Squeeze-out options under Swiss law
Recent legal action
There are several reasons for launching a public takeover bid in order to acquire another company and the different parties involved may have different interests and objectives. For example, an offeror may wish to take complete control of a target with a view to integrating the target fully into its organisational group structure in order to reduce costs. Conversely, an offeror may want only to control a target, which can be accomplished by holding more than 50% of the voting rights, as this will allow it to control the composition of the target's board of directors. However, in targets with an atomised shareholder base and low attendance rates at shareholder meetings, it may be possible to achieve effective control with a smaller share of the voting rights – which is reflected in the fact that a mandatory public offer is triggered at the lower threshold of 33.3% of the outstanding shares.
An offeror's influence increases when it holds more than two-thirds of the voting rights, as it can not only influence, but also control any resolutions which require a qualified quorum under Article 704 of the Code of Obligations. However, significant barriers remain, such as the principles of Article 717 of the code, whereby a company must be led in consideration of its own interests and all shareholders must be treated equally. Additionally, minority shareholder rights must be taken into account, which may reduce the offeror's ability to integrate the target completely into its organisational group structure. Therefore, it may be in the offeror's interest to control 100% of the outstanding equity.
An offeror is not permitted to make a successful takeover bid which stipulates that all or an unreasonably high percentage of shareholders (eg, 90% or even 98%) must tender their shares. Therefore, after the settlement of many takeover bids, there are minority shareholders which have opted not to tender their shares, and thus remain shareholders of the target. To avoid restrictions stemming from corporate law forcing a new majority shareholder to take the interests of minority shareholders into account, an offeror will have to take a different route in order to end up holding 100% of the voting rights. According to Swiss law, an offeror has two options to exclude or 'squeeze out' minority shareholders after a public takeover bid.
Squeeze-out options under Swiss law
Article 33 of the Stock Exchanges and Securities Trading Act
The first option is to cancel all outstanding equity securities according to Article 33 of the Stock Exchanges and Securities Trading Act, whereby an offeror must hold more than 98% of the voting rights of the target. The target must be a Swiss company whose equity securities are, in whole or in part, listed on an exchange in Switzerland (Article 2(e)). The offeror must petition a court within three months following the close of the tender offer in order to cancel outstanding equity securities. The equity securities must be re-issued by the target and allotted to the offeror, either against payment of the offer price or fulfilment of the exchange offer in favour of the holders of the equity securities which have been cancelled. Examples of squeeze-outs pursuant to the Stock Exchanges and Securities Trading Act are the takeover of Swiss International Air Lines Ltd by Lufthansa and the Almea Foundation, and the takeover of Schulthess Group AG by NIBE Industrier AG.
Article 8 of the Merger Act
The second option to squeeze out minority shareholders is set out in the Merger Act: if the acquiring entity holds more than 90% of the voting rights, it can enforce a squeeze-out merger, whereby minority shareholders receive a compensation payment by the acquiring entity rather than shares in the acquiring entity, as would be the case in an ordinary merger. A squeeze-out merger was successfully implemented in the takeovers of Eichhof Holding AG by Heineken Switzerland AG, and BB Medtech AG by Vontobel Beteiligungen AG.
The procedure of a squeeze-out merger pursuant to the Merger Act is as follows. The board of directors of the acquiring and transferring entity enters into a written merger agreement. The acquiring party indicates the amount of compensation that is to be paid to the transferring entity's minority shareholders. The compensation can either consist of cash or listed tradable securities (eg, shares in the acquiring entity's parent company).
Thereafter, a merger report is prepared for the attention of shareholders; this report must mention the amount of compensation to be paid to the transferring entity's minority shareholders and detail why only compensation is provided instead of membership rights. The merger agreement, report and balance sheet are reviewed by an accredited audit expert; the audit report must confirm that the cash compensation on offer is reasonable. After the shareholders have had a chance to inspect the merger documents during a 30-day period, the shareholders' meeting approves the merger agreement; 90% of the shares of the transferring entity which are entitled to vote must approve the agreement. The resolution regarding the approval of the merger agreement must be in the form of a public deed. Thereafter, the board of directors of the merging companies register the merger with the respective commercial registry.
Minority shareholders have two legal remedies. One option is to file a claim for appropriate compensation under Article 105 of the Merger Act. In this circumstance, a court will verify whether the compensation offered to the minority shareholders in the merger agreement is equal to the fair value of the shares of the absorbed entity and, to the extent necessary, adjust such compensation.
Additionally, shareholders which did not approve the merger resolution can challenge the resolution within two months of its publication in the Official Commercial Gazette, if the provisions of the Merger Act (other than relating to fair compensation) were breached. Furthermore, as a provisional measure, a shareholder may, as long as the merger has not been registered, request a court to prohibit registration of the merger with the relevant commercial registry,(1) pending the court's decision about the alleged violations of the Merger Act.
Relationship between squeeze-out mergers under the two acts
Since the threshold in squeeze-out mergers under the Merger Act is lower than in the squeeze-out procedure contained in Article 33 of the Stock Exchanges and Securities Trading Act, the role of squeeze-out mergers in takeover transactions is significant.
According to prevailing doctrine, a squeeze-out merger under the Merger Act is an alternative to the squeeze-out procedure contained in Article 33 of the Stock Exchanges and Securities Trading Act. However, according to secondary doctrine, the squeeze-out procedure under Article 33 of the Stock Exchanges and Securities Trading Act is lex specialis (ie, the main shareholders may not exclude minority shareholders according to the Merger Act if the 98% threshold is not achieved).
Recent legal action
In a recent case, the Supreme Court had to clarify certain questions relating to a squeeze-out merger following a successful public takeover bid which was subsequently challenged under Article 105 of the Merger Act.
Three major shareholders sold their shares in Gornergrat Bahn AG to BVZ Holding AG on May 17 2005; consequently, BVZ held 44.3% of the share capital in Gornergrat. On July 4 2005 BVZ launched a public takeover/exchange offer regarding the publicly held bearer shares, offering three registered BVZ shares with a nominal value of Sfr100 and Sfr250 in cash for each Gornergrat bearer share. After the execution of the offer, BVZ held 95% of the share capital and voting rights in Gornergrat.
On September 9 2005 BVZ, Gornergrat and Matterhorn Gotthard Bahn Tours AG, a fully controlled subsidiary of BVZ, concluded a merger agreement whereby Matterhorn agreed to absorb Gornergrat. The merger agreement provided that BVZ was obliged to pay as compensation to Gornergrat's minority shareholders three registered BVZ shares and Sfr250 in cash for each Gornergrat bearer share (ie, the same consideration as offered in the public offer). Additionally, Matterhorn changed its firm name to Gornergrat Bahn AG. On October 20 2005 the merger agreement was approved at a shareholders' meeting.
On December 22 2005 two minority shareholders lodged a complaint with the district court, demanding that the new Gornergrat Bahn pay all the minority shareholders which had lost their position as shareholders of the new company due to the merger appropriate compensation to be determined by the court. They claimed primarily that the valuation reports used as a basis to determine the compensation given to the minority shareholders were incorrect and asked that the valuation be reviewed and amended by a court-appointed external valuation expert. The district court allowed the minority shareholders' request and had the valuation reviewed by external experts.
In their report the court-appointed experts pointed out that the market risk or equity premium to be included in the discount rate used in the valuation should have been determined by using geometric means – which would have led to a lower market risk or equity premium and, thus, to a higher valuation for the absorbed company – rather than the arithmetic means used by the parties to the merger and their valuation experts.
Since, however, valuation practitioners often use arithmetic means rather than geometric means to determine the market risk premium, the court-appointed valuation experts considered this approach not to be arbitrary, and thus still appropriate. Based on the court-appointed experts' opinion confirming that the compensation was not to be considered inappropriate, the district court rejected the minority shareholders' complaint. Hereafter, the two minority shareholders lodged an appeal to the appellate court, which also rejected the claim. The two minority shareholders then filed an appeal to the Supreme Court.(2)
According to the Merger Act, a transferring legal entity's shareholders are entitled to equity and membership rights in the acquiring legal entity which is on par with their former equity rights. However, a merger agreement can also provide for a choice between cash compensation, or equity or membership rights or it can stipulate that the transferring entity's minority shareholders are entitled to only a compensation payment irrespective of the type of compensation, the fair value of the legal entities involved in the merger, the allotment of voting rights or any other relevant circumstances.
Independent of the actual offered consideration (ie, shares only, a choice between shares or cash or cash only), minority shareholders are entitled, under Article 105 of the Merger Act, to have the competent court review the consideration on offer. In the case at hand, the two minority shareholders exercised this right, as they felt that the compensation payment on offer was inadequate and therefore asked the competent court to determine an adequate compensation payment.
The two minority shareholders were unsuccessful before the district and appellate courts; thus, the Supreme Court had to determine whether the compensation payment was adequate – that is, whether the compensation was equivalent to the real or fair value of the minority shareholders' previous equity rights.(3) Therefore, the previous equity rights were analysed, whereby the Supreme Court confirmed that, based on the constitutional guarantee of property rights, the minority shareholders were entitled to receive compensation that equalled the fair value of the shares that they had held in the transferring entity, and held that the going-concern-value (which is calculated based on a valuation of the future earnings of the company, combined with an actual asset valuation) was decisive.
Numerous methods may be applied to calculate the going-concern value. Therefore, merging companies have a wide margin of discretion in choosing the valuation method, as well as the evaluation of the relevant circumstances. Compensation is inadequate when this discretionary margin is exceeded (ie, when compensation is based on incorrect or incomplete factual assumptions or unusual valuation principles and/or when recognised methods are not applied or applied incorrectly).
In order to evaluate the use of a particular valuation method, courts usually rely on legal experts, and thus a judge must review whether:
- the expert used a method that is comprehensible, plausible and recognised;
- the method has been used in similar cases;
- the method is better or as successful as other methods; and
- the method takes the individual case into consideration.
In the case at hand, the Supreme Court had no reason to question the method used by the legal experts; it considered the choice of method to calculate the market risk or equity premium to be within the discretion of the valuation experts and, thus, concluded that the payment was adequate.
Additionally, the Supreme Court had to determine whether Article 105(3) of the Merger Act regarding the allocation of costs to the acquiring entity applied to these proceedings.(4) An acquiring party is obliged to cover the cost of the proceedings in order to allow shareholders to lodge appeals regarding compensation payments when they have legitimate reasons to do so without the proceedings costs being prohibitive. The Supreme Court concluded that it is difficult for a party to anticipate whether it has any chance of winning a case in the first instance. Therefore, the cost of proceedings may be prohibitive, and thus the acquiring party is obliged to cover the costs.
However, the outcome of proceedings before the Supreme Court is more predictable. Furthermore, costs are lower in general, as there are usually few costs with regards to filing evidence. In particular, the cost of proceedings before the Supreme Court is not considered prohibitive when the complainant has significant financial interests of its own in the proceedings and, thus, no discrepancy between the risk of bearing the proceedings costs and the financial chance of success exists. Therefore, the cost of proceedings is distributed depending on the success of a party in the proceedings and the acquiring entity is not necessarily obliged to cover the costs.
As already mentioned, the Merger Act allows exceptions to the strict principle that all shareholders of a transferring entity must become shareholders of the acquiring entity (the so-called principle of continuity of membership) in two ways:
- The merger agreement can provide that the transferring entity's shareholders – but not the acquiring entity – may choose between a compensation in the form of cash or equity or membership rights of the acquiring entity (or another group company, for example, the acquiring company's parent); and
- The merger agreement can provide that the transferring entity's minority shareholders are entitled only to a compensation payment (or shares of another group company, eg, the acquiring company's parent), but not to shares of the acquiring company.(5)
Minority shareholders have an appraisal remedy – the right to have the consideration offered to them under the merger agreement – whether that be shares only, a choice between shares or cash or cash only (or shares of a third company) – reviewed by the competent court. In cases where minority shareholders are entitled to cash only (ie, they cannot choose to obtain shares in the acquiring company or its parent), they cannot participate in a future upside of the combined entity, and thus it is probably even more crucial that the amount offered as compensation be within a range that is considered to reflect fair value.
Conversely, the Supreme Court underlined that the most important element in determining fair value is the assessment, estimation and valuation of the company's projected future earnings. Since such an assessment and estimate of future earnings is, by its very nature, strongly dependent on the assessment and views of the company's management and business plans prepared by the management, it is impossible to formulate a completely objective valuation of a company.
In the case at hand, the merger was structured as a triangular merger – that is, the minority shareholders received shares of the acquiring company's parent, and thus were able to participate partially in the transferring company's future earnings. In addition, the minority shareholders received the same consideration as the other shareholders in the public offer. The public offer was accompanied by detailed valuation reports for both the transferring company and the offerer (prepared by a reputable accounting firm); based on these valuation reports, the offer was accepted by the majority of the transferring company's shareholders, which obviously considered the compensation being offered as reasonably fair.
It seems that the Supreme Court took a rather lenient approach when reviewing the valuation reports. Valuation reports prepared for a public offer for both the target and the offeror must be submitted to the Takeover Board for review and must measure up to the board's stringent requirements – particularly with regards to comprehensiveness and the degree of detail published.
In particular, the Takeover Board requires that valuation methods and information be explained in the valuation report in detail (eg, discount rates, comparable transactions, historical stock price analysis, horizon and basis for projections), as well as their sources and/or derivation for both the offeror's valuation reports and the target company's fairness opinions. Consequently, it can be questioned whether the district court's decision to appoint valuation experts to review the external valuation experts' report which had already been reviewed and considered compliant by the Takeover Board(6) was correct or whether the district court should have itself reviewed the pre-approved valuation report. Such an approach could have allowed the court to accelerate the procedure considerably, reduce costs substantially and focus on the points in the valuation report claimed by the minority shareholders to be flawed or imprecise.
A court should commission an additional valuation report by a court-appointed expert only once it concludes that the valuation report prepared for a public offer and reviewed by the Takeover Board:
- lacks objectivity;
- is based on incorrect or incomplete factual assumptions or unusual valuation principles; or
- does not apply recognised methods (or applies them incorrectly).
Unfortunately, the Supreme Court's decision did not explicitly address or discuss this particular issue with reference to squeeze-out mergers following public offers for which detailed valuation reports for both the transferring company and the offerer had been prepared. It is hoped that the Supreme Court has another opportunity to clarify this point further and provide further guidance. Conversely, the situation is different if no public offer preceded the squeeze-out merger and the shareholders did not have full access to any expert valuation report(s) used by the two merging companies to fix the exchange ratio and the compensation to be paid to minority shareholders.(7)
The disadvantages of a squeeze out under the Merger Act (ie, the possibility of shareholders to have compensation payments reviewed by the competent court, thereby prolonging the final settlement of the consideration to be paid) remain. However, it is relatively difficult for minority shareholders to challenge the amount of compensation to be paid, as the offeror and target have – as explicitly stated by the Supreme Court – a wide margin of discretion. As a result, when a valuation report is required under Article 40(4) of the Financial Market Supervisory Authority's ordinance on stock exchanges and securities trading – that is, when the listed equity securities of the target are considered to be illiquid according to the criteria set by the Takeover Board in its circular – and when the target's board has commissioned a fairness opinion confirming the fairness of the offer, it is difficult for minority shareholders to claim that the valuation of the compensation is inappropriate, as both valuation reports must meet the Takeover Board's strict requirements regarding transparency and comprehensibility.
Nonetheless, as confirmed in the case at hand, minority shareholders do have a right to request that a valuation report be reviewed by the competent court and – if the court so decides – by external court-appointed valuation experts, which can lead, as in the case at hand, to a time-consuming and costly court procedure.
The Supreme Court's ruling on the application of Article 105 of the Merger Act regarding costs is welcome, as it was uncertain which party bears the cost of proceedings before the appellate court and the Supreme Court. As a result, there is little room for speculation of which party must bear the costs, and minority shareholders considering appealing a lower court decision must contemplate the cost risks relating to an appeal and, thus, carefully weigh up the benefits and risks of an appeal.
For further information on this topic please contact Alexander Vogel or Debora Kern at Meyerlustenberger Lachenal by telephone (+41 44 396 91 91), fax (+41 44 396 91 92) or email ([email protected] or [email protected]).
(1) As required by Article 162 and following of the Commercial Register Ordinance.
(2) Supreme Court decision of September 20 2011, ATF 137 III 577 and 4A_96/2011.
(3) Supreme Court decision of September 20 2011, 4A_96/2011, consid 5.4 with further reference.
(4) Supreme Court decision of September 20 2011, ATF 137 III 577 and 4A_96/2011, consid 8.4.
(5) See Articles 7 and 8 of the Merger Act.
(6) See recommendation of the Takeover Board re: Gornergrat Bahn AG dated June 28 2005, E 4.2.3.
(7) See in this respect the facts underlying the decision of the Supreme Court in the merger of Rothornbahn & Scalottas AG and Lenzerheide Bergbahnen, 4A_440/2007, February 6 2008.