Market practice is developing
The high costs and reputational risks of failed takeovers have increased the creativity of bidders and their advisers to ensure the deal succeeds. There are two ways in which takeovers are typically structured in the UK - contractual offers and schemes of arrangement, the latter being a statutory procedure under the Companies Act 2006 involving approval by shareholders at a meeting and the subsequent sanction by the court. In the last few years, there has been a notable increase in the use of schemes to effect takeovers (of those takeovers in 2007 with a value in excess of £250 million, 28 were announced or subsequently became schemes while only six were structured as contractual takeover offers). The additional execution risks that a scheme timetable creates, combined with the fact that the timing and implementation of a scheme is controlled by the target rather than the bidder, have acted as catalysts in the development of deal protections.
Traditionally, deal protections might have been confined to fairly market standard inducement fees and irrevocable undertakings but they now extend to more sophisticated and intensely negotiated provisions such as matching rights, exclusive inducement fee arrangements, “no-shop” and “no-talk” provisions and “force the vote” provisions. The recent unsuccessful attempt by Halliburton to derail the takeover of Expro International by a Candover/Goldman consortium illustrates the need for the deal protections to be robust in the face of the possibility of vigorous challenge.
This Briefing outlines the most common and some of the more novel deal protection techniques currently being employed in the UK public M&A market and how increasingly the “package” approach to deal protection, contained in a detailed implementation or similar agreement, is becoming standard not just for schemes but increasingly for contractual takeover offers.
Inducement fees and matching rights
Inducement or break fees payable by the target, or occasionally shareholders, to the bidder are common in UK takeovers as a means for the bidder to recover some of the wasted costs associated with an unsuccessful bid. There is generally little argument over the basic structure and quantum of such fees which is typically set at the maximum that the Listing Rules and Takeover Code will allow (i.e. 1 per cent of the offer value). However the basic fee structure is becoming much more complicated and contentious particularly in terms of the trigger events which give rise to an obligation to pay and the stage in the transaction at which a fee should be available. The greater level of complexity is partly a function of a market in which targets may wish to offer break fees to more than one party; conversely, bidders may want “exclusive” break fee arrangements (where targets agree not to offer break fees to other potential bidders as in the offer by AB Acquisitions Limited for Alliance Boots in April 2007) and, where inducement fees are not seen as sufficient to protect the bidder, other mechanisms such as “matching rights” may be deployed.
Matching rights, which were granted in a number of recent transactions including the offer by GE Healthcare Life Sciences Limited for Whatman plc in February of this year, allow a bidder, when faced with a competing higher bid, to match that bid and to receive an inducement fee if the target board fails to recommend its matching bid. In agreeing to the terms of matching rights, target directors must act in a manner which is consistent with their fiduciary duties. This will be a key driver in the scope of such rights and the time scale within which they must be exercised. There is a strong argument that offering matching rights may deter other bidders.
Irrevocables and voting directions
Irrevocable undertakings from directors or shareholders to accept an offer are standard on UK transactions and there is a well-developed body of case-law and regulation governing their form and use.
Of more interest are other mechanisms related to voting which have developed to reduce timetable and other risks inherent in schemes of arrangement such as “force the vote” provisions. These require that a transaction be put to target shareholders at a scheme meeting. Similarly, shareholder voting directions, as used on the aborted Friends Provident/Resolution merger in 2007, involve target shareholders directing the board to disregard any subsequent competing offers and thereby reduce the threat that typically exists on a scheme of a competing bid being made between the shareholder meetings and the court hearing and the target directors then deciding not to seek the court’s sanction of the scheme (a risk which was illustrated in the recent attempt by Halliburton to intervene in the recommended offer by the Candover/Goldman Sachs consortium for Expro International after the consortium’s offer had been approved at the shareholder meeting). The Expro International offer also illustrated another form of bidder direction in relation to the scheme process namely an agreement by the target in the implementation agreement not to adjourn or reconvene the scheme meeting or court hearings (unless in the case of the court hearings there was a superior competing cash offer).
Although not typically considered a deal protection, the right to switch between a scheme and a takeover offer (which is contemplated by the the Takeover Code) has been reserved by a number of bidders on recent deals (such as FNI in its offer for Enodis in May of this year).This creates flexibility, particularly in contested situations, if there is any doubt as to the deliverability of one route over the other. Mechanisms which create deal flexibility are not limited to switching from schemes to takeover offers - on the Friends Provident/Resolution merger, to improve the chances of a successful outcome, the parties switched from a Resolution scheme to a Friends Provident scheme. This was the first time in a UK public takeover that the bidder and target have switched roles.
This refers to a broad category of undertakings all of which have the common purpose of limiting contact between the target and competing bidders. They range from pure exclusivity undertakings prohibiting any contact with third party bidders for a defined period (which are unlikely to be acceptable to directors in view of their fiduciary duties), to “no-talk” provisions which prohibit discussions by the target with a third party or the disclosure of information to a third party in response to an unsolicited approach (again likely to be problematic in view of fiduciary duties unless combined with a carve-out allowing the board to accept a superior proposal) to “no-shop” provisions which only prohibit active solicitation of competing offers.
As with the trigger rights for inducement fees, these provisions and the carve-outs from them are likely to be heavily negotiated but are increasingly found in one form or another (they were used on several bids in 2007 as well as bids in 2008 such as the WasteAcquisitionco Limited offer for Biffa plc).
Stakebuilding is the most common tactic for increasing the chances of success and, as with irrevocable undertakings, carries with it various restrictions and disclosure requirements under the Listing Rules and Takeover Code (as well as the danger of inadvertently triggering a mandatory offer).
Although there are risks associated with stakebuilding activity, particularly on schemes where it may prejudice the chances of success, because market purchases during the scheme period cannot be voted by the bidder at the court convened shareholder meeting, stakebuilding is often still used notwithstanding this to block out a potential rival bidder. Stakebuilding was used with notable success on a number of recent deals such as the 2007 bids by AB Acquisitions for Alliance Boots (where its 25 per cent stake forced Terra Firma to withdraw) and Pearl’s bid for Resolution (where a similar stake forced the withdrawal of Standard Life).
The deal protection package
Increasingly, individual deal protections are not enough to guarantee success. Inducement fees are now standard and are unlikely on their own to deter a target from recommending a rival bid. Matching rights are considered an enhancement on the traditional inducement fee arrangement but even they, used in isolation, have limitations - they pre-suppose that the bidder will be able to raise the funds to match a competing offer, something which in the current market may be challenging in the short time-frame involved.
Accordingly, what bidders are looking for is a deal protection package (typically housed in an implementation or similar agreement) in which inducement fees are supplemented with matching rights or exclusive inducement fee arrangements. These are in turn underpinned by non-solicitation undertakings which reduce the risk of having to use the matching right in the first place and by undertakings to inform the bidder of competing approaches or proposals so that a matching offer can be considered as early as possible. All these mechanisms may be supplemented by stakebuilding (where possible) and securing irrevocable undertakings (where available).
The more elaborate deal protections become, the more likely they are to be subject to scrutiny and challenge. However, there is no doubt that crafting a deal protection package which delivers the right level of protection while adhering to the various legal and regulatory constraints and therefore minimising the risk of challenge is going to become increasingly important