In the past, hedge funds have profited from investing in listed German companies going through a corporate restructuring, particularly those in the midst of a squeeze-out. These investments were attractive because, under the German Stock Corporation Act (Aktiengesetz or AktG), shareholders of German stock corporations are entitled to receive a “fair compensation” for their shares in case of corporate reorganization measures, such as a squeeze-out or the conclusion of a domination and profit-loss pooling agreement (Beherrschungs-und Gewinnabführungsvertrag) with a holding company after a takeover. However, two recent court decisions may signal an end to these profitable opportunities.
Such mandatory compensation situations are the arbitrageur’s ideal opportunity because compensation is based on one of two factors—one fixed and one flexible. Hedge funds and other minority investors have found opportunity between these two factors. In the first “fixed” case, mandatory compensation is based on the company value as of the date of the shareholders’ meeting at which the corporate measure is approved. Value is determined by a chartered accountant in the net earnings method (Ertragswertverfahren) and in accordance with the Standard IDW S1.
In the second “flexible” case, compensation is based on average share price over a three-month period. The German Federal Supreme Court (Bundesgerichtshof) decided in its March 2001 DAT/Altana decision that compensation may not fall short of a three-months average share price if a share price of the relevant company exists. Final compensation is based on the higher of the two factors.
Hedge funds and other minority shareholders liked to invest in these restructuring companies because they could manipulate average share prices to their advantage. According to the DAT/Altana decision, the average share price had to be calculated over a three-month period prior to the relevant shareholders’ meeting. Because the company has to publish its intent to restructure immediately after making that decision (in general several months prior to the shareholders’ meeting), minority shareholders had enough time to acquire shares in the company and then to push the average share price up until it exceeded the company’s value on the date of the announcement, thus ensuring higher mandatory compensation.
Although legal scholars highlighted the flaws in this process, most courts continued to follow the DAT/Altana decision.
Two Court Decisions Affect Compensation
Two higher courts recently took a different view regarding the determination of the average share price, one that is opposite to the Federal Supreme Court’s DAT/Altana decision. In late 2006, the Berlin High Court (Kammergericht) ruled that the relevant end date for the three-month average share price should be the date of the announcement and not the date of the shareholders’ meeting. This means that the average share price relevant for the compensation is already determined in the moment of the announcement of the corporate measure. Any trading and development of the share price after the announcement would be irrelevant for the compensation derived from the average share price. In February 2007, the High Court (Oberlandesgericht) in Stuttgart took the same position.
Although contrary to the DAT/Altana ruling of the Federal Supreme Court, both decisions are not surprising. German legal scholars had already pointed out the flaws of the Federal Supreme Court’s ruling. For example, in the case of a squeeze-out the major shareholder must submit a report on the fairness of the compensation, which it then has to include in the invitation to the shareholders’ meeting. However, the Federal Supreme Court decision made it impossible for the major shareholder to report on the fairness of the compensation prior to the shareholders’ meeting as such compensation could only be determined on the day of the shareholders’ meeting. In addition, the application of the three-month period prior to the shareholders’ meeting made it easy for arbitrageurs to push the share price and therefore the compensation to a higher level, which probably did not accurately reflect the company’s value. Finally, critics argued with a comparison to the relevant offer regulation (Angebotsverordnung) of the German Securities Acquisition and Takeover Act (Wertpapiererwerbs-und Übernahmegeset or WpÜG), which says that in takeover offers, the average share price over the course of three months prior to the date of the announcement of the decision to launch a tender offer determines compensation.
Because it deviated from the DAT/Altana ruling, the High Court Stuttgart submitted its ruling for a final decision to the Federal Supreme Court. If it keeps the above arguments in mind, the Federal Supreme Court very well might overrule the principles set forth in the DAT/Altana decision.
Hedge funds might not find German-listed companies to be the profitable investments they once were. If the Federal Supreme Court agrees that the average share price should be determined the moment the corporate measure is announced, then hedge funds lose their ability to alter share price and to generate a higher return.