The European Takeovers Directive ("The Directive") was implemented in the UK with effect from 20 May 2006. This has changed the regulatory framework applicable to takeovers of companies in the UK and also affects the manner in which takeovers of companies with a dual presence in both the UK and another jurisdiction are made. The purpose of this briefing note is to highlight the principal features of the new regulatory framework as it applies to takeovers of UK companies. This note does not deal with dual jurisdiction companies which should be considered by reference to their particular circumstances.
This briefing note is not exhaustive, but seeks to highlight the principal changes to the regulatory regime and provide a practical insight into the manner in which the new regime will be applied going forward.
Bird & Bird’s Corporate Group in London has extensive experience of the conduct of UK takeovers and would be happy to advise on any specific situation or question arising from this briefing note. It is emphasised that this briefing note should not be taken as a substitute for specific legal advice. Public takeovers in the UK are highly regulated and there are considerable risks in proceeding without proper and specific advice.
The new regulatory framework
The Directive has been implemented in the UK through the Takeovers Directive (Interim Implementation) Regulations 2006 ("The Regulations"). The Regulations are framed as interim regulations because the key provisions are to be incorporated as primary legislation within the Company Law Reform Bill which is currently making its way through parliament. However, this significant piece of company law legislation is not due to be implemented until early 2007 and the UK would have been in breach of European law if it had failed to implement the Takeovers Directive by 20 May 2006.
The Regulations only seek to give effect to the Directive and as the Directive only applies to offers for companies in the UK whose shares are traded on a regulated market, this means that there will be two parallel regulatory frameworks running in tandem with each other until the Company Law Reform Bill is implemented.
- For companies whose shares are traded on a regulated market (primarily fully listed companies), the principal regulatory framework for takeovers will comprise the following:
- the City Code on Takeovers and Mergers (“the Code”);
- the Regulations; and
- the Directive.
- For companies whose shares are not traded on a regulated market (ie. primarily AIM companies and other unquoted companies to which the Code applies) the principal regulatory framework for takeovers will comprise the following:
- the Code; and
- the Companies Act 1985 (“the Companies Act”).
Notwithstanding these changes, it will still be the case that the vast majority of the regulation governing takeovers in the UK will be contained in the Code. The Panel on Takeovers and Mergers ("the Panel") has published changes to the Code which took effect on 20 May 2006. These changes bring the Code into line with the Directive and give effect to a number of other changes which have been the subject of recent consultation.
The Regulations also have the effect of changing the status of the Panel such that it will now be a statutory body and its rules will have statutory affect. However, for the time being, its rules only have statutory affect to the extent that they relate to matters required by the Directive and the Regulations. This position will change on implementation of the Company Law Reform Bill when the powers and duties of the Panel will be put on a statutory basis in respect of all aspects of the Code.
Principal effects of the Regulations
The following are the principal effects of the Regulations and the changes to the Code introduced on 20 May 2006:
Enforcement and the Panel’s powers
- Increased Panel power – the Panel now has statutory powers to require the production of documents and power to seek to enforce its rules through application to the Court for the granting of a court order. Until such time as the Company Law Reform Bill is introduced, these powers will only be exercisable in the case of takeovers of companies whose shares are traded on a regulated market.
- There is a new statutory power for the Panel to order compensation where there has been a breach of certain specific rules of the Code, being any of Rules 6, 9, 11, 14, 15, 16 or 35.3.
- The Regulations impose a statutory obligation on the Panel to co-operate with other regulatory authorities. This requirement is similar to practice under the previous regime in the sense that the Panel has for a number of years sought to cooperate with such bodies as the Financial Services Authority (“FSA”). However, this is now a statutory obligation rather than voluntary cooperation. It will be interesting to see whether, over time, the Panel becomes more closely aligned to other regulators such as the FSA.
- The Panel will not have any power to amend any Directive based rules in the Code until such time as the Company Law Reform Bill comes into effect. In view of this, the Panel is unlikely to introduce further amendments to the Code (beyond those introduced on 20 May 2006) until such time as the Company Law Reform Bill is implemented.
Bid documentation contents rules
- The Regulations introduce a criminal offence of failing to ensure that bid documentation (including defence documents) meet the contents requirements imposed under the Directive. These contents requirements have been incorporated as a new Appendix 6 to the amended version of the Code, although these are in essence cross-references to pre-existing provisions of the Code.
- The offence of failing to comply with the bid documentation contents rules applies not only to offerors and offerees, but also to their respective agents and therefore would extend to financial advisors involved in the preparation of bid documentation. However, there is a defence if a party did not know of a breach and took all reasonable steps to avoid an offence being committed. The potential penalties for breach of these statutory requirements include fines and/or imprisonment.
- On a practical level, an action under the new statutory rules for failing to comply with the bid documentation contents requirements may only be brought by the director of public prosecutions and this is only likely to occur in circumstances where the Panel recommends this. Our expectation is that this is only likely to be a remedy sought in extreme circumstances where there is a clear disregard for the bid documentation contents requirements. Notwithstanding this, financial advisers who have historically made offers as agents on behalf of their corporate client may be less willing to do so in light of this additional level of risk.
Breakthrough, frustrating action and reciprocity
- The concepts of breakthrough, frustrating action and reciprocity, which form a significant element of the Directive, have been introduced into UK law. In the run-up to the Directive, there was much debate and disagreement between different member states throughout Europe as to whether these concepts should form a part of harmonised European legislation. Largely as a result of an inability to reach agreement, the Directive contemplates that member states may opt in or opt out of these concepts within their local implementing legislation.
- In the UK, the position on each of these, as reflected in the Regulations, is as follows:
In relation to breakthrough (a principle which would provide for the unenforceability of restrictions on transfers of securities and other corporate devices which serve as defensive structures, such as preferential shares or voting structures) the starting position is that these provisions will not apply to UK companies. However, the Regulations include a right for any company to opt into the breakthrough provisions of the Directive. Market forces have already reduced the number of companies with preferential share and voting structures in the UK and therefore the question of whether or not a company should opt into the breakthrough provisions of the Directive is unlikely to be relevant in most cases. However, on a practical level it would always be important to check this in relation to any particular bid situation.
The UK has decided to opt into the provisions of the Directive imposing restrictions on target companies undertaking frustrating action without shareholder approval. This has always been a feature of the Code under the existing Rule 21, although changes have now been made to that Rule in order to bring it into line with the scope of the Directive.
Under the Regulations, the UK has opted out of reciprocity, such that UK companies are not able to take advantage of the reciprocity provisions of the Directive. The principle of reciprocity is that where a company within a particular jurisdiction has opted into the Directive provisions relating to breakthrough or frustrating action, then any other party to a takeover transaction with that entity could rely on the principle of reciprocity to ensure that an equivalent approach is adopted in relation to that other party. The UK has opted out of the reciprocity provisions of the Directive, largely because it is believed the principle would otherwise have served as a fetter on the UK's existing open takeover regime.
Increased transparency in annual reports
- New requirements for the contents of a company's annual report have been introduced pursuant to the Regulations in respect of those companies whose shares are traded on a regulated market, and these provisions will apply to all annual reports in respect of financial years beginning on or after 20 May 2006.
- These requirements will be extended to companies whose shares are not traded on a regulated market once the Company Law Reform Bill is implemented.
- The new contents requirements for the directors' report in a company's Annual Report provide that details of the following must be included:
- structure of the company’s share capital (including details of the right attaching to different classes of shares);
- details of any restrictions on transfer of shares;
- details of all significant shareholders known to the company concerned;
- details of any person who has any special right of control over the share capital of the company;
- details of in whom the control of shares held by an employee share scheme is vested where such control is not held by the employees themselves;
- details of any voting restrictions applicable to any shares or classes of shares;
- details of all rules and regulations within the company’s constitution governing the appointment and replacement of directors;
- details of any significant agreements entered into by the company which include change of control clauses; and
- details of any arrangements with directors which provide for compensation on change of control.
- Although these changes will, in practical terms, take some time to become effective, in due course they will result in a Company’s annual report being a more useful source of information to those parties involved in takeovers, as it should help identify any “poison pill” agreements that might exist. Offerors will therefore be able to plan their bid strategies with a greater knowledge of these types of situation.
New squeeze out / sell out provisions
- The existing statutory regime relating to the ability for an offeror to squeeze out minority shareholders (and for minority shareholders to require an offeror to buy them out) is contained in sections 428-430F (inclusive) of the Companies Act. New rules relating to these provisions have been introduced as a result of the Directive. Once the Company Law Reform Bill is implemented, these rules will apply to all offers for UK companies. However, in the intervening period, the new rules will only apply to companies whose shares are traded on a regulated market.
- As a result of this, the manner in which the squeeze out provisions will apply will differ depending on whether an offer is for a fully listed company or for an AIM or unquoted company.
- The principle effects of the change to the squeeze out provisions are as follows:
- In order to be able to rely on the squeeze out provisions, an offeror needs to achieve acceptances in respect of 90% of the shares to which the offer relates and 90% of the voting rights carried by those shares. This is a slightly different test to that under the current regime;
- The right to squeeze out a minority is exercisable under the new regime for a period of 3 months following the date on which the offer ceases to be open for acceptance. This is quite a significant change because under the old regime an offeror had to achieve the necessary threshold within 2 months of an offer becoming unconditional and within 4 months of the offer first being made. The new regime will allow an offeror to leave its offer open indefinitely and thereby maintain its ability to squeeze out minorities without a time limit.
- On a practical level, it will be important to ensure that offer documentation properly reflects the appropriate legislation depending on the nature of the target company.
Changes to the Code and the Panel structure
- It should be noted that the revised Code will comprise rules which are founded on the Directive and rules which are not founded on the Directive but are based on existing practice. Only in the former case will the additional powers of enforcement which are devolved on the Panel by the Directive apply.
- Historically, the Panel has always been able to apply the rules of the Code in a flexible manner and has had the power to grant waivers or derogations from particular rules. This position is likely to continue to apply, but where any particular rule is based on a Directive requirement, there will be an additional obligation on the Panel only to grant a derogation from a particular rule if it is satisfied that the derogation does not infringe the general principles (as modified by the Directive). It is to be expected therefore that the Panel will adopt a more cautious and considered approach in granting waivers and derogations from particular rules.
- The definition of a company to which the Code applies has been modified in the following manner:
- All companies which have a registered office in the UK, whether or not they have central place of management and control in the UK, will be subject to the Code if their shares are traded on a regulated market;
- All other companies which have a UK registered office and whose central place of control and management is considered by the Panel to be in the UK or the Channel Islands will be subject to the Code, save that this will not be the case for private companies other than certain limited categories of private companies, broadly equivalent to the previous regime.
- The practical effect of this is that for UK companies whose shares are traded on a regulated market in the UK, the Code will always apply and it is no longer relevant whether or not the central place of management is in the UK or the Channel Islands.
- Special rules apply where a UK registered company does not have shares traded on a UK regulated market, but does have its shares traded on another European Economic Area regulated market. These should be considered in the circumstances of a particular case.
- Transactions to which the Code apply are broadly equivalent to those which were covered by the Code under the old regime. However, the dual jurisdiction rules in the Directive mean that the Panel may assume a shared regulatory responsibility for offers for non UK companies whose shares are traded in a regulated market in the UK.
- The Panel's approach to re-registration of a public company as private and to the granting of a Code waiver for companies with small numbers of shareholders will broadly follow the existing practice. However, the effect of the Directive is that in the case of companies whose shares are traded on a regulated market, it will not be possible to obtain a Code waiver. In practical terms, however, this is unlikely to be relevant, given that a Code waiver would generally never be available for a listed company anyway given the number of shareholders that are likely to be involved.
- In terms of the manner in which practitioners deal with the Panel, the approach will broadly be the same as the previous regime. However, the Panel's ability to offer guidance or publish practice statements is constrained by the provisions of the Directive. It is likely therefore that guidance notes and practice statements published from time to time will be heavily qualified.
- There are increased obligations on practitioners to seek guidance from the Panel on specific provisions and there is an explicit statement in the revised Code that relying on legal or professional advice on the interpretation of the Code is not a defence for a breach of the Code or a substitute for consulting the Panel Executive.
- There are also new rules which have been introduced by the Directive requiring practitioners to co-operate with the Panel save where the rules of professional privilege apply.
- The enforcement regime that is now available to the Panel has been significantly enhanced, with additional powers available to the Panel including the following:
- the Panel is able to issue directions;
- the Panel is able to make compensation orders for breaches of rules 6, 9, 11, 14, 16, or 35.3;
- the Panel is able to apply to the Court for an order seeking enforcement;
- as indicated earlier, there is a criminal offence for failure to comply with bid documentation contents rules;
- the disciplinary procedures are more prescriptive and are set out in the Code in more detail; and
- there is a statutory duty on the Panel to co-operate with other regulators.
- It remains to be seen whether the Panel adopts a more aggressive approach to its enforcement role.
Specific changes to the rules contained in the Code
- The existing general principles in the Code have been replaced by the general principles contained in the Directive. There are six general principles, as compared to ten in the previous version of the Code. The new general principles are substantially the same as previous general principles and those which have now been removed are instead replicated elsewhere in the Code.
- The most likely practical change arising from the adoption of the Directive’s general principles is that the Panel will always be required to have regard to the general principles when considering whether or not to grant derogations or waivers from particular rules. It is instructive that because the Panel now has an obligation to give reasoned decisions for any derogation or waiver of the Code, a number of express derogations have now been written into the specific rules of the Code so that the Panel is able to continue its existing practice of granting waivers in appropriate circumstances.
- Under the old rules, there was an obligation on an offeree to circulate the first announcement which marked the commencement of an offer period to its shareholders. In many cases, this was a “talks” announcement under Rule 2.4. Offeree shareholders would therefore receive that initial announcement but would not necessarily receive the more detailed announcement of a firm intention to make an offer under Rule 2.5. New rules have been introduced requiring an offeree company to circulate the firm intention to make an offer announcement under Rule 2.5 even where the offer period has already been triggered earlier by a “talks” announcement.
- In keeping with the Directive’s focus on protecting the interests of employees, there is a new obligation under the Code to ensure that the Rule 2.5 announcement is made “readily available” to employee representatives or, where there are no such representatives, to the employees themselves. As to what constitutes “readily available”, this will depend upon the particular circumstances, as the Panel would ordinarily expect a company to inform its employees and/or representatives by whatever means the company normally uses to communicate with its employees. However, there is a specific acknowledgement in note 1 on Rule 2.6 that placing the Rule 2.5 announcement on the offeror’s or offeree’s website might be inappropriate method of disseminating the information to employees.
- It should also be noted that the obligation to circulate an offer announcement to shareholders and employees is absolute and therefore extends to shareholders and employees in overseas jurisdictions. On a practical level, careful thought will therefore need to be given as to how Rule 2.5 announcements are made available to employees and/or shareholders outside the UK. Rule 30.3 recognises that there may be circumstances in which it would be impracticable to circulate announcements and offer documents to persons in overseas jurisdictions, but the scope for declining to do so on the grounds of difficulty is much more specifically defined and there will generally be a requirement to consult the Panel.
- A number of changes have been made in terms of the contents requirements for an announcement of a firm intention to make an offer under Rule 2.5, including the following:
- It is necessary to include in the Rule 2.5 announcement details of any inducement fee arrangements entered into;
- Where the offer is for cash or includes a cash alternative, there is a need to include the cash confirmation required under Rule 24.7 within the Rule 2.5 announcement. Historically, this has only been required where the offer was a Rule 9 offer;
- The Panel is also tightening up its approach to conditional finance in circumstances where the cash element of the consideration due under an offer is to be satisfied through an equity fund raising. Under the revised notes on Rule 13, it is acknowledged that in such circumstances, the funding may be conditional on the passing of necessary offeror shareholder resolutions to create and/or allot the new shares and/or conditional on the new shares being admitted to listing. However, the Panel will not ordinarily permit conditionality to extend to other conditions that an underwriter might seek in the context of an underwriting of an equity fundraising. Historically, the Panel has not sought to intervene on the terms being negotiated between an underwriter and an issuer, but it might be expected that this may change in the future. There is now a specific obligation to consult the Panel where any financing is the subject of an equity fundraising.
Offer documents and defence documents
- As with announcements, there are specific new provisions relating to the publication and circulation of offer documents. It is a Directive requirement for an offer document to be made public and this leads to a requirement for the offer document to be put on display under Rule 26. An announcement will be needed to confirm when an offer document is published and where it may be inspected. As with announcements, there is an obligation to make an offer document “readily available” to employee representatives or employees.
- The rules relating to dissemination of offer documents also apply to documents circulated by an offeree company (ie. defence documents).
- The obligation to ensure proper dissemination of offer documents and defence documents to shareholders and employees or their representatives is enshrined in a new Rule 30.3 which provides that these documents must be sent to shareholders or employees wherever located. Market practice historically has been to refrain from sending documents into jurisdictions where this would require registration of such documents with a local regulatory authority or where there is significant risk of litigation. The new Rule 30.3 provides an ability for the Panel to grant a derogation from this requirement where there is “sufficient objective justification” for not applying the rule to the publication of documents in certain jurisdictions. However, the scope for granting such a derogation is very specifically constrained in that it only applies to non-EEA countries and even then it only applies in circumstances where either less than 3% of the shares of the offeree company are held by shareholders in the relevant jurisdiction or where the circumstances are such that it would be “proportionate” for the Panel to grant a dispensation. On a practical level, therefore, anyone involved in a takeover offer will need to assess where shareholders and employees of an offeree are located and consult with a Panel to the extent that there are regulatory constraints on dispatching documents into those jurisdictions.
- A number of new contents requirements are being introduced in relation to offer documents and defence documents. These include the following:
- It will be a requirement for an offeror to include in its offer document its strategic plans for the target company and their likely repercussions on employment and the location of the offerees place of business. It will also be necessary to specifically highlight details of any material changes in conditions of employment. On a practical level, this is likely to preclude offerors from merely including the usual bland statement that the offeror will have regard to the employments rights of employees of the target.
- Full details of each director’s remuneration will need to be included in an offer document or defence document rather than just a statement of aggregate remuneration.
- It will be necessary for an offeree to include a statement of all known material changes in the offeree’s financial or trading position since its last published accounts, something that was only a requirement for the offeror in relation to the offeree under the previous rules.
- An offeree company is required to append to its document advising shareholders of its recommendations in relation to the offer an opinion from representatives of its employees on the effect of the offer on employment. This obligation will only arise if the employee representative’s opinion is received “in good time” before publication. It should be noted that this does not constitute a prior consultation obligation. For example, in the context of a recommended offer where the Rule 2.5 announcement and the offer document are published simultaneously, there will be no time to obtain an opinion of the employee representative prior to announcing an offer and the Panel acknowledges that this will not be in breach of the new rules. Furthermore, the Panel has confirmed that it would not expect a subsequent consultation obligation to arise. However, it will be interesting to see whether offerees consult more widely with employees in any event given that, regardless of the view taken by the Panel, these requirements are statutory provisions under the Regulations.
- As highlighted above, there is now potential criminal liability for non-compliant offer documents or defence documents.
Derivatives and options
- After extensive consultation, the Panel has concluded that in most cases, an interest in securities and dealings in securities should extend to interests and dealings in derivatives and options. This has led to a significant change in the definitions used throughout the Code, with the introduction of a new definition of “interest in securities”, which extends to interests in long derivatives and options. The impact of these changes can be seen in a number of areas, including the following:
- An acquisition of a long derivative or option by a party to an offer (including those persons acting in concert with that party) will count toward the 30% threshold for the purposes of Rule 9 of the Code and will be subject to the restrictions on acquisitions in Rule 5 of the Code. However, Rule 9.3 of the Code (which requires that a Rule 9 offer can only be conditional on achieving more than 50% of the voting rights by way of acceptances) and the equivalent provisions regarding acceptance in Rule 10 are unchanged. This means that interests in shares by virtue of derivatives and options will not count towards satisfaction of the acceptance conditions. This is consistent with the Panel’s approach that an offer should become unconditional as to acceptances only where statutory control has passed (something which may not be the case if derivatives and options are counted).
Timing restrictions on acquisitions
- One consequence of this is that a Rule 9 offer might lapse because the offeror has not satisfied the acceptance condition, even though it has a derivative or option which, once closed out, could take the offeror through 50%. In these circumstances, new rules have been introduced whereby an offeror would ordinarily be required to make a further mandatory offer in such circumstances.
- Changes are also being made to Rule 6 and Rule 11 such that where an interest in shares that has been acquired by an offeror is in the form of an option or derivative, there is mechanism for calculating what the purchase price is for Rule 6 and Rule 11 purposes.
- From a practical perspective, any dealings in options or derivatives by an offeror or any persons acting in concert with an offeror (including its investment bank) would need to be carefully assessed in relation to the potential impact on the offer terms.
- Notwithstanding the extension of the definition of an interest in shares to include options and derivatives, the Panel has acknowledged that this could give rise to unintended consequences for trading desks of investment banks and securities houses whose business is to provide derivatives dealing services to its clients. In particular, the Panel acknowledges that where a trading desk undertakes a dealing on behalf of its clients and such dealing is wholly unrelated to an offer situation, it would be inappropriate for a mandatory offer obligation to arise. The Panel has therefore introduced the concept of a “recognised intermediary”. Provided the Panel has approved a particular investment bank as a recognised intermediary, then that intermediary’s trading desk dealings in options and derivatives will not be included in the interests of the offeror and persons acting in concert with it for the purposes of Rule 9. It should be noted, however, that having recognised intermediary status does not prevent dealings in options and derivatives from counting for other Code purposes, such as Rules 6 and 11.
- The disclosure regime under Rules 8 and 38 has also been modified to reflect the requirement to disclose interests in securities including options and derivatives and to reflect the concept of recognised intermediaries.
- After an extensive period of consultation, the Panel has decided to abolish the Rules Governing Substantial Acquisitions of Shares (SARs). This means that there will no longer be a restriction on the speed with which an interest in shares at a level below 30% are required. The acquisition of interests in shares at levels between 15% and 30% will continue to be subject to the general Companies Act disclosure obligations and there will no longer be a separate SAR disclosure regime.
- The rules relating to tender offers previously included within the SARs have now been incorporated into a new Appendix 5 to the Code.
- Rule 5 of the Code has been modified so that there is an absolute obligation to consult with the Panel in circumstances where a person receives a gift of shares or interest in shares which takes the aggregate holding to 30% or more.
Incentivisation of management
- The carve out from Rule 16 (general obligation to treat offeree shareholders equally) which in certain circumstances allows arrangements be put in place between an offeror and offeree management for their incentivisation following change of control has been tightened up and extended. In all cases, Panel consent is required and as a condition of such consent, the Panel will require shareholder approval (previously this was only a requirement where management held 5% or more in the shares of the offeree company).
- In addition, the Panel now requires as a further condition to giving its consent to arrangements for the incentivisation of management that the independent Rule 3 adviser to the offeree publicly states that in its opinion the arrangements are fair and reasonable.
- The prohibition on the frustrating action in Rule 21 has been extended to encompass what was previously in the general principles in terms of the general prohibition on frustrating action.
- In addition, the carve out that allowed an offeree company to fulfil an existing contractual obligation without seeking shareholder approval has been removed and instead there is an obligation to consult with the Panel. The indications are that the Panel will give its consent where there is a pre-existing contractual obligation, but the emphasis of the Rule has been changed, bringing it into line with the Directive.
- A new provision is also being introduced into Rule 21 which allows the Panel to waive the requirement for a general meeting to approve a frustrating act if the holders of more than 50% of the voting shares of the offeree confirm in writing that they would approve the action proposed.
Although the above summarises in broad terms the effects of the Regulations and the changes introduced to the Code with effect from 20 May 2006, fairly extensive amendments have been made to all sections of the Code, such that a completely new version has been published.
It will take a little time for market practice to develop in relation to certain things (for example whether or not an offer is made directly by an offeror or by a financial advisor on its behalf, given the additional potential exposure for financial advisors).
As ever, public offers will continue to require the greatest of care and attention in their execution and it will be interesting to see whether market participants take the opportunity to test the Panel in the exercise of its new powers, either through the Courts or otherwise.
If you would like further information or specific advice on any particular aspect of the new rules, please contact Simon Allport or any of the other partners in Bird & Bird’s Corporate Group in London.
Nothing in this briefing constitutes legal advice. Always consult a suitably qualified lawyer on any specific legal problem or matter.
Bird & Bird assumes no responsibility for information contained in this Briefing and disclaims all liability in respect of such information.