Australia has a very active M&A market. It is one of the busiest in the world. This reflects a strong economy, stable government, a welcoming attitude to foreign investment and a well-developed set of rules for M&A activity. The main law regulating the M&A market is the Commonwealth Corporations Act 2001 (Corporations Act). This is administered by the Australian Securities & Investments Commission (ASIC), which takes a deep interest in ensuring that not only are transactions carried out in accordance with the letter of the law, but also consistent with policy objectives of the law. The acquisition of control of publicly held companies in Australia may occur in various ways. The most common ways are by ‘takeover bid’ and by ‘scheme of arrangement’. In general terms, a takeover bid involves an acquisition undertaken by making offers to the shareholders of the target company. Once sufficient shares have been acquired (normally 50%), control of the target will pass to the bidder, who will then be able to appoint new directors and control the company’s operations. A scheme of arrangement, on the other hand, is a transaction which becomes binding on all shareholders once it is approved by a majority of shareholders (including 75% of votes cast) and also by the court. It is a transaction that is driven by the target company so that, unlike a takeover bid, it can only be undertaken on a friendly basis. Where a takeover or scheme of arrangement leads to a combination of two businesses of comparable size, it is commonly referred to as a merger if it is an agreed or recommended transaction and shares in the combined business are issued as consideration. A merger often proceeds without a premium for control flowing from one party to the other, whereas under a takeover, a premium for control is usually paid to target company shareholders. This booklet discusses takeover bids, schemes of arrangement and the laws that govern these transactions. 04 TAKEOVERS AND SCHEMES OF ARRANGEMENT HERBERT SMITH FREEHILLS IN AUSTRALIA 2 Legislative framework In Australia, takeovers and schemes of arrangement are governed by a number of different and overlapping pieces of legislation. This section discusses the legislation most commonly encountered. Other specific industry legislation can be relevant—for example, laws governing banking, media, insurance and trustee companies. 2.1 Corporations Act The Corporations Act is the main legislation governing the acquisition of control of public companies in Australia. The legislation aims to ensure that an acquisition occurs in an orderly and competitive fashion and that shareholders and directors of the target have sufficient time and information to assess the proposal and all shareholders have equal opportunities to participate in benefits arising under the transaction. ASIC has extensive discretionary powers to modify, or to exempt parties from compliance with, certain provisions of the rules that apply to takeover bids. These powers are exercised when strict compliance with the law would lead to unnecessary costs or be contrary to the intention of the legislation. When do the takeover provisions apply? The key prohibition in the legislation applies where there is: • an acquisition of control over issued voting shares in a listed company, or in an unlisted company that has more than 50 shareholders; and • that acquisition results in the number of shares controlled by one person or his or her associates increasing: from 20% or less, to more than 20%; or from a starting point that is above 20% and below 90%. The rule means that a person cannot purchase a stake greater than 20%, unless that occurs under an exception (such as under a formal takeover bid or scheme of arrangement). In other words, the law does not permit a person to buy a stake over 20% provided he or she then makes a bid to other shareholders. This is an important difference from the approach under the UK rules. Our approach tends to produce a contest or auction for control as the takeover process unfolds. A contravention of the restriction is serious. It can constitute a criminal offence and may lead to other penalties and the forced divestment of the shares acquired in contravention of the law. Case study — meaning of ‘control’ In TVW Enterprises v Queensland Press, a person held 14.9% of shares in the Herald & Weekly Times Ltd and also had a pre-emptive right over a further 14.9% of shares held by another person. It was decided that the pre-emptive right gave ‘control’ over the shares, so that a purchase after the pre-emptive right was exercised would not breach the 20% rule. The purchaser already had ‘control’ over 29.8%. HERBERT SMITH FREEHILLS TAKEOVERS AND SCHEMES OF ARRANGEMENT 05 IN AUSTRALIA To whom do the takeover provisions apply? The provisions apply to acquisitions in Australian incorporated companies that are listed in Australia or have more than 50 members. They do not apply to a company merely because it has operations in Australia. The rules also apply to acquisitions in listed managed investment schemes (which are typically unit trusts which own real estate). This is achieved by equating features of a listed managed investment scheme with a listed company. This avoids the need to repeat the takeover provisions specifically for listed managed investment schemes. Takeovers of listed managed investment schemes can also raise difficult issues relating to collateral benefits, particularly if it is proposed that a payment will be made to an outgoing manager. In those cases, it may be necessary to seek unitholder approval, or ASIC relief, to allow the payment to be made. What are the main exceptions to the prohibition? There are various exceptions, as discussed on section 10 of this booklet. The main exceptions allow acquisitions under a formal takeover bids or under a formal scheme of arrangement. Others include shareholder approved acquisitions and creeping acquisitions of no more than 3% in a 6 month period. 2.2 Foreign Acquisitions and Takeovers Act The Commonwealth Foreign Acquisitions and Takeovers Act 1975 (FATA) may be relevant if the bidder is a foreign person. In general terms, the FATA requires that the Australian Treasurer (acting through the Foreign Investment Review Board (FIRB)) be notified in advance of a proposed acquisition: • by a foreign person of 20% or more of the shares of an Australian corporation with total assets or issued securities valued at more than A$266 million (a higher threshold of A$1,154 million applies to direct acquisitions by prescribed non-government investors including Chilean, Chinese, Japanese, South Korean, Singaporean, United States and New Zealand companies in non-sensitive sectors)1; and • by a group of foreign persons of an ‘aggregate substantial interest’, being 40% or more of the shares of such an Australian corporation. Actions which the Australian Treasurer must be notified of are referred to as ‘notifiable actions’ and include agreements to make proposed acquisitions. The FATA gives the Treasurer power to prohibit a ‘notifiable action’ which would be contrary to Australia’s national interest. 1 The figures of A$266 million and A$1,154 million (and any other references to those figures in this booklet) apply from 1 January 2019 until 31 December 2019 and are subject to annual indexation. 06 TAKEOVERS AND SCHEMES OF ARRANGEMENT HERBERT SMITH FREEHILLS IN AUSTRALIA 2 Legislative framework The Treasurer can also make divestment orders where a transaction has already been implemented without prior approval. A ‘foreign person’ includes a foreign government. However, generally most direct investment by foreign governments, their agencies (for example, state-owned enterprises and sovereign wealth funds) and entities in which a foreign government has a substantial interest must be notified to FIRB for review regardless of the value of the investment. A ‘foreign person’ may include an Australian entity if an overseas resident owns 20% or more of issued shares or if various overseas residents own 40% or more, even if they are not associated. In applying the second test to listed entities, only holders of 5% or more are counted. FIRB often wishes to consult with a target company and other relevant regulatory bodies prior to giving approval. This could include communication with the Australian Competition and Consumer Commission (ACCC), Australian Taxation Office (ATO) and, where critical infrastructure assets (such as electricity, water and ports) are involved, the Critical Infrastructure Centre. This consultation process must be managed to avoid premature disclosure of the proposed transaction. The FATA also contains important provisions, which impose different thresholds and obligations, in respect of acquisitions of: • Australian land and companies whose Australian land assets comprise more than 50% of the value of their total assets; • agribusinesses and companies whose agricultural land assets comprise more than 50% of the value of their total assets; • businesses in sensitive sectors, which include media, telecommunications, transport, defence and military related industries and the extraction of uranium and plutonium or the operation of nuclear facilities; and • portfolio investments in the media sector of 5% or more. 2.3 Competition implications The competition implications of Australian mergers and acquisitions are dealt with in the Commonwealth Competition and Consumer Act 2010 (the CCA), which is administered by the ACCC. The CCA regulates anti-competitive mergers and acquisitions. The relevant test is whether the transaction would have the effect, or be likely to have the effect, of substantially lessening competition in a market. What is a ‘substantial’ effect depends on a close consideration of the facts in a particular situation. Generally, the ACCC takes the view that a lessening of competition is substantial if it confers an increase in the market power of the merged firm that is significant and sustainable. For example, a merger may substantially lessen competition if it results in the merged firm being able to significantly and sustainably increase prices. Factors which are relevant to this assessment include post-merger market concentration, barriers to entry and expansion, actual and potential import competition and the availability of substitutes. HERBERT SMITH FREEHILLS TAKEOVERS AND SCHEMES OF ARRANGEMENT 07 IN AUSTRALIA There is no compulsory pre-merger or pre-acquisition notification under the CCA. However, the ACCC encourages parties to notify the ACCC well in advance of completing a merger or acquisition where both of the following apply: • the products of the merger parties are either substitutes or complements; and • the merged firm will have a post-merger market share of greater than 20% in a relevant market. This is a low threshold. The ACCC considers that, where a merger or acquisition meets the above recommended notification threshold, it could potentially give rise to an Australian competition law issue. Where there is a potential concern, the ACCC is often asked to provide an ‘informal clearance’. If, following a review, the ACCC determines that the merger or acquisition is not likely to contravene the CCA, it will provide a ‘no objection’ letter. While such a letter is not binding on the ACCC, past practice shows that it gives a high degree of regulatory comfort. The ACCC considers the vast majority of mergers under the informal clearance process, and clears most without the need for a public review. In the alternative, a merger party may also make an application to the ACCC for ‘merger authorisation’. In order to grant the authorisation, the ACCC will need to be satisfied that either: • the proposed acquisition would not be likely to substantially lessen competition; or • the likely public benefit from the proposed acquisition outweighs the likely public detriment, including any lessening of competition. Authorisation involves a public process under which interested parties have the ability to make submissions and intervene. On application, the Australian Competition Tribunal may review an ACCC merger authorisation. Authorisation is most likely to be sought where there are substantial public benefits to the merger, as these benefits cannot be taken into account under the informal clearance process. 08 TAKEOVERS AND SCHEMES OF ARRANGEMENT HERBERT SMITH FREEHILLS IN AUSTRALIA 3 Preparing for a transaction 3.1 Establish a team It is important to be well prepared before embarking on an M&A transaction. The bidder should establish a working group comprising relevant company executives and external advisers. The exact make-up of the group will depend on the transaction proposed, but should include senior finance, operational and legal executives from the company. The external members should be briefed about the company’s current position and long-term strategy. 3.2 Identify commercial objectives The commercial objective for the bidder needs to be articulated. In planning an acquisition, the bidder needs to consider the value of the target company and its assets and whether the benefits hoped to be achieved can best be obtained by making a bid or a scheme of arrangement or by proposing some other type of transaction, such as a shareholder-approved placement or an asset purchase. The same analysis can assist in responding to a takeover bid as it may identify that the bidder may be seeking only a particular asset or outcome. 3.3 Pre-bid discussions and due diligence A bidder will usually contact the target company in the hope of achieving a friendly bid. If the target is receptive, this will lead to the bidder being granted due diligence and potentially a recommendation by the target’s directors that shareholders support the transaction. Discussions may also be undertaken with major shareholders to gauge the price level at which a bid may be successful. However, any agreement that a major shareholder would accept a bid or sell its shares may be illegal if the bidder would, as a result of such agreement, breach the general 20% limit (discussed in section 2.1). Target due diligence and confidentiality agreements If the target is willing to engage with the bidder, due diligence will be allowed. A confidentiality agreement is invariably entered into designed to protect the secrecy of these discussions, as well as restrict the use of any confidential information that is exchanged between the parties. The confidentiality agreement may also contain standstill provisions which prevent the bidder from acquiring target shares for a period of time. The bidder should be careful to ensure that any confidentiality arrangements it enters into with the target company allow it to disclose material information in its formal documents. Public sources of information If the target is not willing to engage, information about the target may be difficult to obtain. Some information can be obtained from searches of public records. This should indicate whether there are any defensive provisions in the target’s constitution or in terms of issue of securities, details of existing substantial holdings and details of any recent capital raisings. Share registers are also available for inspection. HERBERT SMITH FREEHILLS TAKEOVERS AND SCHEMES OF ARRANGEMENT 09 IN AUSTRALIA Internal due diligence In addition, a bidder must exercise diligence in relation to its own affairs before embarking the transaction. This includes ensuring that it has sufficient finances to pay for the acquisition and all incidental costs, such as legal and advisory fees. It is also necessary to ensure that all public statements it makes in connection with the transaction are not misleading or deceptive, as the Corporations Act may impose civil and criminal liability on persons who make such statements. 3.4 Tax The tax impact of the bid on the bidder and on shareholders in the target must be considered. If tax consolidation is important, 100% of the target’s issued securities (including convertible securities) should be acquired. 3.5 Stake-building Pre-bid acquisitions Before launching a transaction, it is generally lawful to acquire a toehold of up to 20% of the issued voting shares in the target. This may enable acquisitions at lower pre-bid prices and may deter others from buying into the company as rivals. It also gives standing to challenge the actions of the target’s directors if necessary. However, there are disadvantages of acquiring such an interest, including raising market prices, compulsory disclosure to the target and relevant securities exchange once interests in 5% or more of voting shares in the target have been acquired (see section 8.1 of this booklet) and becoming ‘uncovered’ by an ownership tracing notice (see section 8.3 of this booklet). Furthermore, while share purchases may help a bidder reach control or the 90% compulsory acquisition threshold under a takeover bid, any shares acquired by a bidder cannot be voted to support a scheme of arrangement, which therefore increases the percentage of eligible voting shares held by possible spoilers. The price paid (or agreed to be paid) for shares during the four months before a formal takeover offer is made will set a floor for the consideration required under the offer. Pre-bid acceptance or voting arrangements Apart from a firm purchase of shares, it is also possible to take an option over shares from, or to enter into a pre-bid arrangement with, a key shareholder, up to the 20% limit, which may enable the bidder to require an acceptance in a takeover bid or require a vote in support in a scheme of arrangement. Such an agreement may deter others from making a bid, even if the agreement is conditional on no higher unmatched rival bid emerging. Rules against escalators and collateral benefits Agreements with shareholders in the target need to be carefully drafted in light of rules in the Corporations Act restricting ‘escalator agreements’ and ‘collateral benefits’. An ‘escalator agreement’ is an agreement where the bidder buys shares and undertakes to the seller to top up the purchase price if it makes a bid at a higher price subsequently. 10 TAKEOVERS AND SCHEMES OF ARRANGEMENT HERBERT SMITH FREEHILLS IN AUSTRALIA 3 Preparing for a transaction These agreements are void if made within six months of a bid. During the offer period, a bidder or its associates must not give a benefit to a person, which is not offered to all holders of securities in the bid class, and which is likely to induce the person or an associate to accept the offer or to dispose of securities. These are referred to as ‘collateral benefits’. Case study — pre-bid agreements In Pasminco v Savage, Pasminco agreed to buy 17% of shares in Savage from three institutional holders. The agreement required Pasminco to announce a takeover bid within two days and to complete the purchase within three months. The shareholders had the right to terminate the agreement by accepting Pasminco’s formal offer or if a higher bid was made which was not matched by Pasminco. The court decided this agreement was lawful, even though the shareholder retained a flexibility to accept a higher offer made by Pasminco or another person. It was not an ‘escalator’. 3.6 Agreed bids and deal protection mechanisms One advantage of reaching agreement for a friendly transaction is that the bidder would usually get the benefit of an implementation agreement. This would typically include an undertaking that the bid will be recommended by directors (in the absence of a superior proposal). It is also common in a recommended transaction for the bidder and the target to enter into deal protection mechanisms, including exclusivity and break fee arrangements, which may favour the bidder. Care needs to be taken in structuring deal protection devices so as to not create a material disincentive to the prospect of the emergence of a rival bid as the Takeovers Panel has power to set aside those arrangements if it considers them to be unacceptable as anti-competitive. Break fee arrangements Break fees are common in recommended bids in Australia. Typically, a break fee is an agreed amount that becomes payable if certain specified events occur that prevent the takeover from proceeding (such as a change of recommendation or rival bid emerging). Generally, a fee not exceeding 1% of the deal value is considered acceptable by the Takeovers Panel.