Takeovers Panel publishes updated guidance on deal protection mechanisms

12 minute read  17.08.2023 Alberto Colla and Hugh McDonald

The Takeovers Panel recently published updated guidance on the permissible limits of deal protection mechanisms.


Key takeouts


  • Target directors should seek to negotiate and ‘test’, rather than simply accept as a matter of course, any preliminary deal protection mechanisms sought by a prospective bidder at the non-binding indicative proposal stage
  • Target boards should only grant ‘hard’ exclusivity and break fees at the non-binding indicative proposal stage in exceptional circumstances
  • Target directors may need to disclose to ASX the entry into deal protection arrangements at the indicative proposal stage

Typically, these deal protections are focused on giving a prospective acquirer exclusivity and cost reimbursement protection. This is well before it is certain whether or not the negotiations will reach the point of a formal binding offer being put to a target that is capable of being submitted to target shareholders for their consideration.

The Panel’s updated guidance reflects a view that market practice has drifted too far down the 'acquirer friendly' path where prospective acquirers have been successful in securing favourable deal protection mechanisms at the non-binding indicative proposal stage, at the potential expense of facilitating a competitive contest for control of the target.

As a result, the updated guidance seeks to rebalance market practice to more clearly, and in the Panel's view, more equitably, regulate the use of deal protection mechanisms at the non-binding indicative proposal stage. On the one hand, this provides helpful flexibility for target boards to determine when it is appropriate to agree to such arrangements and when to push back against them. On the other hand, early indications are that the updated guidance may have emboldened prospective acquirers to press for these deal protections as a matter of course at the non-binding indicative proposal stage.

Guidance Note 7 Deal protection - what are the key changes?

The changes provide updated market guidance around the permissible limits of the following two matters that prospective acquirers have increasingly been asking target boards to agree to at the time that a non-binding, indicative ‘friendly’ takeover proposal is presented to them:

  • ‘hard’ exclusivity – this refers to where a prospective acquirer asks a target board to agree to provide exclusive due diligence access solely to that prospective acquirer for a designated period, without any so-called ‘fiduciary’ carve out – the absence of a fiduciary carve out means that the target board is prohibited for the designated period from engaging with a competing bidder in any circumstances (including where a competing bidder submits an alternative, potentially superior non-binding indicative proposal on an entirely unsolicited basis); and
  • cost reimbursement – this refers to where a prospective acquirer asks a target board to agree to pay the prospective acquirer a fixed amount to cover its costs if the non-binding indicative proposal does not develop into a formal binding offer that is capable of being submitted to target shareholders for their consideration.

The Panel’s updated guidance also addresses the extent to which these deal protection mechanisms at the non-binding proposal stage need to be disclosed to the market, assuming the target board agrees to them.

The nature of these changes, what prompted them and the key takeaways

Importantly, the Panel’s previous long-standing guidance on the permissible limits of deal protection mechanisms for an acquirer in the context of a formal, binding proposal remains unchanged. Namely, that 'hard' exclusivity is not permissible (it needs to be subject to a fiduciary carve out), a break fee payable by a target to the prospective acquirer needs to be capped at 1% of the equity value of the transaction and the break fee triggers must not be coercive or anti-competitive.

What has prompted the updated guidance?

The Panel’s updated guidance was largely prompted by two earlier Panel decisions in AusNet Services Limited 01 [2021] ATP 9 and Virtus Health Limited [2022] ATP 5, each of which involved deal protection arrangements granted by a target board to a prospective acquirer at the indicative proposal stage that were determined by the Panel to be unacceptable.

In the AusNet auction, the Panel agreed with rival bidder APA that an eight week exclusivity period granted by AusNet to Brookfield at the indicative proposal stage – with no fiduciary carve out that allowed AusNet to respond to an unsolicited competing proposal – was too long. This, together with cost reimbursement arrangements in favour of Brookfield – which were not disclosed to the market in full and in a timely manner – prompted the Panel to make a declaration of unacceptable circumstances.

Similarly, in the auction for control of Virtus Health, the Panel accepted a complaint from rival suiter BGH Capital and declared that Virtus’ exclusivity agreement with its first suitor CapVest was unacceptable, as it locked out BGH and any other potential rival bidders for approximately one month and was also granted at the indicative proposal stage.

'Hard' exclusivity – the exception not the rule, or is it?

The updated guidance reflects the Panel’s expectation that where a target board decides to grant due diligence access to a prospective acquirer, the default position should be for this access to be granted on a non exclusive basis. However, the Panel acknowledges that, in some circumstances, the target board may determine that it is necessary to grant exclusivity to the initial prospective acquirer to facilitate a potential proposal.

In those circumstances, the Panel suggests that the exclusivity arrangements should be subject to an effective ‘fiduciary out’ to allow the target board to respond to and engage with the proponent of an unsolicited competing proposal that is or may be superior to the first proposal, including by granting concurrent due diligence access to that rival proponent.

Despite this, the Panel also acknowledges that, in some circumstances, the target board may determine that it is necessary or otherwise appropriate to grant exclusivity to the initial prospective acquirer, without this type of ‘fiduciary out’ (so-called ‘hard’ exclusivity), at least for a short period, to facilitate a potential proposal.

The Panel considers that ‘hard’ exclusivity is likely to have an anti-competitive effect and, the longer the period of any ‘hard’ exclusivity, the more anti-competitive it will be. Accordingly, the Panel suggests that any period of ‘hard’ exclusivity granted to facilitate a potential proposal should be short, limited to no more than four weeks and must be warranted in all of the circumstances. The Panel has provided some limited examples of when a short period of ‘hard’ exclusivity may be defensible, including where:

  • a major shareholder has made an offer for the target (or a prospective acquirer has the support of a major shareholder) and the target board considers that granting ‘hard’ exclusivity would be required for a competing bidder to enter the process and stimulate competition for the target company;
  • the target board has already conducted an auction process or a fulsome market sounding process, is already aware of a prospective acquirer for the target as a result of that prior process and considers that granting it ‘hard’ exclusivity will encourage an offer to be made;
  • the target board considers that granting ‘hard’ exclusivity would extract a material price increase from an existing prospective acquirer; or
  • there is only one prospective acquirer and the target board considers granting ‘hard’ exclusivity would potentially enable that prospective acquirer to progress its proposal to binding status.

Although the above circumstances will be relevant to the Panel’s determination, they should not be seen as absolute safe harbours. The Panel has made clear that it will look at the circumstances as a whole and the context in which ‘hard’ exclusivity is granted in determining whether it is unacceptable.

It remains to be seen whether this guidance will result in a proliferation of ‘hard’ exclusivity arrangements in reliance on the above circumstances (which may be construed broadly) so that this becomes the new market practice, despite the Panel’s expectation that ‘hard’ exclusivity should be the exception, not the rule.

Initial signs indicate that 'hard' exclusivity is now emerging as market standard - we have already seen numerous examples of targets agreeing to give a prospective acquirer the benefit of ‘hard’ exclusivity for a limited period of four weeks since the Panel released its consultation paper late last year, without any regulatory intervention. For example, see the Process and Exclusivity Deed between United Malt Group Limited and Malteries Soufflet SAS released to ASX on 28 March 2023; the Transaction Process Deed between SILK Laser Australia Limited and Wesfarmers Limited released to ASX on 19 April 2023, and the Process Deed between Estia Health Limited and Bain Capital Private Equity, LP released to ASX on 7 June 2023.

The Panel does not “expect” break fees in non-binding proposals

Together with an increase in the granting of 'hard' exclusivity to a prospective acquirer at the non-binding indicative proposal stage, target boards are also increasingly agreeing to a prospective acquirers' accompanying requests for a break fee (cost reimbursement coverage), if their indicative proposal does not develop into a formal, binding proposal. For example, see the process deed between United Malt Group Limited and Malteries Soufflet SAS released to ASX on 28 March 2023.

Perhaps in an attempt to arrest this trend, the Panel’s updated guidance states that it does not “expect” that a target board would agree to provide a break fee to a prospective acquirer for a non binding proposal. Nevertheless, the Panel also suggests that agreeing to pay a potential break fee at the non-binding indicative proposal stage would not necessarily be unacceptable if the quantum was “substantially lower” than for an equivalent binding proposal (which is generally set at 1% of the equity value of the target).

The Panel has not provided guidance as to what “substantially lower” means in this context. Accordingly, limiting any break fee to reimbursement of the prospective acquirer's verifiable transaction costs (e.g. external advisers' due diligence fees) that are well below the 1% break fee threshold that applies to a formal, binding proposal, might be a good starting point.

Similarly, the Panel has not provided guidance on when it might be acceptable for a target to grant a “substantially lower” break fee to a prospective acquirer. Having regard to a key policy objective of the Panel to promote an efficient, competitive and informed market, and consistent with the position outlined for ‘hard’ exclusivity (see above), we consider it should be acceptable for a target to agree to a reasonable and proportionate break fee at the non-binding indicative proposal stage where the target board considers this is necessary to facilitate a binding proposal from a prospective acquirer (for example, to encourage a prospective acquirer to put forward a proposal in circumstances where it would otherwise be unwilling to do so).

What is clear, however, is that the Panel intends to apply more scrutiny to this area. Therefore, target boards will need to tread carefully and consider whether it is reasonable and appropriate in all of the circumstances to agree to pay a potential break fee at the non-binding indicative proposal stage, and not merely acquiesce to a prospective acquirer’s request.

Disclosure requirements

The Panel’s updated guidance clarifies that, at a minimum, the existence and nature of all material terms of any deal protection arrangements agreed to by a target board at the non-binding indicative proposal stage should be disclosed by the target no later than when the control proposal is announced, although it may be necessary to announce it earlier under continuous disclosure provisions applicable to the prospective acquirer or the target.

In reaching this view, the Panel considers that any failure or delay in disclosing the deal protection mechanism may have an anti-competitive effect and result in an uninformed market for control of the target.

The ASX Listing Rule 3.1A contains an exception to the continuous disclosure requirements for information that concerns an incomplete proposal or negotiation or which comprises matters of supposition or that is insufficiently definite to warrant disclosure, provided that information is and remains confidential. Target company directors regularly rely on this exception to not disclose confidential and non-binding indicative proposals, as well as any exclusivity arrangements agreed in relation to those proposals.

The Panel’s revised guidance makes clear that non-disclosure of the material terms of any agreed deal protection arrangements relating to a non-binding indicative proposal may give rise to unacceptable circumstances despite any exception to the continuous disclosure rules where:

  • the arrangements include a notification obligation which requires notification of the identity of a competing bidder or the terms of its competing proposal; and
  • the target board has agreed (under a ‘process deed’ or similar document) to recommend a transaction if the prospective acquirer makes a binding proposal on the terms of its indicative proposal (or if a material fee would be payable by the target if the target board fails to recommend a binding proposal on the same or better terms than the indicative proposal).

Key takeaways for target directors

In response to the receipt of a non-binding indicative proposal, target directors should be mindful to:

  • consider the potential impact of any preliminary deal protection arrangements requested by the prospective acquirer on competition, to ensure that any acquisition of control of the target company takes place in an efficient, competitive and informed market; and
  • where possible, seek to negotiate and ‘test’, rather than simply accept as a matter of course, any preliminary deal protection mechanisms sought by a prospective acquirer.

The starting position for a target company board should be not to grant any exclusivity to a prospective acquirer at the indicative proposal stage, noting that the target has not at that point received, and may not subsequently receive, a binding proposal from that prospective acquirer. If a prospective acquirer insists on exclusivity as a necessary element of proceeding with its non-binding indicative proposal, any grant of exclusivity should ideally be subject to an effective fiduciary carve out that allows the target board to respond to and engage with the proponent of an unsolicited proposal.

Target boards should only grant ‘hard’ exclusivity and break fees at the non-binding indicative proposal stage in exceptional circumstances (which may include those outlined by the Panel above) and provided further that:

  • the price, conditions and overall terms of the indicative proposal are sufficiently compelling to justify granting these deal protection mechanisms to a prospective acquirer at such an early stage;
  • the duration of any ‘hard’ exclusivity is no more than four weeks;
  • any break fee is confined to reimbursement of the prospective acquirer's verifiable transaction costs (e.g. external advisers' due diligence fees) and are well below the 1% break fee threshold that applies to a formal, binding proposal.

Target directors should also be mindful that they may need to disclose the entry into deal protection arrangements at the indicative proposal stage despite any exception to the continuous disclosure rules where those deal protection mechanisms include:

  • an obligation to notify the proponent of the first proposal of the identity of a competing bidder or the terms of its competing proposal; or
  • an agreement to recommend a binding proposal on the same terms as an indicative proposal or where a material fee would be payable by the target if the target board fails to recommend a binding proposal on the same or better terms than the indicative proposal.

If you have any questions about these developments and would like to discuss, please let us know.

Contact

Tags

eyJhbGciOiJIUzI1NiIsInR5cCI6IkpXVCJ9.eyJuYW1laWQiOiJjYTg5NzdlZC1kMTRlLTQyYzQtYjEzNi02ODNiMDdhOWE1YWIiLCJyb2xlIjoiQXBpVXNlciIsIm5iZiI6MTczOTgzNDM1MSwiZXhwIjoxNzM5ODM1NTUxLCJpYXQiOjE3Mzk4MzQzNTEsImlzcyI6Imh0dHBzOi8vd3d3Lm1pbnRlcmVsbGlzb24uY29tL2FydGljbGVzL3Rha2VvdmVycy1wYW5lbC1wdWJsaXNoZXMtdXBkYXRlZC1ndWlkYW5jZS1vbi1kZWFsLXByb3RlY3Rpb24tbWVjaGFuaXNtcyIsImF1ZCI6Imh0dHBzOi8vd3d3Lm1pbnRlcmVsbGlzb24uY29tL2FydGljbGVzL3Rha2VvdmVycy1wYW5lbC1wdWJsaXNoZXMtdXBkYXRlZC1ndWlkYW5jZS1vbi1kZWFsLXByb3RlY3Rpb24tbWVjaGFuaXNtcyJ9.D3kF8dpZx-vwVwFmXQm7oA-IjfjxHe6_LAgKWNG-f-g
https://www.minterellison.com/articles/takeovers-panel-publishes-updated-guidance-on-deal-protection-mechanisms