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Focus: Acquisition Finance – September 2006

'Certain funds' in acquisition finance – a current trend

In brief: The increasing involvement of private equity funds in acquisition transactions is leading to a blurring of boundaries in the financing conditions adopted in public and private acquisitions. Partner Phillip Cornwell(view CV), Senior Associate Douglas Fung and Lawyer Dorothy Pawlukowski look at recent developments in the conditionality of leveraged funding for public and private acquisitions.

Migrating standards

These changes have seen a version of the requirement for certainty of funds under the UK City Code on Takeovers and Mergers (the City Code) migrated, via European private equity transactions, into recent major private treaty acquisitions in Australia, and also into public market bids in Australia where they have set a higher standard than required by the Takeovers Panel Guidance Note 14. The increased reliance on 'certain funding' across a variety of jurisdictions is evidenced in the following case studies.

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Bids for public companies in the UK
Announcement of bids

The City Code sets out the rules which regulate bids for UK public companies and is enforced by the Panel on Takeovers and Mergers, subject to judicial review. Since the implementation of the EU Takeover Directive in May 2006, the City Code has had statutory effect.

Under the rules and general principles of the City Code, bids for public companies must be announced only:

  • after the bidder has taken all reasonable measures to ensure that any cash consideration of the bid will be provided (General Principle 5); and
  • when the bidder has every reason to believe that it can and will continue to be able to implement the bid, a responsibility which extends to the bidder's financial adviser (Rule 2.5).

Pre-conditions to the bid are not permitted under Rule 13 of the City Code unless they involve official authorisations or regulatory clearances relating to the bid. This means that the bid must not normally be made subject to any financing conditions or pre-conditions (other than regulatory clearances), that is certain funds must be available to implement the bid.

Limited ability to cancel facility

The restrictions imposed by the City Code impact on acquisition facility documents by limiting the ability of lenders to cancel or terminate the facility during a negotiated time period following the announcement of the bid (the Certain Funds Period). Although the detail is a matter of negotiation, because the financial adviser's reputation and balance sheet are on the line, bank commitments are subject to close scrutiny and intense negotiation. Usually the only events which will entitle lenders to cancel or terminate the facility during the Certain Funds Period will be:

  • the insolvency of the bidder;
  • the failure to satisfy the conditions on which the bid is made; or
  • any other matters that are within the control of the bidder.

For this reason, conditions that there be no bidder, target and market material adverse change (MAC) are usually excluded during the Certain Funds Period.

The Certain Funds Period has to reflect the timetable for the bid so that it runs until the last day on which the bidder may be required to pay any cash consideration to accepting shareholders. In the UK this typically requires a period of 90 days to as much as 180 days.

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Bids for public companies in the US

Bids for US public companies are regulated by the Williams Act 1968, which grants the Securities Exchange Commission authority to establish rules to govern bids for shares in companies registered under the Securities Exchange Act 1934. In comparison with the UK, there is no certain funds requirement or, indeed, any restriction on the conditionality of the bid. As a result, the US public company takeover market is more flexible and lender friendly.

A pre-condition requiring there be no MAC is fairly standard. However, there is a trend to excluding market MACs, and clearly any bidder wanting to be taken seriously (especially private equity) will want to be able to demonstrate reasonable certainty of funding. It is increasingly difficult for banks to negotiate conditions which aren't included in the bid.

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Bids for public companies in Australia - Takeovers Panel Guidance Note 14

The Corporations Act 2001 (the Act) does not permit bidders for Australian public companies to:

  • be reckless as to whether they can perform once a proposed bid is announced (section 631(2)(b)); or
  • make the bid subject to conditions that effectively give the bidder discretion, or control, over whether to proceed, known as self-triggering conditions (s629).

Furthermore, s636(1)(f) of the Act requires that the bidder's statement set out, in relation to any cash consideration offered under the bid, details of:

1. the cash amounts (if any) held by the bidder for payment of the consideration;

2. the identity of any other person who is to provide, directly or indirectly, cash consideration from that person's own funds; and

3. any arrangements under which cash will be provided by a person referred to in subparagraph (2).

This legislative regime sets a low threshold regarding certainty of funding, and focuses more on disclosure.

Takeovers in Australia are now predominantly governed by the view of the Takeovers Panel (the Panel) which can intervene in circumstances where it determines the existence of unacceptable conduct (regardless of strict compliance with the law). The Panel's Guidance Note 14 on Financing Arrangements adopts a practical approach to the certain funds concept by requiring a firm commitment of sufficient funding for the bid and a 'reasonable basis' to expect that funding will be available. There is no prescriptive detail.

In practice, this is not a very onerous requirement, as was shown in the Goodman Fielder Ltd (Nos 1 & 3) (In the matter of Goodman Fielder Limited 01 [2003] ATP 01 and In the matter of Goodman Fielder Limited 03 [2003] ATP 14) decisions (Goodman Fielder), which upheld highly conditional financing arrangements and which are discussed below in greater detail (and see AAR Focus: Mergers & Acquisitions - March 2003). A commitment letter and credit approved terms sheet will usually suffice, and the conditions precedent to finance can include bidder, target and market MACs as long as they are disclosed.

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The Panel's view in Goodman Fielder

The Panel's decisions in Goodman Fielder demonstrates that a highly conditional bid in the public market can work if there is no other serious bidder. The Burns Philp bid for Goodman Fielder contained a number of significant conditions, including:

  • a 90 per cent minimum acceptance condition;
  • bidder, target and market MACs; and
  • an 'Availability of Facilities' condition, thus importing the extensive conditions precedent to funding (and the funding commitment was also subject to documentation).

Although Burns Philp had commitment letters for the four facilities it was negotiating, only one letter detailed settled terms on the basis of which the facility was to be provided. One of the facilities was not even credit approved. To mitigate this, Burns Philp undertook in its bidder's statement to use its best efforts to ensure that the pre-conditions to finance were met.

The Panel was not happy with the market and bidder MACs because they were too vague and, in the latter case, potentially self-triggering. The bidder withdrew them, but they remained as conditions precedent to finance. The Panel concluded that the conditional nature of the bid financing was not self-triggering under s629 of the Act due to Burns Philp's best efforts undertaking and because the lenders could waive any of the funding pre-conditions. The 'Availability of Facilities' condition was permitted on the basis that Burns Philp grant to Goodman Fielder shareholders, who accepted the offer, withdrawal rights that would expire after the documentation for the finance facilities was finalised or when the condition was waived by Burns Philp (as it ultimately was).

The Goodman Fielder decision is helping to facilitate leveraged bids in the public takeover market in Australia, as the Panel has shown it is prepared to allow 'subject to finance' and MAC conditions.

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Affinity bid for Colorado

This is the first hostile public takeover bid by private equity in Australia. According to the bidder's statement , the bank funding for the bid includes provision for a 'Waiver Period'. Once the offer is declared free of conditions, the target MAC and stock market index conditions will cease to be conditions precedent to finance for 21 days (which may be extended). The bid conditions, however, can only be waived with bank consent, and the provision of funding is still subject to the absence of any events of default or potential events of default. Nevertheless, this is doubtless the start of a trend which could see the widespread adoption of 'certain funds' provisions in Australian takeover financing.

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UK/Europe private acquisitions

Private equity, in its search for a competitive edge, adopted the City Code 'certain funds' requirement in private treaty transactions in the UK and Europe. Although not legislatively mandated in this context, and so more flexible, it tends to be enforced to the point where the vendor's counsel will carefully scrutinise the bidder's debt funding term sheets for hidden 'outs'.

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Recent private acquisitions in Australia

In the medium to large private acquisition market in Australia, a similar approach to certain funds has been adopted in recent times. In deals such as the sales of Myer and Brambles' Cleanaway and Industrial Services businesses, a UK-style certain funds commitment has been required from lenders to private equity consortiums. Bidders are also increasingly submitting bids on a certain funds basis to gain a tactical advantage in the bid process, and this is likely to become the norm, at least for substantial competitive bid transactions.

In practice, this development means that certain funds provisions are drafted into commitment letters and term sheets with few conditions. Conditionality is generally limited to those conditions:

  • which the share purchase agreement is subject to;
  • which are within the bidder's control, such as:
    • no breach of material undertakings;
    • no material misrepresentations; and
    • no insolvency events concerning the bidder;
  • which are outside the bidder's control such as failure by the bidder to obtain regulatory approvals for the acquisition (usually covered under the first point above); and
  • no insolvency of the target or material subsidiaries of the target.

In addition, it is increasingly common to omit target MACs from the bid conditions.

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Schemes of arrangement

Court and shareholder approved schemes of arrangement under the Act are commonly used to effect LBO style takeovers in the form of the 'public to private' (P2P ). In a P2P, a listed company is acquired by private equity investors. The funding arrangements tend to be similar to those for an LBO, but greater certainty (that is, fewer conditions precedent) is required because of the public nature of the transaction. Courts are generally unwilling to approve schemes that are highly conditional even if the scheme is approved by target shareholders. For this reason, scheme conditions, other than conditions which relate to the solvency of the bidder and target, generally fall away on the morning of the second court approval hearing. In a recent case, the court required the cash consideration in the bid to be held in a trust account for the benefit of shareholders on a pre-funded basis (WebCentral Group Limited, Unreported, Federal Court, Justice Lindgren, 14 July 2006).

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Conclusion

Ironically, the concept of certain funds has been imported and applied into private acquisition financings to a more stringent degree than currently imposed in public markets in Australia. However, this is not a fixed concept and there is plenty of scope to negotiate the important detail. So the critical finance conditions are best negotiated and resolved in the early stages of the bid process.

For assistance with acquisition financing, please contact our experts below.

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