Comment

The Code changes proposed are designed to clarify and, to some extent, ease the restrictions imposed on target companies faced with one or more actual or potential offers. Stipulating that actions would, in most cases, need to be both material and outside the ordinary course of business in order to fall within the restrictions applicable to frustrating action seems a sensible and pragmatic step that will be welcome by listed companies who may find themselves in an offer period, sometimes unsolicited, for many months. The additional guidance and flexibility around what should be considered to be "material" and "ordinary course" is helpful, as is dispensing with the requirement for the elaborate and somewhat artificial process of competing (potential) bidders having to submit lengthy information requests lists on a daily basis to access the information provided to the original bidder. The extension of the "cooling off" period from 2 business days to 7 calendar days may be more contentious but seems justified and, in the round, the proposals are likely to be well received in the market.

In depth

The key changes being proposed can be summarised as follows.

Easing of restrictions - non-material or ordinary course:

• Rule 21.1(a) currently restricts a target board from taking any action which may result in an offer or bona fide potential offer being frustrated, or taking any of a list of specified actions, without shareholder approval, unless an exception applies.
• The Panel believes that the issue with this approach is that it can unduly restrict target companies from taking certain actions that are in the ordinary course of its business or that are not material, particularly in cases where the target's business involves buying and selling assets. The issue is exacerbated by the fact that takeover timetables are often now significantly longer, in particular due to regulatory clearance processes, meaning that the restrictions under Rule 21.1 can have a greater impact on targets and no longer be proportionate.
• The Panel is also concerned that the way in which Rule 21.1(a) is applied can impact the commercial dynamics of an offer. If a target board takes an action which is later determined (possibly following an appeal to the Hearings Committee) to be in breach of Rule 21.1(a), it could be difficult or even impossible to "reverse" that action (eg an issue of shares or disposal of an asset). Accordingly, the Panel's current practice where it is minded to determine that an action should not be restricted is to ask the target board to inform each bidder or potential bidder of its intention to take the relevant action at least 24 hours in advance, to give the bidder an opportunity to challenge this with the Panel. This can, however, alter the commercial dynamics, either by requiring the target to initiate a discussion when it would not otherwise do so or to give a (potential) bidder perceived leverage in negotiations.
• The Panel is therefore proposing to amend Rule 21.1 by relaxing the restrictions such that they would apply only to:
  • actions that are both material and outside the ordinary course of business (such as acquiring or disposing of material assets or entering into or terminating material contracts); and
  • actions that may alter the company's share capital (including granting options or awards over shares, buying back or issuing shares or convertible securities), to any extent, unless in the ordinary course of business.
• The stricter restriction on actions that alter share capital recognises that even a smaller alteration can impact a bidder's financing costs and/or change the voting position in respect of resolutions that may be contentious. The Panel will clarify in the revised notes on Rule 21.1 that the issue of shares or grant of options in accordance with normal practice under an existing share option scheme or the buy back of shares under a pre-existing standard on-market share buyback programme would normally be considered to be in the ordinary course of business.

Acquisitions and disposals of assets:

• When determining whether an acquisition or disposal of assets is material, the Panel proposes retaining the existing 10% threshold with tests relating to consideration v market capitalisation, relative asset values and relative profits, but building in more flexibility for the Panel to use alternative indicators of materiality and/or reach a different conclusion where those tests produce anomalous results. In addition, it is proposed that transactions would only need to be aggregated when applying these tests if the transactions are outside the ordinary course of business.
• The new proposed Practice Statement 34 will set out factors the Panel will consider when determining whether an acquisition or disposal is in the ordinary course, including whether:
  • it falls within the target's established business model, taking into account the frequency and size of similar transactions and how the target describes its strategy to shareholders;
  • the terms of the transaction are in line with normal practice, taking into account previous transactions by the target and its peers, and potentially more broadly in the market; and
  • it is part of an ongoing strategy, rather than a strategic change such as entering or exiting a particular geographical region or business area.

Inducement fee arrangements and ordinary course contracts:

• Under Rule 21.1, the Panel would currently normally allow inducement fees (not in relation to an offer, but an unrelated transaction) where the size is limited to 1% of the relevant transaction. The Panel views that as unnecessarily restrictive and proposes to raise this threshold to 1% of the market capitalisation of the target.
• The new proposed Practice Statement 34 will state that whether a contract is material will be assessed primarily by reference to its financial size in comparison to the target's other contracts. Whether a material contract is then in the ordinary course of the target's business will depend on factors including:
  • the frequency with which the target has entered into similar contracts;
  • the size of the contract compared to similar contracts entered into by the target;
  • whether the contract is of particular importance to the target's business;
  • the terms and whether any non-market terms are onerous on the target; and
  • if relevant, the costs associated with terminating or amending the contract.
• The practice statement will also set out additional matters to be taken into account for particular types of contract, including for example debt, capital expenditure and settlement agreements.

Offer-related employee retention arrangements:

• The Panel proposes to add a new note on Rule 21.1 providing that offer-related employee retentions that relate to a period prior to the end of the offer period (and are not permitted ordinary course employee incentivisation arrangements) and are significant in value or relate to directors or senior management will fall within the rule and thereby require shareholder approval or Panel approval (including where the (potential) bidder consents).
• The new proposed Practice Statement 34 will provide that arrangements will not normally be regarded as being significant in value where the aggregate value is no more than 1% of the offer value. It will go on to set out factors that may be relevant in determining whether the proposed arrangements would constitute frustrating action, for example the proportion of the individual's annual remuneration represented by the proposed award, normal practice in the relevant industry and the views of the Rule 3 adviser.

Relevant period" and extension of "cooling off" period:

• The current period for application of the restrictions under Rule 21.1 ("relevant period") begins when the target board, "has reason to believe that a bona fide offer might be imminent" and ends at the end of the offer period. If the target board "unequivocally rejects" an approach when an offer period has not started, a "cooling off period" (during which the restrictions continue to apply) will run until 5.00 pm on the second business day following the date of the unequivocal rejection.
• The Panel proposes to clarify the trigger for the start of the restrictions by proposing that the relevant period should begin when the target board receives an approach or a potential bidder announces a possible offer. The relevant period will end, as currently, at the end of the offer period.
• The Panel also proposes to extend the "cooling off" period to run until 5.00pm on the seventh calendar day following the date of the unequivocal rejection. The rationale for this is that a rejected potential bidder is likely to need longer then 2 business days to complete the work necessary to support a further approach with an increased proposal. They believe this is proportionate and should not unduly restrict the target board, particularly in the light of the relaxation of some of the restrictions in Rule 21.1 as proposed in the consultation.
• Where there are competing offers that are made at different times, the Panel proposes to allow a proposed course of action based on a combination of: 1) the first bidder giving its consent; and 2) the decision to take the course of action having been taken and partly implemented before the target became aware of the second bidder, even where this was during the offer period.
• Where the target is seeking potential bidders, or where a shareholder is seeking to sell a controlling (30%+) interest in the target, the relevant period will not begin when the offer period starts but instead when the target becomes aware of a proposal with indicative offer terms.

Application to a reverse takeover:

• The Panel proposes that where a transaction is a reverse takeover (defined as only being relevant where the bidder is a Code company), the restrictions under Rule 21.1 will apply to the board of the bidder as if the bidder were a target and vice versa.

Sanction of a scheme in a competitive situation:

• In response to its recent consultation on timetable changes for competitive offer situations, concerns were raised in relation to the proposal that the target board must consult the Panel as to whether the sanction of a scheme of arrangement in a competitive situation would, without an additional shareholder vote, constitute frustrating action under Rule 21.1. In its response statement, the Panel said they would consult further on the point and that in the consultation they would be likely to propose that either: (a) Rule 21.1 should not apply in the context of a scheme sanction hearing; or (b) it should apply but with the Panel being likely to withhold its consent to the taking of this action only in exceptional circumstances.
• In this consultation the Panel sets out the arguments for and against each of these options and concludes that the latter option is preferable, i.e. Rule 21.1 should apply but the Panel would only withhold its consent to the sanction of the scheme in exceptional circumstances.
• The key argument made by the Panel in opting for this approach is that it would encourage competing bidders to approach the target board before the shareholder meeting on the scheme for the first offer. A failure to do so would mean that the scheme is already partly implemented by virtue of the shareholder vote, meaning that Rule 21.1 would not apply as the "relevant period" would not have started in respect of the competing bidder. Incentivising the "flushing out" of actual and potential competing bidders ahead of the shareholder meeting for the scheme for the first offer "will normally result in the most satisfactory outcome for the parties involved in the takeover" as it will enable target shareholders to vote on the scheme in the knowledge of the competing offer.

Extension of "mini-long stop dates":

• A bidder proceeding by way of a scheme of arrangement will typically include within the conditions to the scheme a specific date by which the shareholder meetings must be held and a specific date by which the court sanction hearing must be held, in each case being more than 21 days before the expected date as set out in the scheme circular. These are known as "mini-long stop dates".
• Currently, the mini-long stop dates can only be extended with the consent of the target. The Panel proposes that, in a competitive situation, they can also be extended with the consent of the Panel, even without the target's agreement. This enables the original bidder to extend the mini-long stop dates to reflect the competing bidder's timetable and prevents the original bidder from being at a competitive disadvantage.

Rule 21.2 and restrictions on "offer-related arrangements":

• The Panel considers that Rule 21.2 (applied as described in Practice Statement 29) is operating satisfactorily and is therefore not proposing any amendments to that rule.

Rule 21.3 - Equality of information to competing bidders:

• Currently, the way in which Rule 21.3 (equality of information to competing bidders) operates is such that a competing (potential) bidder will only be provided with information given to the first (potential) bidder if it makes a specific request for that information, with requests in general terms not deemed sufficient. In practice, therefore, a well advised competing bidder will, on a daily basis, submit a long list of specific information requests to the target board, to try to ensure that it receives, on an ongoing basis, all information given to the original bidder.
• The Panel recognises that this practice creates an unnecessary administrative burden for both parties and proposes that a competing bidder be entitled to submit a general request for all information provided to the original bidder. The request would also entitle the competing bidder to receive any information given to the original bidder in the following seven days, meaning that in practice the competing bidder would, instead of submitting a detailed specific request list on a daily basis, submit a general request on a weekly basis. The requirement to submit requests weekly will ensure that the target need not continue to provide information to the competing bidder unless the competing bidder effectively confirms their continued interest in an offer on a weekly basis.
• The target is, under the current rules, able to impose, as a condition to providing the information, a requirement for the competing bidder first to enter into a confidentiality agreement which requires confidentiality to be maintained, non-solicitation of customers or employees and the information to be used solely in connection with an offer or potential offer. The Panel proposes to add another limb to the permitted provisions of the confidentiality agreement, whereby the competing bidder must obtain the target's consent before passing the information to a potential debt or equity finance provider (including a potential joint offeror), such consent not to be unreasonably withheld. This potentially prevents a potential bidder from entering into discussions with large numbers of potential finance providers, which in turn may prevent those finance providers from entering discussions with other competing potential bidders.

Rule 21.4 - Information to independent directors on management buy-outs:

• Like Rule 21.3, Rule 21.4 currently operates such that an MBO bidder need only provide to the target's independent directors, on request, information that it has already provided to external providers or equity or debt finance. Accordingly, in practice daily information requests are made by or on behalf of the independent directors, again creating an unnecessary administrative burden on the parties.
• The Panel proposes that the independent directors need only provide a single request for information, that will then oblige the MBO bidder to provide to the independent directors all information that has been provided to external finance providers and all further information that it subsequently provides to them. Unlike Rule 21.3, the Panel does not consider it necessary to submit further requests (on a weekly basis, under the proposed amendments to Rule 21.3) as the MBO bidder will typically inform the independent directors if it ceases to be interested in making an offer.