In brief

UK Panel consultation paper proposes major rule changes to protect targets including:

  • prohibiting deal protection measures, except where a target has put itself up for public auction
  • forcing potential bidders to clarify their intentions on a possible bid with a short period of time, and
  • giving greater recognition to the interests of employees of the target.  

The UK Takeover Panel issued a consultation paper last week which proposes some radical changes to the UK Code including the banning of break fees and other deal protection measures as well as changes to other rules designed to protect targets from hostile bids.  

This article considers the proposed changes and their possible relevance to Australia.

Background

The UK Takeover Panel Code Committee issued the consultation paper on 21 October 2010 in response to public submissions on a June discussion paper. While the consultation paper refers to an unprecedented number of submissions, the time of its issue follows the successful close of the long running hostile takeover of Cadbury plc by Kraft Foods Inc.

Perceived problems in UK market practice

The discussion and consultation papers concern the increasing influence of ‘short-term investors’ (ie hedge funds, takeover arbitrageurs) and the perceived tactical advantages a hostile bidder may have over a target company under siege. The theme being that these trends in market practice have led to outcomes unfairly skewed against targets and target shareholders.

The UK Panel dismisses suggested rule changes to deal with hedge fund activity. These included raising the minimum acceptance threshold above 50%, disenfranchising shares acquired during the offer period (ie requiring an ownership qualification period before a share carries voting rights) and reducing the disclosure threshold from 1% to 0.5%. Indeed some of these changes would not make sense without parallel changes in UK company law.

However, the UK Panel does consider that the tactical advantage for hostile bidders has become a real problem. It being too easy for a hostile bidder to succeed to the detriment of the target and its shareholders. The Panel consider this imbalance arises because of a number of factors including the destabilising effects on the target of announcing a possible bid, the prospective bidder’s ability to negotiate directly with shareholders, and increasing trend for bidders to persuade targets to enter into a comprehensive range of deal protection measures (including break fees at the 1% maximum).

The destabilising effects on the target could be said to be in part a result of the UK frustrating action rule (which is much wider than ours) and limitations of the UK ‘put up or shut up’ rule in relation to possible bid announcements.

The comment on deal protection measures is very interesting as the UK Panel considers that targets have been increasingly under pressure to accept, and actually accepting without significant negotiation, standard packages of deal protection measures which in practice restrict the target’s ability to deal with potential rival bidders, in a way which is detrimental to the interests of target shareholders.  

As for Australia, one could argue that a similar trend of targets agreeing to extensive deal protection measures has also been developing. Break fees of 1% are often the norm, even when the dollar amount of the break fee far outweighs the out-of-pocket costs of a bidder. Often an increase in the bid price is traded for a target recommendation, break fee and a package of deal protection measures. However, generally, both the Australian Panel and (in the context of schemes of arrangement) the courts have been comfortable with the deal protection measures, finding that they have been negotiated and adapted to the circumstances of the case, incorporating some give and take. The recent Australian Panel decision in Ross Human Directions, which closely reviewed the deal protection clauses in a scheme implementation agreement is an interesting exception to the general position. The timely observations in that case will tend to prevent boards from accepting lock-ups too readily or with shambolic exceptions.

In that respect, query whether any of the matters listed by the Code Committee are a problem in Australia at this time. Indeed, some would argue that the Australian regime, with a 20% rule and inability to lock up more than 20% pre-bid, makes the playing field skewed against hostile bidders.

UK Panel’s proposed rule changes

The Code Committee proposes a number of rule changes to deal with the perceived unfair advantages of hostile bidders. These are set out below together with a comment on whether the proposals should be considered for adoption in Australia.

  • Forcing potential bidders to clarify their intentions on a possible bid with a short period of time (ie four weeks)

This is about making the UK ‘put up or shut up’ rule more stringent. The problem in the UK is in part because from the time a possible bid is announced the target company is restricted from carrying out various actions under the UK frustrating action rule. The UK Panel believes that this rule has been abused systematically and successfully by bidders. Australia does not have a similar rule, largely because our frustrating action policy is narrower than the UK rule.

  • Prohibiting deal protection measures, except where a target has put itself up for public auction

The UK Panel proposes this radical change, notwithstanding a majority of submissions agree with retaining the current approach (which include a 1% cap on break fees).

The UK Panel considers that deal protection measures included in implementation agreements are, in many cases, not the result of arm’s length negotiations. Similarly, in practice, break or inducement fees do not actually induce bidders to make an offer.

It remains to be seen whether this proposal will withstand further consultation.

The approach is at complete odds with the US position where extensive lock-ups and break fees of 3–4% are common.

The proposal is also unlikely to find favour in Australia, where the Panel and the court seem to be satisfied that they can keep lock-ups at a level which facilitates transactions without effectively locking out rival proposals.

  • Amending the Code to clarify that the target directors may consider factors other than price in providing their recommendation whether to accept the offer

This problem seems to be specific to the UK, and not to arise in Australia, where the price is the principal, but not the only consideration.  

  • Increasing transparency and improving the quality of disclosure

There are a number of proposed changes here including requiring:  

  • disclosure of bidders’ and targets’ advisors’ fees, particularly success fees,  
  • provision of the same financial information concerning the bidder, whether the bid is for cash or scrip, and  
  • improving disclosure of the bidder’s intentions regarding the target and its employees (including a requirement that any statement of intentions hold true for at least one year).  

These matters don’t seem to give rise to burning issues for regulators or target shareholders in Australia. Having said that, disclosures of bidder’s intentions are often formulaic and perhaps do not receive the attention they should.  

  • Greater recognition of target employee interests

This includes facilitating exchange of information between a target company and its employees and their representatives in formulating the target’s response and a response by employees, dealing with the likely effects of the bid on them. Given the previous point, this is unlikely to be found compelling in Australia.  

Way forward for the UK? And for Australia?

The radical nature of some of the UK Panel’s proposed changes are sure to lead to much debate. Some of the proposed changes could be said to be a reaction to some aspects of the Kraft bid for Cadbury which were criticised in the press. Whether this proves to be an overreaction remains to be seen.

In due course, the UK Code Committee will issue detailed proposals for the changes it has proposed in the consultation paper.

As for Australia, many of the issues raised in the consultation paper do not seem to be of great concern having regard to current market practice. However, that is not to say there is not some scope for improvement in the following areas:

Bear hug policy?

Australia does not have a ‘put up or shut up’ rule, or the same need of one, as the UK. However, we have seen threats by bidders to use the Panel’s frustrating action policy to prevent a target from acting to improve (or rescue) its financial position. During the GFC, for instance, there were various instances of prospective bidders using the threat of Panel proceedings in an attempt to bully the target into abandoning urgent fundraisings. Those fundraisings usually proceeded without problem.

Perhaps the Australian Panel should look at adopting a policy defining when bear hugs are (or become) unacceptable, to prevent a potential bidder from:

  • causing prolonged uncertainty for a target company, its shareholders and employees
  • affecting the market in its shares, and
  • attempting to depress its prospects (and in turn its medium/long term share price) by preventing it from taking urgent remedial measures.  

Other issues to consider

It may also be worthwhile for the Australian Panel to look at:

  • refining its frustrating action policy by making it clear that it only applies once a firm intention to bid has been made
  • making a firm rule on the period of time which must elapse following the close of the bid before a bidder can bid again for the same target. Currently, we have no rule against this whereas other jurisdictions have 6 or 12 month restrictions
  • lock-ups not mentioned in its existing guidance note, such as exclusive arrangements with financiers, which have been an issue in some recent private equity bids, and
  • the standard of disclosure regarding the bidder’s intentions.