Goldfields that "would be superior to" the Rexadis offer. Later that day Ballarat Goldfields entered into an agreement with Rexadis whereby Ballarat Goldfields agreed to pay Rexadis a break fee if its shareholders did not approve the sale of the gold assets. The break fee was to be paid by issuing the equivalent of 14.9% by number of the Ballarat Goldfields shares on issue as at the day the break fee shares were allotted to Rexadis.
The panel ordered that Ballarat Goldfields not pay the break fee and that Rexadis not acquire the shares that were the subject of the break fee. The panel considered that, although the board of Ballarat may have considered that the break fee was necessary to secure the Rexadis proposal at that time, given its size and the fact that it was payable in scrip the break fee was likely to have a coercive effect on the Ballarat Goldfields shareholders' decision. The panel considered it unacceptable that the shareholders might be forced to allow Rexadis to acquire a substantial interest in Ballarat Goldfields as the cost of rejecting the Rexadis proposal.
The issue that arose from the Ballarat Goldfields decision is whether small listed companies with little cash, for example some IT companies, can ever induce a potential bidder by agreeing to a break fee payable in the form of an issue of shares.
The panel recently published its decision in relation to a break fee arrangement entered into between Ausdoc Group Ltd (target) and ABN AMRO Capital (bidder).
The break fee arrangement provided for Ausdoc to pay ABN AMRO a break fee of up to A$3.5 million, with different amounts payable in different circumstances. The maximum break fee of A$3.5 million was approximately 1.87% of ABN AMRO's bid value of A$187.6 million.
With one exception, the panel decided that the break fees did not give rise to unacceptable circumstances. It decided that the size of the break fees was unlikely to impede competition for control of Ausdoc, despite the fee exceeding the panel's benchmark of 1% of the bid's value.The panel took the following factors into account when reaching its decision:
- The break fee arrangements were agreed at the end of a long public tender process, which was conducted by Ausdoc in an attempt to find a buyer for all or part of the company.
- As a result of the tender process Ausdoc reasonably apprehended that other potential bidders were unlikley to emerge.
- The break fee was not so high as to be anti-competetive if another bidder did emerge.
- The costs facing any bidder would be high regardless of the break fee, because of the complexity of the Ausdoc business.
- ABN AMRO would not have proceeded with the tender process unless Ausdoc agreed to enter into the break fee arrangements, meaning that Ausdoc might have ended up with no potential bidders at the end of the tender process.
ABN AMRO submitted and the panel accepted that the quantum of the break fees was no more than was necessary to reimburse ABN AMRO for the actual costs it had reasonably incurred in its takeover bid.
The aspect of the break fee arrangement that the panel found unacceptable was the so-called '90% break fee'. This required Ausdoc to pay A$2.5 million to ABN AMRO if ABN AMRO proceeded with its bid and no higher bid was made, but ABN AMRO's defeating condition requiring 90% acceptances was not satisfied or waived.
The panel considered that the 90% break fee may have had the effect of coercing shareholders into accepting ABN AMRO's bid even where they did not believe the bid to be in their best interests. The panel considered that a 90% break fee could be distinguished from other types of break fees because the cost must be borne by the existing shareholders of the target rather than the succesful rival bidder. Ausdoc and ABN AMRO provided undertakings to the panel to the effect that the 90% break fee would not be payable. The panel accepted these undertakings and declined to make a declaration regarding unacceptable circumstances in relation to the 90% break fee.
The decision on the Ausdoc takeover demonstrates the panel's willingness to approve break fees exceeding the 1% guideline in certain circumstances and highlights its reluctance to allow 90% break fees in Australian-based takeovers.
The panel's guidance note and jurisdiction are only limited to the takeover aspect of break fees.
In this regard, a break fee may meet all of the panel's requirements and yet still be unlawful. Some further legal issues relevant to the legality or otherwise of break fees include:
- whether the target directors are fulfilling their duties as directors by, among other things, acting in the best interests of the company as a whole;
- whether the directors, in accordance with their duties as directors, have acted for a proper purpose or some unlawful purpose, such as a desire to entrench themselves or a particular shareholder; and
- whether the agreement to pay and payment of the break fee amounts to prohibited financial assistance under the Corporations Act.
The agreement to a break fee by a target, particularly if there is already another takeover bid in progress, may also be considered to constitute frustrating action on the part of the target (especially in respect of a prior existing bid or potential bid). This may, for example, be the case where the agreement as to a break fee between the target and a bidder may lead to a prior existing bid or potential bid by another party being withdrawn or not proceeding. In certain circumstances, the panel may consider that such frustrating action on the part of a target gives rise to unacceptable circumstances. Accordingly, the break fee may be the subject of orders by the panel including that it not be paid. The panel recently issued a draft guidance note on frustrating action, the issues in relation to which overlap to a certain extent with those arising in connection with break fees and other lock up devices.
The panel does not regard break fees in Australian takeovers as prima facie unacceptable but, in certain circumstances, they may be held to constitute "unacceptable circumstances" and accordingly be the subject of orders by the panel, including that they not be paid. The panel has set out some guidelines that it will take into account when assessing the reasonableness of a break fee. However, it is clear that the panel will adopt what it sees as a commercial case-by-case approach and deviate from its guidelines where it feels necessary. Accordingly, a company wishing to include a break fee as part of a takeover bid finds itself in the unenviable position that the legality and/or enforceability of such a fee may not be entirely clear. Further decisions from the panel on this subject will be welcomed by takeover professionals, as they will provide further practical examples of the panel's views in this area.
It is arguable that the panel had the benefit of two somewhat extreme sets of facts, which were easy to decide in the two cases which have so far come before it.
To the extent that the relevant consideration in assessing whether a break fee constitutes unacceptable circumstances, and is accordingly subject to orders by the panel, is whether the break fee inhibits the competition for control of the target, the objector has a difficult evidentiary burden in proving that a rival bidder was deterred. In this regard, and contrary to the panel's approach at present, it may be preferable that consideration as to the reasonableness of the size of a break fee be independent of whether there is a rival bidder.
Further, the panel's departure from the 1% guideline in its decision on the Normandy and Ausdoc takeovers may well encourage 'white knight' counter bidders to seek substantial break fees from target companies.
For further information on this topic please contact Danny Simmons, Linda Morris or Lance Sacks at Atanaskovic Hartnell by telephone (+61 2 9777 7000) or by fax (+61 2 9777 8777) or by email ([email protected], [email protected] or [email protected]). The Atanaskovic Hartnell website can be accessed at www.ah.com.au.