Key Points: Fiduciary-outs should not be so restrictively drafted that they unreasonably prevent target directors from responding to approaches that could reasonably be expected to lead to a superior competing proposal.
It's not back to the drawing board, but bidders and targets may have to be a bit more circumspect when drafting merger implementation agreements.
The Takeovers Panel decision in Ross Human Directions clearly illustrates that the negotiation of a MIA is a three-sided contest. Those three sides are the bidder, the target directors - and potential rival bidders.
The Panel's concern is that the target board should perform the difficult balancing act of giving the bidder sufficient certainty to commit to a bid without completely or unreasonably shutting the door to potential rival bids. It is from that perspective that it recently examined the lock-up provisions negotiated between Ross Human Directions and bidder Peoplebank.
Directors' room for manoeuvre
In any MIA, the target's no talk, no due diligence and other exclusivity restrictions (except for the no shop) will be subject to a fiduciary-out clause, allowing the target directors to respond to or accept a superior rival proposal where required by their fiduciary duties.
Bidders always try to ensure that fiduciary-outs are drafted as tightly as possible.
The Ross case shows that a fiduciary-out should not be so tightly drafted that it is almost a dead letter.
The MIA contained no-talk and no-due diligence provisions which nevertheless allowed Ross's directors to respond to an approach which they had determined to be a "superior" competing proposal. A "superior" competing proposal was defined as one which:
"(a) is capable of being valued and completed, taking into account all aspects of the Competing Proposal, including its conditions precedent; and
(b) would, if completed substantially in accordance with its terms, be more favourable to Shareholders (as a whole) than the Scheme, taking into account all the terms and conditions of the Competing Proposal and all aspects of the Scheme."
According to the Panel, this effectively made the fiduciary-out a contradiction in terms. Target directors could not engage with a potential rival bidder until they had determined that the rival proposal was superior, taking into account all the terms and conditions of the rival proposal. However, unless they spoke to the potential rival bidder (and possibly granted due diligence), the rival proposal might never get to the point of containing terms and conditions that the target directors could evaluate.
The Panel's solution was to amend the no-talk and no due diligence clauses so that the fiduciary-out operated where there was a superior rival proposal or a proposal which "may reasonably be expected to lead to" a superior proposal. This form of drafting has become relatively standard in recent times. However, the decision reinforces the importance of ensuring that these types of provisions are carefully drafted so as to operate properly in practice and avoid unnecessary trips to the Panel.
Another common device for tightening up fiduciary-outs is to require the board to obtain independent advice before deciding whether it should change its stance on an agreed merger.
The Panel had a number of concerns about the advice requirements to which the Ross directors were subject:
- it was concerned that a requirement to obtain financial advice on a rival proposal should not supplant the directors' ability to determine whether it was superior;
- once the directors had obtained legal advice on whether it would be a breach of their duties to reject a rival proposal, it was inappropriate to impose an additional requirement that they should act in what they "reasonably considered" to be their duty;
- there appeared to be little point in requiring the target directors to obtain financial advice that a rival proposal was superior and legal advice that it would be a breach of duty not to respond to such a proposal.
The Panel ultimately decided that the fiduciary-out could remain subject to both a requirement that the proposal be determined to be superior and that, having taken legal advice, not responding would be a breach of the directors' fiduciary duties. Many targets would argue that they should only need to determine that it would otherwise be a breach of the directors' fiduciary duties without the additional requirement that the proposal is superior. Market practice appears to adopt this approach, although the Panel saw no problem with the dual requirement, presumably because if one is satisfied, the other will ordinarily also be satisfied as a matter of course.
Confidentiality and standstill requirements
Before granting due diligence to a potential rival bidder, the MIA required the target directors to extract confidentiality and standstill agreements from that rival. These had to include all the material terms in the confidentiality deed already agreed between Peoplebank and Ross.
One problem, as the Panel pointed out, was that that confidentiality deed had not been made public. Potential rival bidders might not be willing to declare themselves if they had no idea what they would be required to sign up to.
The Panel did agree with Peoplebank that a target's ability to insist on standstill arrangements with individual bidders shouldn't be used to produce an unlevel playing field between bidders. However, it didn't follow that the first bidder at the table should have the ability to determine what that level was. There was no reason, in the Panel's view, why standstill arrangements with the first bidder shouldn't be able to be scaled back to match those agreed with subsequent bidders.
Notification obligations and matching rights
As usual, the MIA required Ross to notify Peoplebank of any rival approaches, and to allow Peoplebank the right to produce a matching offer.
The Panel was concerned about the duration of the matching rights, for two reasons.
The first was that the matching rights were open for five clear business days. The Panel noted that, when they originally appeared in Australian M&A, matching rights tended to be no longer than three days. However, five days (and sometimes longer) has increasingly become common.
The Panel didn't want to prescribe any particular time period for matching rights, but did issue a warning that "any material extension of these periods is likely to be unacceptable, because of the effect that the provision has on the willingness of a third party to put forward a competing proposal".
In the case of Ross and Peoplebank, it was prepared to accept five business days, because Peoplebank's major shareholders were overseas and it was claimed that they would therefore need five days to respond to a competing proposal.
A related concern flagged by the Panel was that the five day clock would restart each time the competing proposal changed, whether or not the change was material. It did not develop its concerns on this point, because the parties reduced the five day refresh period to three days.
The actual notification obligations required Ross to give Peoplebank "any information provided to any person associated with the Competing Proposal that has not been disclosed previously to Peoplebank". The Panel believed that this obligation should be restricted to material confidential information concerning Ross's operations.
The auction issue, again
One of the perennial questions in Australian M&A is the extent to which target directors are subject to a duty to get the best price possible for their company (sometimes referred to as the Revlon duty, after a leading US case).
Before the Panel in this case, it was argued that Ross should not have entered into no-talk and no due diligence agreements with Peoplebank without first having tested the market via a public auction process.
The Panel rejected this argument, on the grounds of business practicalities:
"[T]here is no requirement that a target company must undertake a public sale process prior to entry into an implementation agreement containing such arrangements. We note that there may be many reasons why a target board seeking to obtain a control transaction for the benefit of shareholders does not wish to publicly put itself up for sale, including the impact of such a move on its relationships with its suppliers, customers and employees."
This decision doesn't mark a major departure from the Panel's policy.
Nevertheless, it does show that the Panel refuses to view takeover regulation as a matter of "set & forget". The negotiation of MIAs is constantly evolving, and the Panel has demonstrated a clear willingness to adopt and adapt its underlying principles to that changing reality.
It would be useful, of course, if the Panel were willing to draw clear lines in the sand (eg. setting a fixed maximum period for matching rights). That is not, however, how the Panel works: it is very aware that fixed policy prescriptions introduce rigidities that both hamper genuine commercial negotiations and divert resources into overly-technical drafting.
What emerges from this decision, therefore, is that, at the end of the day, the parties negotiating an MIA must test their draft agreement not only against their commercial objectives, but against the "efficient, competitive and informed market" principle that drives the Panel's decisions.
With that in mind, some of the specific issues which arise from this decision and which should now be taken on board are:
- fiduciary-outs should not be so restrictively drafted that they unreasonably prevent target directors from responding to approaches that could reasonably be expected to lead to a superior competing proposal;
- the material terms of confidentiality agreements between the bidder and the target may need to be disclosed before the bidder can insist that the target should impose them on other potential bidders and, even then, the bidder may not be able to insist that those terms be imposed, having to instead insist that its own terms be scaled back if less onerous terms are agreed with a rival bidder;
- matching right periods beyond three days may need special justification;
- notification requirements should not require the disclosure of information about the rival proposal that would deter a rival from approaching the target board.
An interesting matter which the Panel referred to in passing at the end of its statement of reasons was the extent of Ross's financial liability for any breach of the MIA:
"One issue which we did consider in determining the anti-competitive effect of the various deal protection measures, including the no-shop, no-talk and no-due diligence restrictions, is that under the SIA, RHD's sole liability for breach of the agreement is for payment of the break fee of $500,000. We clarified with the parties that this was the intention of clause 11.1(d) of the SIA, and Peoplebank and RHD agreed to make certain amendments to the drafting to put this beyond doubt."
The issue of the full extent of the target's liability for breaching an MIA is one which has not yet been fully explored by the Panel. This type of liability cap is becoming increasingly common in MIAs. However, it is not clear what the Panel's concern is in this regard. We would have thought that, provided the exclusivity provisions are appropriately drafted so as to not unreasonably deter competing bids and do not otherwise offend the "efficient, competitive and informed market" principle (which the Panel took great care in this decision to ensure), the bidder should be entitled to be fully compensated for any breach of those provisions by the target. Whether or not the liability cap should apply is simply a matter for commercial agreement.
We would be concerned if the Panel were to insist that such a liability cap apply in all cases given that there does not appear to be any basis for such a policy. As a commercial matter, a bidder may well be reluctant to agree to such a cap in circumstances where, as is usually the case, the bidder is completely exposed for all losses incurred as a result of a breach of an MIA by the bidder. This inequality is even greater where the target seeks to extend the bidder's liability under the MIA to losses suffered by target shareholders.