Proposed Changes to the UK Takeover Code

Introduction

On 21 March 2011 The Takeover Panel (the "Panel") published a public consultation paper setting out detailed amendments to the Takeover Code (the "Code"). This followed an initial consultation paper published in June 2010 and a response paper published in October 2010 addressing feedback from the initial consultation. The proposed amendments were prompted by the much publicised takeover of Cadbury plc by Kraft Foods Inc. and seek to:

• increase the protection for offeree companies against protracted "virtual bid" periods by requiring potential offerors to clarify their position within a short period of time: offerors are to "put up or shut up" within four weeks of being publicly named as an offeror;
• strengthen the position of the offeree company by:

(i) prohibiting deal protection measures and inducement fees other than in certain limited cases; and
(ii) clarifying that offeree company boards are not limited in the factors that they may take into account in giving their opinion and recommendation on an offer;

• increase transparency and improve the quality of disclosure by:

(i) requiring the disclosure of offer-related fees; and
(ii) requiring the disclosure of the same financial information in relation to an offeror and the financing of an offer irrespective of the nature of the offer; and

• provide greater recognition of the interests of offeree company employees by:

(i) improving the quality of disclosure by offerors and offeree companies in relation to the offeror's intentions regarding the offeree company and its employees; and
(ii) improving the ability of employee representatives to make their views known.

Stakeholders have until Friday, 27 May 2011 to comment on the Panel's proposed amendments to the Code and the Panel will then publish a further response statement which will include the final text of the amendments which will be made to the Code. The Panel has indicated that it will then implement amendments to the Code within a month of the response statement.

Response to these proposed changes in the market has been mixed, with some commentators in the press claiming that it could dampen the recovering M&A market. This note considers the proposed changes in more detail.

Proposed Amendments to the Code

1. Increasing the protection for offeree companies against protracted "virtual bid" periods

The key amendments here will require that:

• Following an approach to an offeree board, the potential offeror should be named in the announcement which commences the offer period, regardless of which party publishes the announcement. This means that where an announcement by an offeree company commences the offer period, that announcement should be required to identify any potential offeror with whom the offeree company is in talks.
• Any publicly named potential offeror must within a period of four weeks of being publicly named, be required to "put up or shut up": either announce a firm intention to make an offer or announce that it will not make an offer. This four week deadline will not apply to the sale of a company by means of public auction.

The rationale from the Panel here is that by identifying the offeror at an early stage the tactical advantage that offerors are currently perceived to have over the board of offeree companies is reduced. Offerors will have a greater incentive to ensure that secrecy regarding a potential offer is maintained and no leaks occur which would require an announcement identifying them and which would start the clock ticking on the four week deadline. From an offeree company perspective, the Panel believes that the requirement for the offeree board to announce the identity of a potential offeror in any announcement it is required to make will obviate the need for the board to make a potentially difficult and contentious decision as to whether to identify the potential offeror in such announcement. The Panel also believes that it will be beneficial for offeree company shareholders and other market participants to be able to identify the potential offeror from an earlier stage.

The proposed four week "put up or shut up" deadline has caused some of the strongest criticism. Panel rationale for the move is to redress the balance in favour of the offeree company in that offeree companies would be subject to a shorter period of uncertainty and disruption prior to a formal offer being announced and would have a greater degree of control than present over that duration. Critics have suggested that certain offerors, such as private equity firms which often fund buyouts though leveraged financings and with lengthy due diligence requirements will simply run out of time under the current proposals, unless they can convince the offeree board to apply for an extension.

2. Strengthening the position of the Company by prohibiting deal protection measures, including inducement fees other than in limited circumstances

On a similar theme of strengthening the position of the offeree company, the Panel is proposing prohibition on all deal protection measures, namely:

• Undertakings, such as those contained in "Implementation Agreements" which commit the offeree company to implement a bid, or to refrain from taking action which may facilitate a competing bid, such as non-solicitation undertakings; and
• Inducement or break fee arrangements and any "offer related arrangement" entered into in connection with an offer, either during the offer period or when the offer is reasonably in contemplation, such as an exclusivity agreement.

These will apply to all bids other than where an offeree company board has initiated a formal public auction. There will also be a limited dispensation to allow inducement fees for "white knights" that announce a firm intention to make a recommended competing offer. However, the Panel's general view is that these current practices may deter competing offerors or lead to competing offerors making an offer on less favourable terms, which is not in the best interests of offeree shareholders.

The Panel has recognised that an offeror might legitimately request certain specific undertakings from the offeree company board, for example in relation to:

• the confidentiality of information provided to the offeree company during the course of the offer;
• the non-solicitation of an offeror's employees or customers; and
• the provision of information that is required in order to satisfy the conditions to the offer or obtain regulatory approvals.

Critics are concerned that the removal of break fees may discourage certain bidders, such as private equity firms from making offers for fear of being unable to recoup costs if a target leaves the talks. Significantly reducing the scope of implementation agreements will also make it easier for an offeree board to withdraw from a bid. However, the Panel hasrecognised that offerors need certainty as to the implementation of schemes of arrangement and it is proposing an amendment to the Code to require the board of an offeree company to implement the scheme of arrangement in accordance with a timetable to be agreed with the Panel, subject to the withdrawal of the board's recommendation. Nevertheless, this still leaves the offeree board with the ability to walk away from a recommended scheme if it withdraws its recommendation. This is in contrast to the current practice under Implementation Agreements which only allow the board to withdraw in circumstances where they would otherwise be in breach of their fiduciary duties.

The proposed general prohibition on agreements or arrangements entered into as part of the offer discussions also extend to arrangements whereby the offeree proposes to sell certain assets to an offeror, or under which an offeror proposes to extend financing to an offeree.

3. Clarifying that offeree company boards are not limited in the factors that they may take into account in giving their opinion on an offer

Here the Panel were concerned that there appeared to be a perception among certain market participants that the board of an offeree company is bound by its obligations under the Code to consider the offer price as the determining factor in giving its opinion and deciding whether to recommend an offer. In view of this, the Panel concluded that amendments should be proposed to clarify that the Code does not limit the factors that the board of an offeree company is able to take into account in giving its opinion on an offer, and reaching a conclusion as to whether it should recommend a bid, and is not bound by the Code to consider the offer price as the determining factor. Under the Code, as part of the opinion the board of the offeree is required to send to shareholders, it must state its reasons for forming its opinion and must include the views of the board on:

• the effects of the implementation of the offer on all the company's interests, including, specifically, employment; and
• the offeror's strategic plans for the offeree company and their likely repercussions on employment and the locations of the offeree company's places of business.

A new note in the Code will be added which clarifies that when giving its opinion, the board of the offeree company is not required by the Code to consider the offer price as the determining factor and is not precluded by the Code from taking into account any other factors which it considers relevant.

Whether this will, in practice, have any effect on the offeree board's opinion remains to be seen as skeptics maintain that price will ultimately always be the determining factor unless the offeree board is able to conclude that the acquisition is actually detrimental to the company in a significant way.

4. Increasing transparency and improving the quality of disclosure by requiring the disclosure of offer-related fees and expenses

To increase transparency and give greater information to shareholders the Panel has proposed amendments to the Code to require that:

• each of the parties to an offer should set out an estimate of aggregate fees in the offer document or offeree board circular and that:
  • the estimated fees of the advisers to each of the parties to an offer (including financial advisers and corporate brokers, accountants, lawyers and public relations advisers) should be disclosed separately, by category of adviser; and
  • fees in respect of financing should be disclosed separately from advisory fees;
• maximum and minimum amounts payable as a result of any success, incentive or ratchet mechanism should be disclosed, but without revealing commercially sensitive information regarding the offer; and
• any material changes to the disclosed estimated fees of the advisers to each of the parties to an offer should be announced promptly.

Although these changes have been broadly welcomed, some critics are still concerned that increased speculation on fees could detract attention from the value of a potential bid to the offeree shareholders.

5. Requiring the disclosure of the same financial information in relation to an offeror and the financing of an offer irrespective of the nature of the offer

Here the Panel has recognised that constituencies other than the offeree company shareholders have an interest in information regarding the financial position of the offeror and its group, such as offeree company directors, shareholders of the offeror and employees and customers of both the offeree and offeror. The Panel's proposed amendments will require:

• the inclusion of detailed financial information in respect of an offeror in all offers (including cash offers) and not only in the case of securities exchange offers;
• greater scope for incorporation of financial information by reference (such as by reference to the audited accounts on a company's website);
• in the case of securities exchange offers only, the offer document must contain all known "significant changes" of the offerors financial or trading position since the date of its last audited accounts, or a statement that there are no significant changes;
• details of the ratings outlooks published in relation to the offeror and the offeree and any changes made to those ratings during the offer period and a summary of the reasons given, if any, for a change in these ratings;
• greater disclosure of debt facilities or other instruments entered into by an offeror to finance the offer, irrespective of whether the servicing of those facilities depends to a significant extent on the business of the offeree company (however, this is subject to certain carve outs where an offeror would be commercially disadvantaged by full disclosure); and
• all documents relating to the financing arrangements are to be put on display.

The Panel had also proposed previously that where an offer was "material", the offeror should include a pro forma balance sheet of the proposed enlarged group. However, following discussions with a number of leading accountancy firms, this proposal has been dropped as it could be unduly onerous and advisers to the offeror may not have sufficient time or information available to produce a consolidated pro forma to the required standards.

6. Improving the quality of disclosure in relation to the offeror's intentions regarding the offeree company and its employees and improving the ability of employee representatives to make their views known

The Panel has concluded that the Code should be amended so as to improve the quality of disclosure by offerors and offeree companies in relation to the offeror's intentions regarding the offeree company and its employees. Whilst wholesale changes to the Code are not proposed, amendments will be made so as to require further disclosures to be made. In particular, the Panel has proposed amendments to:

• require offerors to make negative statements if they have no plans regarding the offeree company's employees, locations of business and fixed assets;
• except with the consent of the Panel, require statements in offer documents regarding an offeror's intentions in relation to the offeree company and, in particular, the offeree company's employees, locations of business and fixed assets (or the absence of any such plans), to be expected to hold true for a period of at least one year following the offer becoming or being declared wholly unconditional (save where another period is stated);
• clarify that the Code does not prevent information being provided to employee representatives in confidence during the offer period;
• clarify that it is the offeree company board's responsibility to publish the employee representatives' opinion at the offeree company's expense;
• require that the offeree company pay the costs of obtaining advice reasonably required for the verification of the information in the employee representatives' opinion; and
• require offeree companies to inform employee representatives at the earliest point of the right of employee representatives to give an opinion on the effects of the offer on employment.

It is clear that some of these proposed changes are a direct result of the actions of Kraft Foods Inc. in relation to its statement that it would keep Cadbury's Somerbury factory open, only to close it once the bid was successful. Under the proposed changes, offerors could be disciplined for not complying with statements of intention in relation to the offeree's business and employees.

Conclusion

These changes are likely to come into force by the end of 2011 and it will only be then that we will begin to see whether changes brought about to protect the interests of the offeree company, its employees and shareholders could in fact damage their long term interests by detracting from the number of willing and able bidders.

April 2011
Orrick, Herrington & Sutcliffe (Europe) LLP

Hilary Winter       Partner                     +44 (0)20 7862 4605

Maurice Hoo        Partner                          +852 2218 9130