20 September 2001
The Corporations and Securities Panel
AUSTRALIAN INSTITUTE OF COMPANY DIRECTORS COMMENTS ON CORPORATIONS AND SECURITIES PANEL POLICY STATEMENT ON LOCK-UP DEVICES
The Australian Institute of Company Directors
The Australian Institute of Company Directors (AICD) is the peak organisation representing the interests of company directors in Australia. Current membership is over 15,000, drawn from large and small organisations, across all industries, and from private, public and the not-for-profit sectors. Membership is on an individual, as opposed to a corporate basis.
The AICD is a federation of seven State divisions, each of which is represented on a National Council. Overall governance of the AICD is in the hands of its National Council which is comprised of the seven division Presidents, plus a National President, two National Vice-Presidents and a National Treasurer. AICD has several national policy committees, focusing on issues such as corporations law, accounting and finance, environment, taxation and economics, and national education, along with task forces to handle matters such as corporate governance.
The key functions of AICD are:
1. Simplicity, Clarity and Brevity
- to promote excellence in director's performance through education and professional development;
- to initiate research and formulate policies that facilitate improved director performance;
- to represent the views and interests of directors to government, regulatory bodies and the community;
- to provide timely, relevant and targeted information and support services to members and, where appropriate, government and the community;
- to maintain a member's code of professional and ethical conduct;
- to uphold the free enterprise system;
- to develop strategic alliances with relevant organisations domestically and internationally to further the objectives of the AICD.
The Policy is long and partly repetitive. Directors who are not lawyers will have difficulty understanding it and should not be obliged to take legal advice on such a matter.
It may be helpful if the Policy is divided into several parts. The first part might constitute General Rules which summarise the Policy. Other parts could contain a detailed analysis, definitions and a glossary.
Since the Policy is intended for directors as well as lawyers and advisers, it would be useful to attach excerpts from primary references to eliminate the need to refer to external materials such as the Corporations Act.
The AASB Statement approach might be considered to include a specific summary, a general exposition and a definitions section (as well as excerpts from relevant primary materials).
2. Need for Explicit Warnings
The Panel's Policy is likely to be applied literally by directors in an area of legal ambiguity. It will therefore be appropriate to provide preliminary boxed warnings to readers in relation to the following matters:
2.1The Policy is not a Statement of Law
AICD is concerned that the Policy does not sufficiently warn directors that they may still breach their duties by entering into a device which complies with the Policy.
The Policy refers to directors' duties, but AICD considers that the Panel has not sufficiently emphasised the seriousness of this issue.
The views of the Panel concerning device acceptability may be interpreted as a "safe harbour" although a Court might later take a different view based on legal principles. To avoid such an interpretation, there should be an explicit warning at the start of the Policy that compliance with the Policy will not necessarily fulfil the duties imposed on directors by the common law. The Policy should recommend that any person who wishes to enter into a lock-up device should seek expert legal advice.
2.2The Policy Cannot Bind Particular Cases
The warning should also state that the Panel does not have authority to bind the decisions of Panels empanelled for particular cases.
The Panel does clearly indicate that particular Panels will exercise discretion, but AICD considers that this point should be stated plainly in a warning box.
3. Statement of Authority for Panel to Issue Policy Statements
The Policy should identify the authority of the Panel to issue Policy Statements.
AICD supports the Panel's objective of creating order in takeovers, but since it has no express power to issue Policy Statements, their legal basis should be justified. The Panel is in effect creating a new type of law by releasing a Policy which will create the commercial assumption that the lock-up devices acceptable under the Policy are legally valid.
This assumption may be incorrect, as a lock-up device may be void or unenforceable (despite conformity with the Policy) because it contravenes the law relating to directors' duties, reductions of capital, related party transactions or otherwise.
Under section 657A of the Corporations Act, the Panel only has power to intervene in particular cases to declare circumstances in relation to the affairs of a particular company to be unacceptable.
Neither the Corporations Act nor any other legislation gives the Panel a general power to promulgate policy guidelines. There is a risk that publication of the Policy could cause participants to assume that the Panel exercises a general binding and unchallengeable power.
Public debate should take place in relation to the Policy. AICD recommends that the Panel should make all submissions publicly available through its website.
5. Comments About Specific Issues
5.1 Cap On Break Fees
The Policy proposes a general cap on break fees of 1% of the value of the bid. AICD notes that this is similar to Rule 21.2 of the City Code on Takeovers and Mergers published by the Takeovers Panel in the United Kingdom ("City Code") which provides that "an inducement fee must be de minimis (normally no more than 1% of the offer value)".
AICD submits that the Panel should emphasise more clearly that it will be flexible in considering exceptions.
A situation could arise in which the size of the bidder's offer (e.g., 20-30% above the average price of the target's shares) is such that rejection of the bid by the directors, on the basis of the fact that the break fee exceeds the cap, could amount to a breach of the duty that the directors owe the target shareholders. It is necessary to take into account the circumstances of individual cases to determine what is appropriate. As the Panel notes, the 1% cap may be too low in the case of some small bids and unacceptably high in the case of very large bids.
The Panel seems to adopt a "liquidated damages model" to determine the level of break fees. AICD questions whether this is the appropriate model to determine "reasonable costs" when deciding upon the acceptability of a break fee arrangement. AICD suggests that a much broader view should be adopted to incorporate value-added fees (e.g., reasonable costs plus incentive fees).
AICD submits that the guiding principle for the Panel should be that break fees should be acceptable if they do not prejudice shareholders. In making a decision regarding the acceptability of a break fee arrangement, a distinction should be drawn between the amounts payable by the company and the amounts payable by major shareholders.
5.2 Inducement Fees
AICD generally believes that a liquidated damages approach to break fees in the Policy (paragraph 50 and following) is overall justified, but submits that there should be a greater recognition of exceptional circumstances which might even justify the payment of a proportionate "success fee" in unusual cases.
The Panel must recognise the diverse circumstances that exist for business. Due to the relative difficulty of attracting interest in a target, a target board may need to provide greater assurances as to costs to be incurred or possibly even greater incentives or inducements to bid than is contemplated by the Panel.
Straightforward guidelines are desirable, but there is a danger in being overly prescriptive.
It is noteworthy that the City Code refers only to "inducement fees" on the basis that a bidder sometimes needs to be induced to commence a takeover process which may create the auction process desired by the Panel. Provided the inducement fee is considerably less than the additional value created for the shareholders, there may be reason to reward the initiating bidder with a success fee.
AICD suggests that the Panel consider permitting the recovery of all actual costs as well as an appropriate inducement fee in unusual cases.
5.3 Definition of Pre-emptive Rights
Paragraph 12 of the Policy describes "pre-emptive right arrangements" and gives as an example an option to purchase key assets in the event of a change of control. Such an option is usually referred to as a "crown jewels" arrangement and does not appear to the AICD to constitute a pre-emptive rights arrangement. Pre-emptive right arrangements should be properly defined in the Policy.
5.4 Pre-emptive Rights in Joint Venture Agreements
AICD submits that paragraph 45 (in particular paragraph 45(d)) should not be so prescriptive and that it will be more appropriate for the Panel to make decisions on a case by case basis.
Paragraph 45(d) states that in considering the acceptability of pre-emptive right agreements, issues that the Panel will consider include whether target shareholders approved the agreement at the time the target company entered into it, or when the underlying assets had grown sufficiently large in proportion to the target company to affect the competitiveness of the market for the target company.
Paragraph 45(d) may create problems in the establishment of joint venture agreements. This is because arrangements concerning pre-emptive rights tend to be entered into at the outset of the joint venture when the value of the companies is small. Paragraph 45(d) creates the risk that joint venturers will not enter into arrangements conferring pre-emptive rights at the outset of the transaction for fear that if the joint venture is successful and the value of the companies becomes large, the Panel may decide that the pre-emptive arrangements constitute unacceptable lock-up devices. The Policy may thus considerably inhibit joint venture arrangements which have been traditionally and properly used in major ventures in Australia.
The approach suggested in paragraph 45(d) may also affect certainty of contract in joint venture agreements. Pre-emptive rights are an essential element in many joint venture agreements (especially in the mining and petroleum and technology sectors of the economy) and are settled arrangements. AICD submits that the statements in paragraph 45(d) may be subject to strong legal challenge and recommends deletion.
AICD also believes that pre-emptive right arrangements should only be viewed as infringing competition and being unacceptable if there is some immediacy between the time when they were entered into and the emergence of a takeover bid or if the pre-emptive rights arrangements are otherwise related to a takeover bid.
Paragraph 46 of the Policy states that the existence and terms of material pre-emptive right arrangements entered into by listed entities must be clearly and fully disclosed to the market at the time of commencement. AICD believes that this matter should be dealt with by the continuous disclosure requirements in the ASX Listing Rules.
5.5 No-talk and No-shop Agreements
Paragraph 23 of the Policy states that:
"... the acceptability threshold for justifying agreements [containing no-talk or no-shop agreements] which commence or continue once a bid has been announced rises markedly"
Whilst in theory no-talk or no-shop clauses that cease to apply when a bid is announced minimise the impact on competition for control of the target, clauses are rarely drafted in this manner. A bidder will usually want to have the protection of these clauses throughout the period of the bid, otherwise there is a risk of the target actively soliciting rival bids immediately after the initial bid is announced.
Accordingly, AICD considers that no-talk and no-shop clauses that continue to run after a bid has been announced should not of themselves give rise to unacceptable circumstances, provided:
The discussion of no-talk and no-shop agreements in paragraphs 40 to 43 should also discuss the creation of "black-out" periods in takeovers to allow the due diligence process to take place.
5.6 Relevant Factors
Paragraph 49 generally summaries the various matters covered in earlier paragraphs of the policy, but AICD is concerned that paragraph 49(g) contains language that goes beyond commercially accepted practice in the consideration of issues normally placed before a Board and its advisers in the context of a lock-up device and potential bids.
In AICD's view, it is not necessary that the bid which the break-fee induces offers shareholders exceptional value for their holdings. There may be commercial circumstances where it is in the best interests of shareholders for the directors to facilitate a bid through a pre-bid agreement containing a lock-up device, e.g., in the case of an under-performing company needing the benefit of new capital expenditure which cannot be sourced from the listed market or other sources. Such an offer could be at a significant premium to the market price (which may not reflect underlying value).
AICD suggests that such an offer should be evaluated by reference to traditional "fair and reasonable" criteria and not by whether it creates exceptional value for shareholders. The latter approach has the potential to introduce a new set of evaluation criteria.
AICD considers that, irrespective of the circumstances of its initiation, every bid needs to be evaluated by reference to the well accepted methodology of "fairness and reasonableness".
5.7 Recovery of Reasonable Outgoings, Expenses and Opportunity Costs
AICD agrees with the view expressed by the Panel that break fees will generally only be acceptable if they relate to reimbursement of the costs actually incurred by the bidder. However, AICD believes there should be some flexibility in this approach.
The appropriateness of the Panel determining that the opportunity costs incurred by a party are covered by a break fee is questionable. Opportunity cost is extremely difficult to measure, particularly in large transactions.
As noted above at 5.2, there may be occasions when a target is justified in paying an inducement or success fee to a bidder, particularly if the bidder initiates a takeover contest leading to significant added value for the shareholders.
Accordingly, AICD is concerned by the specificity of the statement in paragraph 54 that the Panel does not see any basis for reimbursement of success fees. In some cases, the commercial reality may be that some companies are difficult to sell and such an arrangement is necessary when intermediaries are involved.
AICD suggests that a break fee including reimbursement for opportunity costs and a success fee could be considered reasonable if the directors can clearly demonstrate that such an arrangement is to the benefit of the company's shareholders.
5.8 Full Disclosure
AICD agrees with the thrust of the requirement for full disclosure of lock-up devices set out in paragraphs 59 and 60.
However, the question of whether a lock-up device should be fully disclosed by announcement to the ASX should depend on the application of the ASX Listing Rules. Whether it should be disclosed in a bidder's statement or target's statement should depend on the requirements contained in the Corporations Act.
AICD submits that the severity of the statement in paragraph 50 should be reduced by the inclusion of a requirement that the relevant lock-up device have a "material effect on price or value".
AICD is aware of Panel proceedings in which the Panel was not informed of a target company's lock-up arrangements with potential bidders. The recommendation in paragraph 59 that lock-up devices be disclosed in a target's statement may be inadequate if Panel proceedings are completed before a target statement is issued. AICD therefore recommends that the Panel require as standard procedure that all lock-up devices be fully disclosed to it if Panel proceedings are commenced, whether or not they are considered by any party to be relevant to the proceedings.