Often, compliance officers find themselves being dragged into debates about company law, especially at wealth management firms that handle stock for their high-net-worth clients. In the eighth of a series of regulatory columns in Compliance Matters by experts in Guernsey’s legal sector, Mourant Ozannes Partner Abel Lyall and Counsel Alex Davies discuss shareholder activism, which is on the rise in the UK - fuelled by activist investment funds with capital to deploy and a legal framework susceptible to such activism. Given Guernsey corporate law shares many of these features, what is the potential for shareholder activism here?
Activist shareholder campaigns, traditionally a feature of the US corporate environment, have become an increasingly common occurrence outside the US. A recent report by FTI Consulting [Activism Threat Level (Mid-2017 Report)] found that there were 30 shareholder campaigns commenced in the UK during the first half of 2017, more than the amount as for the whole of 2015. The trend is global, although most keenly felt in the UK as well as Australia and Canada.
Indeed, the corporate law framework in the UK is considered to be particularly susceptible to such activism. As Guernsey corporate law shares many of these features, what is the potential for shareholder activism here?
Here we look at the latest trends on shareholder activism and consider what powers such activists might be able to capitalise on in relation to Guernsey companies. We also consider how Guernsey companies might respond to such actions.
What is shareholder activism?
Shareholder activism describes a range of activities undertaken by a company's shareholders intended to cause some change to the behaviour of the company.
As one would expect, the objectives of the activist campaigns vary. FTI reported that the most common types in the UK include seeking the removal of a CEO or other board member (through statutory requisitions), the push for the sale of a company or the making of a distribution to shareholders. Other campaigns have targeted particular events, such as a proposed takeover transaction with a view to obtaining a higher offer price.
In many cases, activist campaigns are led by investment funds specialising in pursuing such opportunities, the so-called 'activist funds'. A recent JP Morgan report [The 2017 Proxy Season: Globalisation and a new normal for shareholder activism (July 2017)] suggests that institutional investors have now also become more engaged in activism, and indeed have partnered with activist funds to pursue increased shareholder value.
There are no statistics on shareholder activism in Guernsey. Anecdotal evidence and experience from recent matters suggests that just as in the UK, investors as well as activist funds are looking at opportunities to extract value from shareholdings in Guernsey listed companies. Given the similarities in the legal framework with the UK, and the fact that there are more Guernsey entities listed on the London Stock Exchange than in any other non-UK jurisdiction, this is not surprising and we expect this will likely to continue to develop as these practices become more widespread in the UK.
Use of activism in takeovers
Events such as a takeover bid for the company can bring about an activist campaign and encourage the use of activist strategies by investors. Whilst jurisdictions such as the UK and Guernsey don’t have avenues such as the "appraisal process" exploited with varying degrees of success in the US and the Cayman Islands, one method that activists are currently exploring is through challenges to the scheme of arrangement mechanism used to implement takeovers.
Schemes of arrangement have become a common feature of both public and private M&A transactions in Guernsey. In the 12 months to date, we have acted as Guernsey counsel on five public takeovers via scheme of arrangement.
While schemes have a compulsive effect on shareholders and are used to "drag along" those who dissent, as takeover tools they also come with significant minority protections. The Guernsey Courts will be careful to ensure that such rights are protected. A recent example is the decision in Re Puma Brandenburg Limited [Guernsey Court of Appeal, 18 May 2017. For further details on the decision, see our update here]where we successfully challenged a scheme on behalf of a minority shareholder despite it having been approved by the requisite statutory majority.
However, whilst primarily there to protect, those minority protections can also be exploited by activist investors pursuing bid activism strategies. At its most aggressive is the so-called "bumpitrage", which involves investors acquiring a strategic stake in a company following the announcement of a bid with the express objective of forcing the bidder to improve the bid terms.
It is not only takeovers by way of scheme of arrangement that are at risk of such practices - they can also be used against contractual takeover bids. In a contractual bid scenario, the bidding company must achieve an acceptance of 90% of the shares to which the offer relates in order to acquire 100% of the target using the compulsory "squeeze out" provisions in The Companies (Guernsey) Law, 2008 (the Law). As such, activist investors can enter the market to increase their holding and exploit that position to improve the bid terms.
What strategies can activist shareholders deploy in Guernsey?
The approach used by investor activists can vary. In its most subtle form, activists will seek to persuade the company’s directors to pursue a particular course of action. Such private engagement avoids the considerable expense and reputational risk of more public action whilst still achieving the desired outcome. Of course, private engagement with directors comes with the implied or even express threat that failure to comply could lead to the exercise of other, more aggressive options.
A common strategy beyond private engagement is the use of company general meetings to pass resolutions, including for the replacement directors. Bid activists seeking to force a higher bid price may acquire a larger stake or attract sufficient investor support to block (or at the very least, significantly frustrate) a contractual takeover bid or scheme of arrangement. The threat of a takeover failing to gain sufficient support can be enough to encourage a bidder to increase the price offered and in the most extreme of circumstances, invite hostile bidders to enter the market.
With the ever-increasing use of social media as a primary platform, publicity is another tool commonly utilised and the use of social media strategies (in addition to other more traditional forms of garnering support such as investor forums) to develop support may form an important part of an activists strategy. Of course, the use of these strategies also carries risks for activist investors.
The powers that shareholders in Guernsey companies have are considered below.
Access to information
Under the Law, shareholders are able to request that the company provide a copy of the share register. Following such a request, the company must provide a copy of share register within five days or alternatively, apply to the court for directions where the company does not believe that the request is for a proper purpose.
Access to the share register provides an activist investor with details that enable them to garner support for the campaign from fellow shareholders. For non-listed companies, it may also open the way to acquire further shareholdings.
The Law also allows a non-shareholder to request a company's share register, on payment of a fee, though this may be more likely to prompt a challenge to the request by the company.
Exercising shareholder powers at company meetings
Notwithstanding the common feature of general meetings, shareholders don't need to wait for an AGM to bring proposals to a company meeting. A shareholding of 10% will enable the shareholder to requisition the directors to convene a meeting to consider the proposals provided by the requisitioning shareholder. The meeting must be called within 21 days of receipt of the requisition notice with the meeting being held within 28 days of being called. If the directors fail to do so, shareholders may call a meeting themselves, at the company's expense.
Bid activists may use court convened meetings of the company to block a scheme of arrangement. To proceed, a scheme needs to be approved by a majority in number and 75% by value of those shareholders attending the meeting (whether in person or by proxy). As such, a scheme of arrangement can be blocked if the activist investor can secure a majority of investors at the meeting or attract 25% by value of those voting. Given that turnout levels can vary, and almost inevitably for a listed company won't reach 100%, a strategic stake of less than 25% is likely to be sufficient to vote the scheme down.
It should be noted that the use of artificial mechanisms such as "share splitting" to achieve a majority in number against the scheme may be successfully challenged in court, as was the case in the recent English decision in Re Dee Valley Group Plc  EWHC 184 (Ch).
Legal proceedings and challenges
An activist investor may consider the use of the various minority protection provisions in the Law to advance their objectives. Whilst the below is non-exhaustive, there are a number of different options that can be pursued:
- Unfair prejudice petitions – Directors need to conduct the affairs of the company in a way that is not "unfairly prejudicial" to the interests of shareholders. The unfair prejudice remedy allows shareholders to seek relief from the court where they can establish that the conduct of the directors is unfair and also prejudices their interests as shareholder.
- Derivative actions – directors owe their duties to the company and generally only the company can claim against the director for breach of those duties. The exception is the derivative action, under which a shareholder can seek permission to bring such claims, in certain limited circumstances.
- Challenge to compulsory takeover – If the 90% "squeeze out" trigger is reached, the compulsory squeeze out provisions under the Law can be effected, and a notice to acquire sent to dissenting shareholders. However, those shareholders may challenge the notice and seek an order for the compulsory acquisition to be set aside.
- Opposing a scheme of arrangement – Even if the company achieves the statutory voting requirements in favour of a takeover by way of a scheme of arrangement, the company needs the sanction of the court to approve the scheme. The sanction hearing provides a unique opportunity for a shareholder affected by the scheme to challenge it in court. Grounds for challenge will focus on any technical deficiencies, as well as whether the classes of shareholders voting on it were properly constituted (for example, are some shareholders receiving additional or collateral benefits under the scheme), whether the bid price is justified and verified and whether the scheme is fair such that a reasonable member would have approved it.
Risks faced by activist investors
These strategies are not without risks for the particular activist investor.
Activist investors need to keep in mind relevant regulatory obligations that apply, including the City Code of Takeovers and Mergers (Takeover Code), Market Abuse Regulation (MAR) and relevant exchange listing rules.
Investors seeking to increase their stake in a company will need to be mindful of notification requirements under listing rules as well as mandatory takeover provisions under the Takeover Code. This is particularly important in circumstances where garnering support may inadvertently associate them with other aligned shareholders such that a mandatory bid is required (which may not be the strategic aim of the activist) or their combined shareholding is excluded from the squeeze out or voting threshold calculations.
In addition, insider dealing can arise under the MAR where a person possesses inside information and uses that information to acquire or dispose of securities to which that information relates. Information regarding another shareholder’s plans and strategies for trading may also amount to inside information.
All indications are that activism is likely to grow as activist funds seek to deploy capital and regular investors take steps to support them, with an eye on improved returns. There is no reason to expect that Guernsey companies will be immune to this trend. Indeed, not all activism should be seen as counter-productive. It can often assist in addressing structural management problems and provide benefits to shareholders as a whole.
How should a company respond? Ultimately, there is no one way of effectively responding, defending or avoiding them. To try and do so, a company should regularly review its business portfolio and strategy, and ensure its corporate governance and director remuneration are acceptable. Directors should also ensure they have a program of engagement with investors.
Whilst there are various pre-emptive takeover defence techniques such as "poison pills" that assist in warding off potential bidders, those tactics are also problematic in circumstances where the board wants to recommend a bid. As such, the best response to an activist investor will normally be to engage and negotiate with them at an early stage, keeping matters private where possible. Directors should look to understand the issues investors raise and reach a settlement on acceptable terms. That said, it may not always be feasible or in the interests of the company, and the demands made may simply be unreasonable.
An original version of this article was first published by Compliance Matters, December 2017.