On 21 March 2011, the Code Committee of the Takeover Panel (the Panel) published a consultation paper, PCP 2011/1, setting out the amendments to the Takeover Code (the Code) that it proposes to make to implement the conclusions described in Statement 2010/22 (published last October).
A summary of the proposed changes can be found here. Below we discuss the implications of the main amendments for market practice.
The proposed amendments contain important changes, for example:
- the banning of deal protection measures (other than notably a break fee in favour of a white knight or where the target board initiates a public auction);
- the requirement to name potential bidders in the announcement beginning an offer period;
- a 28-day ‘put up or shut up’ (PUSU) deadline;
- the ability for a target board to agree or withhold consent to extensions of this deadline; and
- clarification that the target board may extend the PUSU deadline for some bidders and not others.
We expect that these changes, in particular, will give the target board greater tactical power to influence the course of a bid. At the same time, though, we would expect this to be accompanied by an increased focus (by shareholders and others) on the decisions the target board takes.
From a potential bidder's point of view, the changes will undoubtedly encourage even greater attention to maintaining secrecy and will probably require a bidder's preparations to be much further advanced by the time an initial approach is made. These challenges will be amplified for those potential bidders who need to put funding in place (eg private equity bidders) or who are acting in a consortium and in cases where there are complex cross-border or other structuring aspects.
The changes will affect the way in which all bidders and targets conduct and respond to bids.
- Deal protection measures
- Empowering the target
- Price is not the determining factor
- More transparency on fees and financing arrangements
- Future plans for the target
- Greater rights for target employees to make their views known
- More radical reform of takeover rules?
- What happens next?
Deal protection measures
No break fees or other offer-related arrangements
The Panel proposes to prohibit deal protection measures, including break fees, except in the event of a hostile bid where the target board wishes to incentivise a white knight or where the company initiates a public auction or where it is in financial distress.
The proposed amendments prohibit other 'offer-related arrangements' that would often be included in implementation agreements, for example 'no shop' agreements and 'matching rights'. However, irrevocable undertakings, confidentiality and non-solicitation undertakings (preventing solicitation of a bidder's employees, customers and suppliers) and undertakings from the target to provide the information required to satisfy offer conditions or obtain regulatory approvals are permitted. The amendments do not prevent the imposition of obligations on the bidder only (or a bidder concert party) – for example, a reverse break fee or a standstill agreement.
Abolishing deal protection measures will clearly change market practice: inducement fees of 1 per cent are currently the norm on bids, leaving the target with little room to negotiate them (hence the Panel's proposed ban). The change is being made despite market opinion, which was generally supportive of the current regulation of break fees.
There is a view that the prohibition will make it harder for all prospective bidders to commit to the up-front costs (for example, due diligence and financing fees) associated with a bid if they cannot rely on a break fee to compensate them for those wasted costs if their bid is trumped. These concerns are particularly strongly held among private equity firms, whose financing costs tend to be higher than strategic investors. Opponents of the change therefore argue that it will result in fewer bidders coming forward, which may not be in the interests of target companies' shareholders.
If a hostile (non-recommended) bid has been announced, however, a target will be able to agree to a single 1 per cent break fee in favour of a white knight. This is an important change to the Code Committee's original proposals and addresses concerns that a blanket prohibition may deter topping bids and, therefore, maximisation of target shareholder value once a company has been put into play. It should be seen as part of the overall attempt to strengthen the target board's position.
More use of stakebuilding and irrevocables in the future?
As mentioned earlier, the breadth of the prohibition on offer-related arrangements will also prevent target companies agreeing a range of restrictions, including on their ability to solicit alternative bidders ('no shop' clauses), engage with competing bidders and recommend alternative bids. It will also prevent agreements for matching rights. Bidders concerned by interloper risk may therefore make more use of alternative means of deal protection, such as stakebuilding and obtaining irrevocables to protect themselves.
As stakebuilding is more effective on a contractual takeover offer rather than a statutory scheme of arrangement, it may be that we see a shift away from the popularity that schemes have enjoyed in recent years in favour of the traditional takeover offer structure. The pros and cons of a scheme vs a takeover offer will certainly be more finely balanced in potentially competitive situations.
Exceptions for break fees in the context of public auctions and financial distress
A target that has initiated a formal sale process will be able to apply to the Panel for a dispensation to allow it to agree a break fee at the time of a firm intention to bid being announced. A dispensation may also be sought where the target is in financial distress.
The prohibition on offer-related arrangements would also prevent the target committing to help the bidder arrange alternative financing during an offer period. This will be of concern for those re-financings that need a significant degree of target board co-operation, eg where a bridge financing in place on announcement is to be re-financed through a high yield offering to be available on closing.
Empowering the target
28-day PUSU and bidders to be named
The 28-day PUSU deadline and the requirement to name potential bidders in the announcement that starts an offer period are likely to significantly affect bidder strategy and bid planning. This is especially true for private equity and other buyers who are reliant on third-party finance and who will probably therefore need to have their bid financing arranged much sooner than is currently the case.
No more virtual bids
The Panel intends these amendments to limit 'virtual bids' (so-called 'bear hugs'), where a potential bidder announces it is considering making a bid without committing itself to do so. This would end the lengthy periods for which a target is under siege by a bidder.
Undoubtedly the new rules are likely to encourage potential bidders to maintain secrecy and avoid leaks, for fear of being publicly identified and triggering a 28-day PUSU.
Many have suggested that the corollary of this is that target companies may feel a greater temptation to announce an approach for exactly the same reason. However, target companies are usually reluctant to take action that will put themselves into play and thereby initiate a public debate on their future, the consequences of which they are unable to control. Equally, a willing target is probably unlikely to make an announcement if that would make the delivery of an acceptable bid more difficult. It is therefore thought that most potential target companies would not find a pre-emptive announcement of an approach to be a more attractive tactic as a result of the changes in the rules.
Bidders are nevertheless likely to pay additional attention to the obligations of confidentiality that accompany their approach. They may also need to be clearer than usual with a target company and its advisers that a premature announcement or leak by the target will result in the bidder walking away.
As well as maintaining secrecy, bidders will want to be much better prepared before approaching a target, given the 28-day deadline within which to announce a firm bid. Currently, it is not unusual for a bidder to announce an intention to bid without first having advanced its financing discussions or obtaining the target board’s support in principle. Given the risk of a leak triggering the 28-day deadline, bidders will need to have already well progressed their financing or be confident of being able to arrange it within that shorter period – while at the same time ensuring confidentiality among a potentially large number of funders. Consortium bids, cross-border bids and those involving complex share-exchange consideration will also be more challenging for similar reasons.
Impact on target board
The 28-day PUSU deadline and the requirement to name potential bidders in the announcement that starts an offer period seek to redress in favour of the target board the balance of advantage in bid approaches. Once a 28-day PUSU period has been triggered, however, the target board may itself come under additional public and private pressure from institutional and other shareholders and the media regarding its response. In particular, it may come under pressure to agree to one or more extensions of the 28-day period.
It should also be noted that, under the proposed rules, if there are multiple potential bidders they will each have their own 28-day PUSU period and these periods will not automatically be co-terminus. A target board may, of course, agree to extensions of the periods applicable to the later bidders to address this, but it will not be required to do so.
The requirement to name potential bidders in the announcement, the 28-day PUSU deadline and the ability to withhold consent to extensions will therefore give the target board greater tactical power to influence the course of a bid. This is likely though to be accompanied by increased scrutiny (by shareholders and others) of the decisions the board takes. The extent to which target boards take advantage of these increased powers will clearly vary but in all cases the tactical dynamic will be changed.
Exception for public auctions
Neither the fixed 28-day PUSU deadline nor the requirement to name a potential bidder will apply if the target puts itself up for sale by a public auction process – although this will only rarely be a route that targets wish to go down.
Price is not the determining factor
The clarification that the Code does not require target boards to consider price as the determining factor is unlikely to make any real difference in practice. This is because boards are already obliged to consider a bid in line with their fiduciary duties and, when they advise shareholders, to do so in good faith and honestly.
While price will clearly be an important factor in the context of any bid, and sometimes the most important, it does not follow that directors cannot also have regard to other factors that affect the prospects of the company in the future. Nor does it follow that those other factors cannot be as significant, or even more significant, than price. The Code changes are in line with this position.
More transparency on fees and financing arrangements
The proposal to disclose advisory fees is intended to help shareholders of bidders and targets to judge whether a bid is likely to destroy shareholder value or enhance it. The proposed requirement to put financing agreements on display (for all bids) from the time of the firm offer announcement may result in short-term interim financing agreements being entered into to limit the disclosure of commercially sensitive information, such as refinancing obligations, or may result in that information being dealt with in a different way.
Future plans for the target
The proposal to hold bidders and targets to any stated plans for the target and its employees should certainly make parties more cautious about what they say publicly about them. One risk is that we will see the development of very caveated disclosure designed to preserve room for manoeuvre in the future.
Greater rights for target employees to make their views known
The proposals to improve target employees' ability to make their views known on the bid's effect on employment may give employees more of a say in takeovers than they currently enjoy (although these rights already exist, they have rarely been exercised); but it is unlikely to affect whether a bid proceeds or not. It is doubtful whether these amendments would have made any difference to Kraft's successful bid for Cadbury, because the Cadbury employees made their views known in any event. It does, however, facilitate and encourage employees' participation.
More radical reform of takeover rules?
There has been some comment in the market that more radical reforms of the Code should be implemented. This has included suggestions of a relaxation of the 60-day timetable in favour of target companies and even a retreat from the certain funds requirements. These provisions, which would more fundamentally alter the landscape for takeovers in the UK, have not been included in the Code Committee's proposals.
However, radical reform of takeovers by the government remains a possibility. The government's call for evidence, A Long-Term Focus for Corporate Britain, issued last October, states that it wishes 'to look further at broader issues relating to the economic case, and the corporate law framework, for takeovers'. In relation to takeovers, the government has asked for views on whether boards understand the long-term implications of takeovers (and communicate these effectively to shareholders and wider stakeholders) and whether the shareholders of a bidder company should always be invited to vote on takeover bids. The consultation closed on 14 January 2011. Although the outcome of the consultation, including the government's proposals, will be published by 14 April 2011, an announcement is expected in the budget later this week.
What happens next?
The consultation paper includes the text of the amendments to the Code and invites comments on the proposed new rules by 27 May 2011. The Code Committee does not believe it will be necessary for there to be a lengthy implementation period. It will provide guidance as to when the changes are likely to come into force once it has considered the responses to this consultation