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The UK Takeover Code: Changes following the Cadbury / Kraft Takeover

By Sidley Austin LLP
Jan 17, 2011

M&A Update

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Introduction

In light of the adverse public comments following Kraft's takeover of Cadbury, the UK Takeover Panel (the "Panel"), with the encouragement of the British Government, initiated a period of consultation regarding the possibility of some key changes to takeover practice in the UK.

Background

It is reported that, at the critical time of the Cadbury transaction, almost 30% of the shares were held by hedge/arbitrage funds which had recently bought into the company's stock for the purposes of a short term gain. This meant that only a small percentage of long term investors needed to be persuaded that the price was sufficient to justify a sale.

Some of the most significant comments made at the time are summarised below.

Lord Mandelson (when Secretary of State for the Government Department of Business, Innovation and Skills) said:

"In the case of Cadbury and Kraft it is hard to ignore the fact that the fate of a company with a long history and many tens of thousands of employees was decided by people who had not owned the company a few weeks earlier, and probably had no intention of owning it a few weeks later."

Lord Myners (when he was the Financial Services Secretary) said that he:

"would particularly encourage the giving of serious consideration to a requirement that shareholders in the target company (as opposed to the board of directors) should be entitled to receive independent advice on any proposed purchase of the company from a qualified party having no financial interest in the outcome."

Finally (and in response to some of the adverse comments), the Association of British Insurers said that:

"...we agree that getting a high price in a takeover may not be the perfect proxy for the fiduciary duties of directors to consider the best outcome for the company in the long term. A board should not feel obliged to recommend a bid as long as it is able to provide a cogent and convincing explanation of its position for which shareholders can hold it accountable."

There was also significant adverse comment regarding the fact that Kraft was not able to deliver on its stated belief that a manufacturing facility in the UK would not be closed down, even though the Panel accepted that this was not an intentional misstatement made in bad faith.

Key issue for consultation

The basic thrust of the consultation related to whether the playing field needed to be tilted more in favour of target boards. As a result of this, a key issue for consultation was whether the 50% + 1 threshold for acceptance of an offer regulated by the UK Takeover Code should be increased (to, say, 60%, 66% or 75%) and / or whether shares acquired on a short term basis should be disenfranchised for the purposes of the offer. In relation to this, it is to be noted that in France many companies provide for additional votes for long term shareholders and that in Germany the acceptance threshold is 75%.

Any such increase in the acceptance threshold would clearly give rise to several consequential issues, including whether the ordinary resolution threshold would need to increase generally under UK company law. Any disenfranchisement would also give rise to a disproportionate increase in power for the ever-decreasing pool of remaining long term investors, whilst affecting fundamental company law principles (including the EU principle of free movement of capital) and General Principle 1 in the Takeover Code (that all target shareholders are to be afforded equal treatment). If takeovers were to be made more difficult, there could also be downward pressure on share pricing generally.

Summary of proposed changes

The Code Committee (the "Code Committee") of the Panel has recently announced the outcome of its extensive consultation process.

In summary, the Code Committee has concluded that hostile offerors have increasingly been able to obtain a tactical advantage over the target company to the detriment of the target company and its shareholders. It has determined, therefore, to introduce proposals to amend the Code with a view to reducing this tactical advantage and redressing the balance in favour of the target company. The Code Committee has also concluded that a number of changes should be proposed to the Code to improve the offer process and to take more account of the position of persons, in addition to target company shareholders, who are affected by takeovers.

The objectives of the proposed changes are to:

  • increase the protection for target companies against protracted "virtual bid" periods;
  • strengthen the position of the target company;
  • increase transparency and improve the quality of disclosure; and
  • provide greater recognition of the interests of target company employees.

It is proposed that these objectives are to be achieved by amending the Code to:

  • require potential offerors to clarify their position within a short period of time;
  • prohibit deal protection measures and inducement fees other than in certain limited cases;
  • clarify that target company boards are not limited in the factors that they may take into account in giving their opinion and recommendation on the offer;
  • require the disclosure of offer-related fees;
  • require the disclosure of the same financial information regarding an offeror and the financing of an offer irrespective of the nature of the offer;
  • improve the quality of disclosure by offerors and target companies in relation to the offeror's intention regarding the target company and its employees; and
  • improve the ability of employee representatives to make their views known.

The Code Committee determined that any changes to success thresholds or voting rights could only be effected by legislation and so these potentially far-reaching changes are not being considered at this stage.

There will be a further phase of consultation on the detailed wording of the proposed changes (as well as regarding transitional provisions) and it is expected that the changes will be in place by late Spring 2011.

Comment

We would make the following observations regarding the proposed changes to the Code:

  • the removal of inducement/break fees (and other deal protection) could fundamentally impact the number of deals that are proposed, particularly those involving private equity offerors;
  • it has been noticeable that the private equity sector did not involve itself in the consultation process – it is likely that this will change in the next, more detailed, phase of consultation (although the indications are that the Panel will resist the expected PE push-back against the removal of inducement fees and other deal protection);
  • in order to compensate for the removal of the traditional forms of deal protection, it is likely that there will be more stakebuilding as a means of giving more certainty of deal delivery and as a hedge against the costs of deal failure – which, in turn, will give rise to other issues, such as the need to balance concerns regarding insider dealing against the wish to carry out due diligence; there could also be circumstances where there will be more inclination to seek deal protection from parties other than the target;
  • the new short timetable following the announcement of a potential offeror is likely to make hostile bids more difficult, particularly those requiring significant financing; potential offerors will need to be much more prepared at an earlier stage and will also wish to be even more careful to minimise the risk of leaks (which is a recent theme of the FSA in any event – see, for example, Market Watch 27);
  • the newly articulated objective element of the standard of disclosure will require careful consideration in the context of offeror statements being made without full access to target information;
  • the new enhanced disclosure requirements regarding bid financing could give rise to a significant advantage to subsequent bidders;
  • there will be a window of opportunity for deal protection (and virtual bids) pending the changes coming into effect (expected to be late Spring 2011); and
  • whilst the Government has indicated this it is still looking at ways to facilitate long term decision making and transparency for offerors, there does not appear to be any current appetite to look at fundamental changes to UK corporate law relating to the threshold at which control passes.

Some further details in relation to the proposed Code amendments are set out below.

1. Requiring potential offerors to clarify their position within a short period of time

Background

One of the primary purposes of the Code is to provide an orderly framework in which UK takeover bids may be conducted. So, after a firm intention to make a bid is announced, an offer document must be published within 28 days. However, an "offer period" could start much earlier with a "possible offer" announcement, which could be voluntary or in order to avoid a false market after speculation or an untoward price movement.

In recent years, a voluntary "possible offer" announcement has been increasingly used in order to test the sentiment of target shareholders without incurring an obligation to make a formal offer and/or to put pressure on a target board to engage in talks in relation to an otherwise unwelcome approach. This became known as making a "virtual bid" – in that there would be no certainty of a final bid ever being made, even though debate would take place as if an offer had been made.

The impact of this "virtual bid" period was ameliorated to a certain extent by the introduction in 2004 of the "put up or shut up" regime pursuant to which, at the request of the target, the Panel would set a period (usually six to eight weeks) in which the potential bidder either had to announce a firm intention to make a bid or withdraw (for at least six months).

Proposed change

The Code Committee has determined that target companies should be provided with greater protection against protracted 'virtual bids', primarily through amendments to the 'put up or shut up' regime. It is proposed, therefore, that the Code be amended as follows:

  • to require that, following an approach, the potential offeror is named in the announcement which commences an offer period, regardless of which party publishes the announcement; and
  • to require that, except with the consent of the Panel, any publicly named potential offeror must, within a fixed period of four weeks following the date on which the potential offeror is publicly named:
  • announce a firm intention to make an offer (under Rule 2.5); or
  • announce that it will not make an offer, whereupon it will then be subject to the restrictions referred to in Rule 2.8 (ie, it will not be able to bid for a six month period); or
  • make an application, jointly with the target company, for an extension to the deadline and explain the expected timetable to the announcement of a firm intention to make an offer under Rule 2.5, following which an announcement would normally be required to be published updating the market on the status of the discussions and the revised deadline. The Panel has indicated that it will look at each case on its merits and will be sympathetic to well argued requests for a specific extension by reference to particular facts.