A consultation process launched by the Takeovers Panel late last year has produced updates to two Guidance Notes, released on 8 August. Both the updated Guidance Note 7 and Guidance Note 19 pose some issues for Boards entering exclusivity arrangements, or managing insider participation in control transactions.
Guidance Note 7: deal protection and fiduciary outs in M&A transactions
The aim of Guidance Note 7 is to assist market participants in understanding the Panel's approach to deal protection devices sought by bidders. Deal protection devices are strategic tools that typically impose restrictions on the target's ability to encourage or facilitate a competing proposal during a control transaction. While the Panel recognises that deal protection devices can be used by a target board to secure a proposal, these devices also raise concerns about restricting competition and sidelining competing bidders, especially at the indicative non-binding stage.
In light of the recent cases of Virtus Health and AusNet, each of which included deal protection devices with no fiduciary out, at the non-binding indicative proposal stage of negotiations – the Panel has revised Guidance Note 7 in order to clarify the position in relation to lock-up devices, seeking to strike a balance between protecting a deal during its early stages, and upholding a competitive market.
In the matter of AusNet, the Panel evaluated the viability of "hard" exclusivity periods during the pre-deal phase. AusNet entered into exclusivity arrangements with Brookfield Infrastructure Group (Australia) Pty Ltd with what appeared to be common terms in relation to the no-shop, no-talk restrictions and notifications obligations. When Australian Pipeline Limited (APA) announced a competing proposal and AustNet responded that it would only consider the proposal following the lapse of the timeline as per its exclusivity arrangement with Brookfield (where the exclusivity arrangement could only be terminated with a week's notice after the seventh week, regardless of whether the competing proposal was superior to the initial proposal ie. an 8-week exclusivity was given to Brookfield). APA made an application to the Panel where it sought orders for the Panel to either order a termination of the exclusivity arrangements with Brookfield or for the arrangements to be made subject to a fiduciary out (ie. to allow the target board to consider a superior proposal which were in the best interest of its shareholders). The exclusivity arrangements with Brookfield also included a $5 million cost reimbursement in some circumstances. The Panel deemed the arrangements (as a whole) with Brookfield to be unacceptable and ordered the inclusion of a fiduciary out clause and also ordered for AusNet to disclose the material terms of the amended exclusivity arrangements including the cost reimbursement.
The case of Virtus also brought into focus the question of the suitability of lock-up devices in pre-deal arrangements, where the Panel looked at an exclusivity window of 10 to 11 weeks where the fiduciary out is triggered only if the target receives a superior proposal. The notification obligations of Virtus were to inform the initial bidder of the particulars of a competing proposal, who had 1 business day under a matching right to match the competing proposal with a further non-binding proposal.
The Panel was concerned about the above obligations on the target in a non-binding agreement and agreed that the combined effect of Virtus' deal protection devices had an anti-competitive effect, where the target remained without the certainty of a binding proposal and that those arrangements (especially at the non-binding stage) exacerbate the anti-competitive effect of the arrangements. Similarly, in the earlier decision of AusNet, where the Panel found that an 8-week exclusivity period and a "no talk" restriction granted by the target with no fiduciary carve-out were unacceptable, particularly in circumstances where the measures were not disclosed to the market in a full and timely manner, the Panel ordered for the terms be amended to include an effective fiduciary carve-out and shortening the length of exclusivity arrangements.
The Panel's key changes to Guidance Note 7
The revisions to Guidance Note 7 centre around the terms of a non-binding, indicative takeover proposal. In particular:
"Hard" exclusivity: the Panel expects that where a target board decides to grant due diligence access to a potential bidder, the default position is that it should be granted on a non-exclusive basis (with short periods of exclusivity (not more than 4 weeks) subject to an effective "fiduciary out" clause). However, the Panel gives some examples where "hard" exclusivity, if granted during a limited period, could be acceptable:
- A major shareholder has made a bid for the target company (or a bidder has the support of a major shareholder) and the target board considers that granting hard exclusivity would be required for another bidder to enter the process and stimulate competition for the target company.
- The target board has conducted an auction process or a fulsome sounding out of the market and is aware of a potential bidder for the target company and considers that granting hard exclusivity will encourage an offer to be made.
- The target board has granted hard exclusivity to extract a material price increase from an existing bidder.
- There is a single bidder for the target company and the board of the target company considers it unlikely that any competing bid at a higher price will emerge, the target board considers that the price offered fairly values the company and the target board considers that granting hard exclusivity to that bidder would potentially enable the proposal to progress to binding status.
Break fees: the Panel has made clear it does not "expect" break fees in non-binding proposals, but that any break fee payable by a target during the non-binding bid stage should be "substantially lower" than 1% of the equity value (which is generally acceptable in the case of a binding agreement) of the target in order to be acceptable.
Disclosure: the Panel also clarified that at a minimum, the "existence and nature" of all material terms of any deal protection arrangement should be disclosed before the relevant control proposal is announced (if not earlier). In particular, the Panel will expect disclosure in the following circumstances:
- where there is an obligation requiring the target to notify the prospective bidder of any competing bidder's identity or the terms of a competing proposal; or
- where the target board has agreed to recommend a transaction where the bidder puts forward a binding proposal on the terms of its indicative proposal.
What should target company boards consider in light of those changes
Guidance Note 7 increases the threshold for upholding a competitive, informed market during the non-binding indicative proposal stage of negotiations. Moving forward, target directors should:
- question any onerous deal protection mechanisms in a non-binding offer put forward by a bidder company;
- as a starting point no exclusivity is to be granted, but only grant "hard" exclusivity to a potential bidder where that exclusivity is for a short period of time (of not more than 4 weeks) and subject to an effective fiduciary out clause;
- agree to break fees only in exceptional circumstances, and ensure that the amount of any such fee during the non-binding stage is well below the normal 1% break fee threshold; and
- when entering into deal protection arrangements during the non-binding indicative proposal stage be aware of their disclosure requirements to at least disclose the material terms and conditions of those arrangements.
Overall, target directors should test the terms and conditions of exclusivity arrangements (including any cost reimbursement) as a whole (especially at the pre-binding stage), if there are any impediment if a competing proposal props up. Target directors should also keep in mind their disclosure obligations to the market when entering exclusivity arrangements.
Insider participation in control transactions: an enhanced approach in Guidance Note 19
Although the Panel's decision to release Guidance Note 19 was primarily driven by an increase in private equity bids, subsequent Panel judgements have taken issues of managing conflicts outside of private equity into consideration and occasionally in recent Panel decisions considered issues outside of the scope of Guidance Note 19.
Therefore, the objective of the updated Guidance Note 19 is to provide market participants with a better understanding by clarifying the regulatory framework the Panel employs when addressing scenarios involving insiders' participation or potential participation alongside a bidder in a takeover bid or prospective bid for a target entity. The guidance is designed to ensure that target boards and managerial teams conduct proper evaluation of a bid our counterbid being free from any insider influence, whether actual or perceived. The Panel's reason for providing updated guidance is rooted in the fact that "in order to have a competitive, informed and efficient market there must be no inside control over voting shares and market participants should be given enough information to enable them to assess the merits of any transaction."
The key changes by the Panel include amongst other things provide an extended definition of an "insider" to now include individuals beyond officers or former officers of the target company, incorporating those with significant undisclosed information about the target or its operations, such as current or past advisors.
Furthermore, the revised definition of a "participating insider" includes insiders who are bidders, potential bidders, or have affiliations with them. The Panel has also outlined several factors that could trigger unacceptable circumstances, including bid process integrity, disclosure levels to shareholders regarding insider relationships with bidders, the potential negative impacts of insider involvement in fundraising with significant control impact, fairness of transaction terms involving participating insiders, the effectiveness of board protocol, information disparities among bidders, and sharing of sensitive information by insiders with potential bidders without proper authorisation.
Guidance Note 19 also provides that if all directors are "participating insiders", companies should consider appointing at least one independent director to form an independent board committee. This initiative reinforces independent decision-making and good governance.
Ultimately, the Panel has the power to order remedies such as requiring further disclosure, commissioning expert reports, restricting voting rights of insiders, extending bid periods, or cancelling acceptances.
Things for Boards to consider
Boards should consider creating processes and protocols for when a bid is received (in which there is participation by insiders) which also covers the negotiation process in order to mitigate potential conflicts (or consider if existing processes and protocols are in line with the updated Guidance Note 19). The Panel is aware that no situation or scenario is analogous and as such has only provided guidance on what protocols companies should seek to implement instead of prescribing a set list of protocols.
The process
Board should consider their processes for insider participations such as:
- notification, where insiders should be encouraged to promptly inform the board or relevant sub-committee about potential approaches or before entering into any agreement with a proponent for a potential control transaction;
- the steps insiders should take to prevent conflicts until disclosure including the sharing of non-public information (to be done with prior board consent);
- ensuring that the process steps are clearly communicated to the company's management and board.
The protocols
Board should check the overall premise of their protocols, which should seek to:
- establish rules concerning information disclosure, access and confidentiality;
- prevent participating insiders from influencing the target's response to any proposal;
- ensure that the IBC has appropriate advice, including legal and financial guidance;
- safeguard the integrity of the process when appointing advisers by avoiding conflicts ; and
- ensure that shareholders' best interests are prioritised when assessing a proposal involving participating insiders.
When setting up an IBC, Boards should be mindful that the role of the IBC is to manage potential conflicts if there is insider participation, and the Panel encourages IBCs to consider implementing the following potential protocols:
- informing participating insiders and bidders about IBC's process control and level of involvement.
- A representative of the target company may attend meetings between insiders and bidders.
- Require participating insiders to limit communications with bidders or resign if necessary.
- Insiders must not disclose corporate information without IBC's approval and a confidentiality agreement.
- Restrict discussions of bids or proposals with third parties unless approved by the IBC; and
- Participating insiders must disclose any material non-public information shared with bidders.
The Panel considers that an IBC should establish processes to manage the flow of information to all bidders, including those associated with insiders.
The guidance acknowledges that each situation is unique, and the IBC's approach should be aligned with the company's circumstances. Therefore, Boards should take a broad approach and assess if their processes and protocols provide adequate transparency, information control, and protection to shareholders' interests while managing potential conflicts arising from participating insiders.
Disclosure to shareholders
Adequate disclosure is essential, Boards need to also ensure that the protocols in place provide proper guidance to the IBC, to ensure that target shareholders receive clear information, for example in the target's statement, which includes details about participating insiders' identities, any relationships with the bidder, incentives offered, and protocols to manage conflicts of interest. Additionally, the identity of individuals behind a bidder should also be disclosed.