There has been considerable interest in the New South Wales Supreme Court's recent decision in the Pendal / Perpetual merger. What does it mean for M&A deals going forward? Does it change the way targets and acquirers need to approach deals? We unpack the implications.
- The NSW Supreme Court's recent decision on the Perpetual / Pendal merger has clarified a target's and acquirer's rights in a corporate merger.
- Pendal was entitled under its agreement with Perpetual to force it to follow through with its commitment to their merger process, even if a superior proposal emerged for Perpetual.
- The decision also confirms that a target can seek an alternative to monetary compensation – specific performance is available as an alternative.
The New South Wales Supreme Court's recent decision in the Perpetual / Pendal merger has attracted considerable interest and media commentary. Perpetual had agreed to acquire Pendal. But then a consortium comprising Baring Private Equity Asia (BPEA) and Regal emerged with successive non-binding indicative cash offers for Perpetual, at $30 and $33 per Perpetual share respectively. These were conditional though on Perpetual abandoning its planned acquisition of Pendal.
Perpetual had publicly rejected these two successive overtures from BPEA / Regal. There was an impending sense though that BPEA / Regal would increase their cash offer for Perpetual further. Some speculated that Perpetual might ultimately conclude that its shareholders would be better off if Perpetual abandoned its planned acquisition of Pendal and instead pursued the all-cash offer from BPEA / Regal.
It was this possibility that prompted Pendal and Perpetual to approach the Court for judicial guidance on the interpretation of how their merger agreement would respond to any such development.
The decision – could Perpetual abandon the deal with Pendal?
Justice Black ruled that not only did BPEA / Regal not have standing to be heard at the hearing but also that the implementation agreement between Pendal and Perpetual, although not perfectly drafted, was tolerably clear. Specifically, his Honour ruled that Pendal was entitled under its agreement with Perpetual to compel it to follow through with its commitment to their merger process.
If Perpetual's commitment to the merger fell away, the Court confirmed that Pendal could console itself with monetary compensation, to the tune of at least $23 million as their agreement provided. Alternatively, Pendal could return to the Court for orders directing Perpetual to proceed with the merger process – even though the parties' agreement didn't expressly make that alternative clear.
His Honour didn't have much sympathy for Perpetual's position: that its broader fiduciary duties to its own shareholders (i.e. maximising optionality and potential future value for them) meant that it too should have the same right as Pendal under their agreement to walk away if a superior proposal emerged for Perpetual. His Honour ruled that the agreement didn't give Perpetual that same 'walk-away' right as Pendal. So Perpetual was, in essence, stuck instead with what it had signed up to with Pendal.
What makes the decision noteworthy?
The decision is eminently sensible. It gives primacy to the terms of a written agreement between two sophisticated, well-resourced and well advised parties. Further, it is in some respects unremarkable – Justice Black simply interpreted and upheld the relatively clear words of the parties' agreement.
The noteworthy aspect of his judgment is his Honour made it clear that, if things went awry in terms of Perpetual's ongoing commitment to the parties' merger process, Pendal was entitled to return to Court to seek an order for specific performance. This is welcome judicial clarity in a public M&A setting.
The judge confirmed that Pendal could elect between, on the one hand, terminating the merger agreement and then seeking monetary damages and/or the receipt of the agreed $23.0m 'reverse' break fee payable by Perpetual or, on the other, keeping the merger agreement on foot and seeking an order for specific performance; i.e. an order that Perpetual follow through and do what it has contractually agreed to do. For a target, specific performance (being a discretionary remedy) is available as an alternative in a situation like this where the prospective acquirer does not have an express right to terminate if it receives a superior proposal.
This is significant because any monetary compensation – whether court awarded damages and/or a reverse break fee paid by the withdrawing acquirer – would be money that is received by the target company, not its shareholders. More to the point, target shareholders are far less interested in their company receiving compensation for a failed deal than they are in the deal actually completing. A completed deal gives target shareholders a cash exit at a material premium to the prevailing market price or, in a scrip deal, the ability to rollover their shares into the acquirer's listed shares and participate in the future expected benefits of the merged entity.
“Directors and shareholders of ASX listed targets will welcome the clarity this decision brings. Namely, provided that the merger agreement is suitably clear, a Court will stand ready to make an order directing a reluctant acquirer to specifically perform its obligations to consummate a merger.” Alberto Colla, MinterEllison partner
What would have been significantly more remarkable, noteworthy and potentially problematic for future deal certainty is if Justice Black had gone the other way and elevated the interests of Perpetual's shareholders above Pendal shareholders – as many market participants had speculated might occur.
If his Honour had decided that Perpetual was free to withdraw from its merger with Pendal and instead pursue a superior proposal with the only consequence being monetary compensation, this would have been problematic.
It would have sent a signal to ASX listed targets, their current and prospective shareholders (including hedge funds who base their trading decision on an assessment of completion certainty) that any take-private deal where the prospective acquirer is itself listed is susceptible to failure if the acquirer receives an unsolicited better offer.
Does this set a precedent in the Australian M&A market?
This is not the first time these issues have played out in the Australian M&A market. A series of earlier Takeovers Panel decisions have considered similar issues.
For example, the circumstances in the Gascoyne Resources / Firefly merger in 2021 are similar in many respects to the Perpetual / Pendal merger. The Panel expressed some disquiet about the lack of utility of Gascoyne having a so-called fiduciary exception to its 'no-talk' restriction but with no corresponding termination right for Gascoyne if it concluded that the competing proposal was in fact a superior one to its merger proposal with Firefly. In the end, neither the Panel nor the Review Panel intervened to disrupt the agreed terms of the Gascoyne / Firefly merger, even though Gascoyne ended up receiving what it concluded was a superior proposal. Simply put, Gacoyne couldn't extricate itself from its merger with Firefly – and it proceeded, much to the dismay of the suitor for Gascoyne and no doubt many of its shareholders (but no doubt much to the relief of Firefly and its shareholders).
What are the lessons for prospective acquirers and targets?
So what does this all mean going forward? Are we seeing a new law or is Justice Black's decision confined to its specific facts?
The short answer is a bit of both.
Justice Black has clarified that, provided a merger agreement is suitably clear on a prospective acquirer's inability to walk away if it receives a superior proposal, a Court will be prepared to make an order directing an equivocating acquirer to specifically perform its obligations to consummate a merger.
For prospective acquirers, the lessons going forward are very clear:
- If acquirers want the flexibility to terminate a merger agreement to pursue a better deal that they might subsequently receive on an unsolicited basis, then the implementation agreement needs to expressly allow it.
- In this scenario, acquirers will most likely be contractually obligated to pay the target a so-called 'reverse' break fee. An acquirer should try to contain the reverse break fee to 1% of the deal value, consistent with the maximum 1% break fee that the target agrees to pay the acquirer if the intended acquisition fails due to events attributable to the target's own circumstances (e.g. its pursuit of a superior proposal) or its conduct (material unremedied breach).
- Acquirers should also try to negotiate this 1% reverse break fee as being the target's sole and exclusive remedy for an actual or anticipatory breach including expressly excluding specific performance as a remedy that is available to the target.
Some or all of these protections might prove increasingly difficult to negotiate, as targets and their advisers will now be acutely aware of the need to better protect themselves in light of the messy situations that have unfolded where a string of prospective acquirers have looked to potentially extricate themselves from agreed deals. That was the case in Perpetual, in Gascoyne in 2021, in Gloucester Coal in 2009, and in the mother of them all, Roc Oil.
In 2014, Roc Oil was able to extricate itself from its intended scrip merger with Horizon with no reverse break fee or other recourse available to Horizon. This left Horizon stranded with significant sunk costs of issuing a voluminous scheme booklet and convening a scheme meeting that was abandoned after Roc Oil eloped a few days before the scheduled meeting with a foreign suitor offering a better all-cash deal.
For a prospective target, the lessons are equally clear:
- Seek to resist any right for a prospective acquirer to terminate a merger agreement to pursue a better deal that the acquirer might receive on an unsolicited basis.
- At a stretch, allow the acquirer the right to respond to and engage with the proponent of an unsolicited superior proposal for the acquirer. But don't go so far as to give the acquirer a termination right to walk away from your deal.
- Make it expressly clear that a reverse break fee payable by the acquirer is not the target's sole and exclusive remedy for an actual or anticipatory breach by the acquirer – expressly preserve your capacity to apply for an order for specific performance.
- Also seek to set the quantum of the reverse break fee at a level considerably above the 1% limit the Takeovers Panel says applies to any break fee payable by a target to a bidder. Importantly, this 1% limit does not apply to reverse break fees payable by a prospective acquirer to a target. A steep reverse break fee will make the prospective acquirer think longer and harder before walking away from your deal to pursue a better deal for itself.
By taking these collective steps, the prospective acquirer will appreciate from the outset that it will be a very expensive exercise for it to seek to walk away from its agreed deal with the target – assuming the target even allows the acquirer to do so.
Targets will also be sending a strong signal to any prospective party who may be interested in making a play for the acquirer that any such interest will need to extend to accommodating them as well, and the intended future subsidiary of the acquirer.
What do organisations need to consider when committing to a corporate merger?
“Committing to consummating a corporate merger involves considerable preparation, expense and – above all else – contingency planning.”
As history shows, the landscape is often fluid and can become tricky to navigate as circumstances change. So it's vitally important for each party to take counsel on steps to protect its own interests in the lead up to the consummation stage. Even in the initial throes of amorous excitement of an impending union, each party needs to foresee what can cause its own initial enthusiasm (or that of the other party) to fade or turn completely cold before their intended union is consummated.