The revised public M&A process is encouraging lawyers and clients to work more closely, and get more imaginative about how legal work is paid for
What are the merits and demerits of changes to the Takeover Code regarding naming and put-up-or-shut-up (PUSU) disclosure requirements and deal protection measures?
Mark Bardell, partner, Herbert Smith Freehills: The biggest change was the PUSU regime, intended to strengthen the position of target companies. This is undoubtedly a powerful tool for the target company board and it has had a real impact in the early stages of negotiations. The possibility of being subjected to a deadline as short as 28 days and the threat of target boards responding in that way gives the target board a new lever.
By the same token, we have not seen a large number of bidders being publicly identified and seen off in the first 28-day period. Target boards are, rightly, being careful of their shareholders’ reaction to learning of an approach by a bidder and do not want to risk being seen as hasty in dismissing approaches. So this aspect is working well in practice.
One concern is that potential bidders less familiar with the panel’s consultative regime and practice are incentivised not to appoint external advisers so as to remain outside the panel’s definition of “active consideration” and therefore attempt to remain outside the panel’s leak and PUSU regime prior to approach. This is counterproductive: better for bidders to take advice as early as possible to be better informed and prepared, and better for the panel to have bidders that are better informed at an earlier stage.
Paul Whitelock, partner, Norton Rose Fulbright: The pros and cons of the regime were debated at length at the time of the overhaul of the code and opinions continue to differ on the merits of the changes. The compressed timetable has not been the real hurdle. Early naming is and always will be an issue for certain bidders and that, coupled with an inability to mitigate execution risk through deal protection, has had an impact on the appetite for bid activity among certain of our clients. The bottom line, though, is that if the deal’s worth doing commercially, you usually get round these issues.
Tom Mercer, partner, Ashurst: The evidence suggests naming can discourage certain types of offerors – particularly listed corporates who may face downward pressure on their share price as a result of public disclosure of their interest in a company. There are also concerns that naming can, perversely, operate against the interests of a company seeking to approach offerors to gauge interest in a possible bid.
The automatic PUSU regime doesn’t appear to have had a huge market impact. The panel will always in practice agree to an offeree-sponsored request for a PUSU deadline extension, and it is a brave offeree board that will refuse to seek such an extension if requested by a potential offeror, given the directors’ overriding duties.
This said, the regime has, to a certain extent, achieved its objective of improving the negotiating position of the offeree board.
Given the relative scarcity of public-to-private transactions in the past two years deal protection measures have not had an appreciable effect on public M&A. Offerors have, for the most part, treated this as a fact of life and moved on.
Nick Rumsby, partner, Linklaters: There has been limited dealflow since the changes so it’s early days. The PUSU and naming changes have reinforced the need for secrecy and, in most cases, have made bear hugs less attractive. However, a significant number of PUSU deadlines have been extended, which suggests the automatic 28-day period is too short, leaving potential offerors reliant on the will of target boards to extend. The market has quickly adapted to the measures.
How are potential offerors adapting to the restrictions when they’re preparing to make a bid?
Bardell: The biggest practical impact of the new regime is that well-advised bidders are better prepared when making the initial approach. Bidders, both domestic and international, are initially surprised to hear of the right of target boards publicly to identify bidders and subject them to a deadline as short as 28 days, and that they are not permitted to seek any period of exclusivity or other deal protection. This usually takes time to come to terms with, but the practical consequence is that any bidder must be well-prepared at the time of approach, having completed its due diligence on publicly available information, so as to be in a position to table a well-thought through and compelling proposal.
Whitelock: As the market expected, the 28-day time constraint means there’s more emphasis on early stage preparation. There’s nervousness around early identification and bidders will often now, as a matter of course, put targets on notice that they intend to walk away if a deal leaks prematurely.
Getting deal protection from elsewhere has been a focus for bidders, with increased consideration of stakebuilding or direct contractual comfort from target shareholders, whether through tightly negotiated irrevocable undertakings or, at the other end of the spectrum, shareholder break fees, where the target shareholder base makes that a viable option. Another effect of the compressed timetable is that it has resulted in earlier and more realistic engagement on price with target boards, where a bidder’s due diligence and financing requirements mean assistance is required from the target company.
Mercer: Offerors now need to be better prepared before making private approaches to offeree boards. This means early consideration must be given to issues such as financing and levels of shareholder support.
The prohibition of deal protection measures has meant that offerors are looking at alternative ways of improving certainty of execution. This has resulted in more focus on shareholder irrevocables, as well as more interest in stakebuilding in the offeree’s shares. The latter typically requires advice in relation to market abuse and insider dealing risks.
Rumsby: Potential offerors are focused on maintaining confidentiality at the start of a possible bid to avoid being named and a PUSU deadline being imposed before they have had a chance to consider properly their options and gauge the reaction of a target board to any approach. Potential offerors recognise the importance of constructive engagement with a target board unless they are willing to go hostile in a short timeframe. Unfortunately, the changes have discouraged some participants from looking at UK public bids.
How has this affected legal fee arrangements?
Bardell: Prospective bidders want more protection against the risk of the deal failing. On the other side, target boards do not want to incur substantial costs in relation to potential bidders who they believe will walk away or be seen off relatively quickly. This means providing more visibility on the quantum of fees in different scenarios and much more emphasis on risk-sharing, with abort/success arrangements and other fee structures.
It also means moving away from hourly rates, the need for a more commercial approach and greater empathy with clients’ needs.
Whitelock: Disclosure on legal fees in offer documentation has not particularly affected how fees are structured. Increased deal execution risk may, however, have contributed to a degree of contingency and risk-sharing. This has not been driven solely by the code changes though, as an element of risk-sharing/reward has become a feature of fee structuring on M&A deals across the board, not just on public M&A transactions. Depressed takeover activity and competition for mandates among firms has probably had a more significant impact on legal fee arrangements.
Mercer: Legal work on bids is increasingly being front-loaded, meaning that significant costs can be incurred before an offer is announced. At the same time, the new requirement for fees to be disclosed has helped legal advisers estimate legal costs more accurately.
Rumsby: The changes haven’t themselves changed client approaches to fee arrangements but, in line with the wider market, we’re seeing clients considering success/abort arrangements for early-stage work.
How has the new regime been received internationally, particularly with regard to disclosure and deal protection measures?
Bardell: While public M&A volumes are low we’re all working in a global environment. I don’t think the new regime has put off non-UK bidders. The biggest challenge in practice is working the various international regulatory approvals required in most deals into the code framework and timetable.
The issue of non-domestic bidders is always politically sensitive. The changes we are discussing here are the product of Kraft’s hostile bid for Cadbury and, more recently, the Government has invited comment on the suggestion that short-term shareholders should be disenfranchised in the takeover context.
Compare this with France where the parliament has just approved the first reading of a law which would mean shareholders holding shares for two or more years would be allocated double voting rights.
Whitelock: There’s a considerable amount of time spent explaining the impact of the rules to clients and the regulatory environment is now quite different from most other international capital markets, where exclusivity arrangements and break fees are commonplace. Some observers would no doubt point to the statistics on announced bids in 2012/13, note that the vast majority of bidders are still international and conclude that the revised rules are not having much effect.
But that’s only half the story. In our experience, on certain deals with international corporates the rules have been a factor in deciding whether or not to proceed and, more generally, takeover activity levels have been lower this year than for five years.
Mercer: Concerns have been expressed that the PUSU regime might operate particularly harshly in relation to state-owned overseas offerors who cannot obtain the necessary outbound clearances to bid for a UK plc within 28 days. This is because the panel will not typically allow state-owned offerors to make their offers conditional or pre-conditional on such clearances.
Separately, potential offerors overseas are bemused by the prohibition of deal protection measures, which they consider unnecessary and paternalistic.
Changes to disclosure rules have also raised eyebrows abroad, with particular concerns being raised by US leverage finance desks about the extent of the required disclosure in relation to an offeror’s financing arrangements.
Rumsby: A lot of overseas buyers are quite surprised by the UK rules, but are not put off if they’re sufficiently interested in the target.
More than two years on and the changes to the Takeover Code implemented in September 2011 are still being described by City practitioners as “in the early stages”, given the relatively low public market deal volumes since the changes were made. However, some interesting trends are emerging, particularly in respect of the relationships between advisers, principals and the regulators.
The naming and PUSU regimes have had a positive impact on confidentiality, with fewer companies entering into offer periods as a consequence of leaks or untoward share price movements. However, we share the concern of some panellists that some potential offerors are now instinctively reluctant to involve external advisers early, in the
belief their absence makes the presumption of “active consideration” easier to rebut.
In addition, as financial advisers, we are seeing more referrals from lawyers where the legal adviser has been the first point of contact for an offeror and has had to promote the appointment of a competent UK financial adviser subsequently. This is particularly notable for overseas companies. An obvious example of the issues that could arise is a lack of appropriate coverage of Rule 2 obligations in the early stages.
Smith Square Partners believes the changes to the Code have made it more, rather than less, important for companies to be properly advised in the early stages of a possible deal. Our view is reinforced by a number of factors which have been highlighted by the panellists: (i) the trend for front-loading diligence; (ii) the experimental development of alternative sources of deal protection (for example, the use of shareholder break fees and/or other non-conventional irrevocable terms); and (iii) the interest from overseas buyers to whom the UK regulatory framework and rules might be unfamiliar.
Advisers’ interactions with the Panel have also evolved. Years ago, this was almost exclusively through financial advisers, but it is now far more common for legal advisers to interact directly. We believe this has been driven by a number of factors, including frequent and more complex changes to the Code and the fact that fewer financial advisers have in-depth Code expertise. The legal community has been more consistent in this regard.
As a consequence, an obvious asymmetry has arisen between those who are often giving Code-specific advice and the regime of censure, which is almost entirely focused on financial advisers. It is unlikely that the Panel will allow this to persist. There are two possible consequences – either the Panel looks to draw legal advisers more explicitly into the governance aspects of the Code, or it moves the focus of its interactions back to financial advisers. It will be interesting to see what steps are taken.
Jade Jack and Jonathan Coddington, Smith Square Partners