Select Major M&A Transactions
Framework of an M&A Transaction
Significance of the Due Diligence Review
Structuring a Transaction
Defences against Hostile Takeover Attempts
The year 2000 proved a high-water mark for global M&A activity. The figures were impressive: 37,000 transactions representing €3.5 trillion, an increase of 5.5% over 1999's record-breaking figures. One of the most significant transactions was the Mannesmann/Vodafone merger, the first successful hostile takeover of a publicly held German stock corporation.
The following year saw a sharp decline in worldwide M&A activity (just over 29,000 deals valued at €1.75 trillion). Although there was still no shortage of transactions, deal value was considerably lower than in 2000. Moreover, there was a greater number of announced but ultimately failed deals (eg, GE/Honeywell) as a consequence of tougher merger control reviews in Europe and the United States. While the events of September 11 had a negative impact on the markets, there had already been some indications of a downturn in the latter half of 2001, caused by an almost unprecedented drop in share prices worldwide, notably in the technology/telecommunications sector. The terrorist attacks in New York merely accelerated this negative trend. Worldwide M&A has been hit further by the US financial accounting crisis triggered by Enron, Tyco, Global Crossing and Worldcom.
In 2001 Europe witnessed almost 12,000 transactions with a combined value of some €620 billion. While the United Kingdom remained the leading market in Europe, Germany took second spot with 1,500 deals and a combined value of some €89 billion. The most active sector was financial services, followed by media/publishing and energy. Other notable sectors included telecommunications and general industrial.
In the first part of 2002 the downturn in M&A activity continued. Third-quarter figures show that M&A business has plummeted by 25% in Europe (compared with 2001). However, this worldwide downturn has given Europe a growing share of the global M&A market, rising 5% to 37%. Once again, Germany has taken second place behind the United Kingdom.
The following legal developments in Germany in 2001 and 2002 are noteworthy within the framework of M&A transactions:
- The tax reform acts became effective in 2001 and 2002, providing for a significant reduction in corporate tax rates, an annual reduction in the progressive income tax rates for individuals until 2005, and the abolition of the complex imputation system (which integrated corporate tax with income tax by virtue of a tax credit at shareholder level). The new full or partial exemption for capital gains from the sale of stock became effective on January 1 2002. In general, a parent corporation may sell shares in its corporate subsidiaries tax free. However, this rule is subject to important limitations, the scope of which remains to be determined by the German tax administration. In addition, the tax reform acts changed significantly the tax treatment of the acquirer's financing costs.
- The new Act on the Acquisition of Securities and on Takeovers became effective on January 1 2002, creating for the first time an enforceable procedural framework for takeovers of publicly held corporations in Germany. This act raises numerous new legal issues which are beyond the scope of this Overview.
- New provisions concerning the squeeze-out of minority shareholders of stock corporations became effective on January 1 2002, permitting a majority shareholder owning at least 95% of a company's shares to acquire the outstanding shares in in exchange for fair market value.
- The new German Corporate Governance Code became effective on January 1 2002, providing for new rules relating to the governance of listed companies.
- The Act on Enhanced Disclosure and Corporate Governance Rules of Stock Corporations became effective in July 2002. The rules aim (i) to facilitate communication among German stock corporations and their investors; (ii) to improve the rules concerning financial accounting and financial disclosures; (iii) to bring general German corporate practice closer into line with the expectations of the international capital markets; and (iv) to increase the effectiveness of the German dual-board structure.
- Amendments to the Civil Code relating to the law of obligations became effective on January 1 2002, modernizing the entire law of obligations and providing for new rules with respect to representations and warranties. In particular, the impact of the new Section 444 on M&A transactions remains to be determined.
Some of the most important recent M&A transactions from a German perspective are listed in the table below.
|Financial services||Allianz's takeover of Dresdner Bank||€ 25 billion|
|Merger of HypoVereinsbank and Bank Austria||€ 7.5 billion|
|Merger of the mortgage banks of Deutsche Bank, Dresdner Bank and Commerzbank||€ 6.9 billion|
|Deutsche Bank's acquisition of Zurich Scudder and sale of Deutscher Herold||€ 3.7 billion|
|Bertelsmann's acquisition of RTL Group||€ 7.5 billion|
|The acquisition of broadband cable assets of Deutsche Telekom by investors||€ 5.5 billion|
|Energy||E.on's acquisition of PowerGen||€ 17.6 billion|
|RWE's acquisition of Thames Water||€ 9 billion|
|RAG's takeover of Degussa||€ 8.4 billion|
|RWE's acquisition of Innogy||€ 8.4 billion|
|Telecommunications||Deutsche Telekom's acquisition of Voicestream||€ 29.3 billion|
|Other industrial||Imperial Tobacco's acquisition of Reemtsma Cigarettenfabriken||€ 6.8 billion|
|Goldman Sachs' acquisition of Messer Griesheim||€ 2.6 billion|
|KKR's acquisition of seven business units of Siemens||€ 1.7 billion|
Framework of an M&A Transaction
In a private M&A transaction initiated by the buyer the procedure is fairly standardized by market practice. Once a suitable target has been found, sometimes with the assistance of an investment bank, a willingness to cooperate is determined in initial talks and the terms of the deal are roughly spelled out in a legally non-binding letter of intent (or so-called 'heads of agreement'). At the same time, both the acquirer and the target usually enter into a confidentiality agreement. Subsequently, the acquirer conducts its due diligence review of the target. The results of the due diligence provide the factual basis for the subsequent contract negotiations.
In contrast, if the initiative is taken by the seller the procedure is different. First, an investment bank is asked to describe in detail the subsidiary or division to be sold in an offering memorandum, emphasizing the benefits for potential buyers identified by the investment bank. Thereafter, the offering memorandum is sent to the potential buyers, together with a request to submit a (non-binding) offer on the basis of the offering memorandum.
After receiving a number of non-binding bids the investment bank, together with the seller, organizes an auction. At this point the documents for the due diligence are made available in a so-called 'data room'. In most cases there is also a presentation by the target's management. Finally, the seller often provides a draft of the purchase agreement. The due diligence review, the presentation by management and the draft of the purchase agreement are intended to enable the potential buyers to submit binding offers. The seller then compares the offers, usually with the help of both the investment bank and the legal advisers. Only those potential buyers which have submitted the most attractive offers, both commercially and legally, reach the next round. The sale and transfer agreement is ultimately signed with the buyer which makes the most attractive offer, both with regard to the offered price and the terms and conditions.
In the case of publicly listed companies - that is, in relation to cross-border 'mergers of equals' - mutual high-level due diligence reviews are conducted before or after the signing of a basic agreement on the different steps to be taken during the course of the merger (these agreements are known as 'business combination agreements'). The scope and depth of the due diligence reviews essentially depend on the size of the companies involved and the time available. Moreover, the entire transaction, or certain steps therein, might require shareholder approval.
Significance of the Due Diligence Review
At the heart of an acquisition is due diligence. Its core function is to enable the buyer to value the target properly and so avoid paying an excessive purchase price. Most valuation models are built upon four factors:
- future cash-flow;
- assets used to generate the cash-flow;
- risks associated with the future cash-flow and the assets; and
- control over the cash-flow and the assets.
The facts and circumstances related to these four factors must be established through an intricate and comprehensive due diligence process.
Although there is no accepted market practice as to how to conduct a due diligence review, some standards have been established. Thus, the following are generally the subject of special reviews:
- the company's economic position in the market (commercial due diligence);
- the company's accounting (financial due diligence);
- the company's legal environment (legal due diligence);
- the company's tax situation (tax due diligence); and
- the company's real estate (environmental due diligence).
Environmental due diligence in particular has become increasingly important in recent years, as the new Federal Ground Protection Act has created significant liability risks for buyers.
Another reason for conducting due diligence is the German statutory contract law relating to warranties in sales contracts. In principle, these rules are designed for standard (consumer) asset sales; they are not primarily aimed at the acquisition of an entire business. As a consequence, these rules are inappropriate for M&A transactions, irrespective of whether the deal is structured as an asset or a share deal. In particular, the application of these asset sales rules in the case of share deals is subject to uncertainty.
For these reasons, the buyer and seller generally deal comprehensively in the purchase agreement with the representations and warranties. The results of the due diligence should therefore be taken into account in the agreement, in the form of specific representations and warranties and specific exceptions thereto (so-called 'disclosure schedules'). The legal consequences of breaches of warranties are also spelled out in the purchase agreement. Typically, any reduction of the purchase price and any rescission rights are excluded. In addition, a well-drafted purchase agreement will contain detailed provisions on both the time-barring of actions for damages and the computation of such damages. However, in view of the new Section 444 of the Civil Code, which was introduced on January 1 2002 following the code's reform, the extent to which the seller may limit its representations and warranties by thresholds and caps is not fully clear.
Confidentiality is always an important issue in M&A transactions. For instance, a number of problems arise from the fact that the participants in due diligence include not only the buyer and seller, but also third parties called in by the buyer or seller, such as lawyers, accountants and consultants. Adequate precautionary measures must therefore be taken to ensure the continued confidentiality of the data and the imposition of meaningful sanctions for violations of confidentiality.
Moreover, the buyer and target are often direct competitors, or at least operate in closely related sectors. This raises the question of whether - and if so, under what circumstances - the target's management should allow a potential buyer due diligence, and what precautionary measures the target's management board should take against any unintended use of the information obtained by the prospective buyer should the deal ultimately collapse.
In German practice, these issues arose in connection with BHF Bank's proposed sale of a major shareholding. The bank intended to sell its controlling interest in AGIV AG to Metallgesellschaft. However, AGIV's management board halted the due diligence which Metallgesellschaft began for this purpose after learning that Metallgesellschaft was intending to break up important divisions of AGIV. Although the acquisition failed as a result of this problem, no judicial ruling was obtained by any party as to whether the conduct of AGIV's management board was in accordance with the rules of the German Stock Corporation Act.
The legal debate on this issue centres on the proper interpretation of the statutory obligation of the target's management board to keep sensitive corporate data strictly confidential. If the management board negligently violates its duty of confidentiality, each director may be personally liable for any damages directly or indirectly caused by the due diligence. Some commentators and practitioners believe that the target's management board may allow due diligence only within narrow limits, for example if the company's survival is in jeopardy. Others suggest that due diligence must be permitted as long as the target's interests are properly safeguarded, in particular by carefully considering all the benefits and the disadvantages associated with the conduct of the due diligence, and by agreeing on confidentiality. No prevailing opinion has emerged. As a result, careful consideration is necessary to protect the target's board members against personal liability.
After the due diligence, the buyer and seller must decide whether to proceed with the transaction and how to structure it properly. Various considerations are pertinent, a few of which are discussed below by way of example.
In structuring a private acquisition, the two main issues to resolve are (i) whether to structure the deal as an asset or a share deal, and (ii) whether to pay cash or shares as consideration. If the target is a publicly traded corporation, the impact of the newly enacted Acquisitions and Takeovers Act on any contemplated acquisition structure must be considered.
Where the acquirer is a stock corporation, the Federal Supreme Court has significantly relaxed the legal rules so that it is easier to use its shares as consideration. In principle, the corporate law problem is that under the German Stock Corporation Act, the acquirer's shareholders have a statutory subscription right to any newly issued shares. This statutory subscription right must thus be abandoned to enable the acquirer to deliver the new shares to the target's shareholders. Under old case law, the difficulties of excluding the statutory subscription right proved insurmountable in most cases. The Federal Supreme Court therefore reviewed its position and took a more practical stance. If the target of a share-for-share deal is publicly traded, the new Section 31 of the Acquisitions and Takeovers Act provides important additional rules relating to use of the acquirer's shares as consideration (eg, the offer document must contain detailed information about the acquirer, so that the target shareholders can value the shares offered to them).
Another important goal in structuring a transaction is to avoid any delays caused by the actions of minority shareholders. 'Predatory' shareholders' actions are still a significant transactional problem in Germany. The high-profile Thyssen/Krupp merger showed once again that shareholders with an insignificant number of shares can nonetheless delay a merger by commencing an action to have the merger resolution set aside. A special fast-track procedure available under Section 16 of the Reorganization Act goes some way towards mitigating this problem. This provision empowers the trial court, in the case of an action against a merger resolution, to order that the necessary entries in the commercial register may be made despite the pending shareholder action. However, the court can only make such an order, allowing the merger to go ahead, if (i) the action against the merger resolution is inadmissible or manifestly unfounded, or (ii) the court determines, at its discretion, that the avoidance of substantial disadvantages for the participating companies and their shareholders outweigh any (alleged) violations of minority shareholder rights claimed by the plaintiffs.
With regard to post-acquisition/post-merger restructurings, the problem of predatory shareholders has been substantially mitigated by new rules relating to the squeeze-out of minority shareholders. Under these provisions, an acquirer holding at least 95% of the target's shares may squeeze out the remaining shareholders for a fair market value consideration in cash.
In structuring an M&A transaction tax issues are of paramount importance, as tax liabilities triggered by the acquisition (or the post-acquisition restructuring) result in an immediate cash outflow.
Reforms to the German corporate tax regime have completely overhauled the tax framework for M&A transactions. In general, a parent corporation may sell the shares of its corporate subsidiary tax free, and dividends can be paid within the corporate group without triggering any corporate tax. However, these new rules might well change again under the new government elected in September 2002. If a widely held parent corporation is the target, German individuals as shareholders will benefit from the so-called 'half-income' system, which excludes half of the capital gains realized through the sale of their shares from taxable income, thereby integrating the corporate and income tax. Conversely, losses from the sale of corporate subsidiaries cannot be used against the tax liability of a target parent corporation.
Tax treatment for the acquirer has become far less favourable. First, all commonly used step-up models (which essentially transform a less tax-efficient share deal into a tax-efficient asset deal) have been eliminated. Second, the financing costs of an acquisition are generally not tax deductible for corporate tax purposes. To make financing costs tax deductible for German tax purposes, careful tax planning is thus required. Third, the important safe havens in the cross-border earning stripping rules have been tightened (very important in cross-border leveraged buy-out deals). Fourth, preservation of the target's net operating losses has become more difficult following a recent Federal Tax Court ruling.
The avoidance of real estate transfer tax is also a hot tax issue. In 2000 the legislature significantly broadened the scope of this tax by including certain indirect stock and partnership-interest transfers as taxable transactions. As a result of these statutory amendments, the acquisition of the shares of a widely held parent corporation may trigger real estate transfer tax even if only a sixth-tier corporate subsidiary owns German real estate. Most importantly, the tax can be triggered multiple times in an acquisition, given that the statute does not provide for an exemption for intra-group restructurings. This can easily result in a huge immediate cash-outflow.
Defences against Hostile Takeover Attempts
If the management board of a widely held target and an interested acquirer cannot agree on a friendly acquisition (ie, an acquisition with the full support of the target's management and supervisory boards), the acquirer must consider the possibility of a hostile bid. Hostile takeovers can be successful even in very large transactions in Germany, as the hostile takeover of Mannesmann by (aggressive) Vodafone has demonstrated. Therefore, the option of a hostile takeover of a widely held target should not be ruled out.
If the acquirer can safely value the target despite limited access to its sensitive corporate data, the success of a hostile bid depends largely on whether the target's management board can take defensive measures against a hostile bid. This issue is at the centre of a heated legal dispute in Germany (and in Europe). The first question is whether, from an economic perspective, hostile bids should be encouraged and therefore facilitated by legal rules. The second is how to coordinate (international) capital market rules and (local) corporate law rules (eg, the European Court of Justice's recent ruling on golden shares). The third question is in whose interest the target's management board should act (this question seems to be open in Germany). Finally, the fourth question is how corporate power should be allocated between the management board and the shareholders (the leading cases are Holzmüller and Altana/Milupa).
The new Section 33 of the Acquisitions and Takeovers Act expressly considers the reaction of the target's management board to a friendly or hostile bid. In general, the target management must not take any action that might thwart the bid. In addition, both the management and supervisory boards must issue, in a timely manner, written statements (or a joint statement) providing arguments in favour of or against the bid. However, this basic rule is subject to certain exceptions, the scope of which remains to be determined.
According to most commentators and practitioners, the target's management has few defensive opportunities available once a hostile bid has been launched. The most important permissible defence is the search for a 'white knight', as this is considered as a search for a (higher) competing bid and is thus generally encouraged by the new Acquisitions and Takeovers Act as for the benefit of the target's shareholders. In addition, with the consent of the supervisory board, the target's management may have some further options available. Before any hostile bid is launched, the target's shareholders may also give the management board advance authorization to take a wide range of defensive measures, although the legal limits of these precautionary measures should be discussed with a legal adviser on a case-by-case basis. This authorization cannot be granted for a period of more than 18 months. So far, no case involving such a resolution has been reported.
In German practice, workers' co-determination and the (often staggered) dual-board structure are highly effective defences created by statutory law. These peculiarities of German law make hostile bids more difficult in Germany than in other markets.
A cross-border acquisition creates additional legal problems. If the transaction involves high-profile corporations, it can also become a highly political issue (eg, the failed merger of the London and Frankfurt Stock Exchanges).
In general, German corporate reorganization rules do not allow cross-border mergers (although the European Union has adopted a directive dealing with cross-border mergers within the European Union from an income tax point of view). Therefore, from a German corporate and tax perspective, there are no special rules designed for cross-border business combinations. General principles must thus be used creatively to make cross-border mergers possible.
The most disputed question in a cross-border 'merger of equals' is the matter of who should acquire whom. The answer to this question depends on issues such as:
- taxation of unrealized built-in gains;
- tax rates;
- taxation of dividends;
- inclusion in leading stock indices;
- listing requirements of stock exchanges;
- corporate governance regimes; and
- the political sensitivity of the transaction in the countries of the corporations involved.
From a structural point of view, numerous transactional schemes must be considered, such as share-for-share deals, cash-acquisitions, 'newco' structures, dual-headed structures and tracking stock structures.
The newco structure has become the most important structure in the case of mergers of equals. Under this structure, a newco is set up and the shares of the merging corporations are contributed to newco in exchange for newly issued newco shares. Newco thus becomes a new 'holdco', with the two merging corporations as first-tier subsidiaries. Finally, newco is renamed. This structure was used in the merger of Germany's Daimler-Benz AG and the US Chrysler Corporation. The advantage of this structure is that it can be achieved (largely) tax free in many countries (as most countries provide rules for tax-free incorporations), and the idea of a 'merger of equals' is reflected in the merger structure, as neither merging corporation is technically the target. However, the details of this structure can be very complicated and can thus present many traps for the unwary. For instance, if care is not taken, employment benefit schemes can be triggered on the level of both merging corporations (instead of solely on the level of the target corporation). Moreover, the treatment of newco shares with respect to the new Section 31 of the Acquisitions and Takeovers Act is not fully clear. In addition, the (dual) listing of the newly issued newco shares can be a complex problem. Finally, a 'merger of equals' never exists in practice, as the Daimler/Chrysler merger has shown. Ultimately, it will always be a takeover.
In a dual-headed (or dual-listed) structure, the corporations only merge virtually (ie, economically). From a legal point of view, they remain independent corporations. Such a virtual merger can be achieved either by dropping the two operating businesses into a newly created joint-venture vehicle, or by entering into a horizontal equalization agreement. This complex structure allows both corporations to remain in their leading local stock indices, such as Standard & Poor's (S&P), the Dow Jones, the Financial Times Stock Exchange or DAX (Deutscher Aktienindex). For instance, under a dual-headed structure Chrysler would have stayed in the S&P 500. This would have prevented the massive divestitures of US investment funds which occurred after the consummation of the Daimler/Chrysler deal. These sales put severe pressure on the stock price of newly formed Daimler/Chrysler, bringing Daimler's German management under intense public scrutiny. However, the disadvantage of the dual-headed structure is that day-to-day operations after the (virtual) merger can be negatively affected by a highly complex corporate governance structure.
With respect to large cross-border transactions, the issue of antitrust clearance as a closing condition has become increasingly important. The core transactional challenge is that numerous antitrust authorities in different countries are involved in these large international transactions. Thus, multiple pre-closing filings and clearances must be completed. Experienced legal advisers should be retained to handle these intricate and time-consuming antitrust procedures. From a substantive law perspective, negotiation strategies should be developed with respect to the different antitrust authorities. In particular, the US and European antitrust authorities have different standards of review, as displayed by the failure of the proposed GE/Honeywell merger. As a result, antitrust issues must be identified and addressed as early as possible.
Although media attention focuses on transactions involving stock corporations, private M&A deals between companies which are not stock corporations still account for the lion's share in Germany.
Lawyers handling M&A transactions often face complex and unexpected problems. The core challenge is to provide commercially and legally suitable structures to the companies involved. In addition, high-quality transactional management of complex cross-border acquisitions is a trademark of well-trained and experienced M&A lawyers.
For further information please contact Oleg de Lousanoff at Hengeler Mueller by telephone (+49 69 17 09 50) or by fax (+49 69 72 57 73) or by email ([email protected]). The Hengeler Mueller website can be accessed at www.hengeler.com.