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Focus: Mergers & Acquisitions – August 2008

Frustrating action – but for whom?

In brief: In a recent decision, the Takeovers Panel has provided additional guidance on the application of its policy regarding frustrating action, and may well have added to the armoury of bidders at the expense of target companies. Partner Robert Pick (view CV) reports.

How does it affect you?

  • In a recent decision, the Takeovers Panel held that the actions of a potential target amounted to a frustrating action in circumstances where the potential bidder had made a conditional, indicative, non-binding and incomplete proposal to make a takeover bid but had no obligation to make a bid for the target.
  • The decision has the potential to swing the advantage in favour of potential bidders at the expense of potential targets and their shareholders.
  • This application of the frustrating action policy, although providing protection against action that may frustrate a possible bidder, may also provide scope for a potential bidder to frustrate a possible target.

Background

On 6 June 2008, AMP Capital Investors Limited (AMP) acquired a relevant interest in 18.4 per cent of the issued shares in ASX-listed MacarthurCook Limited (MCK) through a pre-bid agreement with a significant MCK shareholder.

On the same day, AMP wrote to MCK outlining the indicative terms of a proposal to make a takeover bid for MCK (the AMP proposal), which included an indicative price of $1.35 per MCK share. The letter stated that the AMP proposal was 'non-binding, indicative and incomplete and expresses current intentions only'.

The AMP proposal was subject to various conditions that AMP stated had to be satisfied before it would make a bid. These conditions included completion by AMP of satisfactory due diligence on MCK, a recommendation by the MCK board, a commitment by the MCK board to accept the offer for all of the shares they held in MCK (in the absence of a superior offer) and a 1 per cent break fee. The letter stated that, if the AMP proposal was implemented, offers 'would be subject to customary defeating conditions including, but not limited to:

  • no material asset sales or acquisitions by MCK or any group member;
  • no material adverse change in the MCK business;
  • no 'prescribed occurrences', regulatory prohibition or unanticipated distribution; and
  • a 50.1 per cent minimum acceptance condition by MCK shareholders'.

On 13 June 2008, MCK announced that, after more than four months of discussions, it had formed a strategic investment management and distribution alliance (the strategic alliance) with IOOF Limited (IOOF). The strategic alliance provided a range of benefits to MCK and IOOF in terms of increased product distribution and funds under management, and included the following relevant aspects:

  • IOOF subscribed for 3.45 million MCK shares at $1.15 per share (the placement), representing approximately 13 per cent of MCK shares after completion of the placement;
  • IOOF was prevented from disposing of the placement shares for 24 months except where a takeover or scheme of arrangement was recommended by the MCK board or a third party acquired voting power of greater than 50 per cent in MCK (the IOOF undertaking); and
  • IOOF was granted the option to underwrite the MCK dividend reinvestment plan until 31 December 2009 (the DRP underwriting option).

On 16 June 2008, MCK announced to the market that it considered that the conditions attaching to the AMP proposal were unlikely to be met and, as such, that it was not in the interests of MCK and its shareholders to enter further discussions regarding the AMP proposal in its current form.

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AMP's application to the Panel

On 25 June 2008, AMP made an application to the Takeovers Panel, claiming that the strategic alliance constituted 'frustrating action' in relation to the AMP proposal.

The primary basis of AMP's application was that the issue of shares under the placement constituted a frustrating action in relation to the AMP proposal, as it triggered one of the defeating conditions specified in the AMP proposal – namely, the 'prescribed occurrences' condition1 that was triggered when MCK issued shares under the placement.

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When will an action be a frustrating action?

The Takeovers Panel has provided guidance to the market in relation to frustrating action in Guidance Note 12 (GN 12), which sets out the Panel's views on what action will constitute frustrating action and how a target company should deal with a corporate action that may constitute a frustrating action.

The underlying principle behind GN 12 is that decisions about the control and ownership of listed companies are properly made by the company's shareholders and not the board. In general terms, GN 12 provides the following guidance:

  • Where a corporate action by a target company is likely to frustrate or prevent a 'genuine potential offer', the Panel will generally require target shareholder approval for that action to be taken.
  • A genuine potential offer is an offer, the terms of which are communicated to target directors publicly or privately by a genuine bidder but is not yet a formal offer under Chapter 6 of the Corporations Act 2001 (Cth).
  • An action may constitute a frustrating action even where that action exhibits no lack of good faith and is consistent with the target directors complying with their fiduciary duties.
  • An action will not constitute a frustrating action if there is a commercial or legal imperative for the target to take that action other than as a result of some voluntary action taken by the target directors after they become aware of an offer or a potential offer. For example, the target may be seeking to avoid a materially adverse financial effect or to meet an obligation which, if not performed, may result in materially adverse legal action against the target.
  • When a company is informed of a genuine potential offer, and undertakes any frustrating action without seeking the approval of the target company shareholders, unacceptable circumstances may occur. In such a case, the Panel may make orders, in the absence of shareholder approval, to prevent the target from proceeding with the action or to reverse it.

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Applying the general principles to MCK

Having regard to the guidance provided in GN 12, the Panel found that the entry into the strategic alliance – in particular, the placement, the IOOF undertaking and the DRP underwriting option – constituted a frustrating action and that the failure by MCK to seek shareholder approval gave rise to unacceptable circumstances.

In making their decision, the Panel reached the following conclusions:

  • The AMP proposal was a genuine potential offer in relation to MCK shares. The Panel concluded that:
    • AMP was a genuine potential bidder. It had sufficient resources to comply with its obligations under the AMP proposal and had demonstrated a commitment to the proposal by entering into discussions with MCK and through its pre-bid agreement with a substantial MCK shareholder.
    • The statements made by AMP in the letter setting out the AMP proposal that the proposal was 'non-binding, indicative and incomplete and expresses current intentions only' had to be read in the context of the whole letter and the likely concerns that AMP had about the proposal being disclosed and s631 of the Corporations Act2 being triggered.
    • The letter setting out the AMP proposal set out (in sufficient detail) a proposal to make a takeover bid, including the price and conditions on which it would proceed, if made. The Panel considered that offer terms need not be finally settled for a proposal to be a 'genuine potential offer'.
  • As the AMP proposal was a genuine potential offer in relation to MCK shares, and the entry into the strategic alliance would trigger one of the defeating conditions in the AMP proposal, the entry into the strategic alliance constituted a frustrating action in relation to the AMP proposal. In particular, the Panel found that:
    • The placement gave IOOF approximately 13 per cent (fully diluted) of MCK, making a full takeover impossible without IOOF's support, and reduced the likelihood of a 90 per cent minimum acceptance condition being satisfied.
    • The IOOF undertaking prevented IOOF disposing of the placement shares for 24 months except in the limited circumstances permitted by the terms of the IOOF undertaking.
    • The placement expanded the capital base of MCK (at a discount to AMP's indicative offer price of $1.35), making the total consideration required to succeed in a takeover greater than before the placement.

Accordingly, the Panel made the orders to the following effect:

  • MCK seek shareholder approval for those aspects of the strategic alliance that constituted frustrating action;
  • MCK disregard any votes cast on any resolutions by IOOF and its associates; and
  • if shareholder approval for any aspect is not obtained by 1 September 2008, all agreements that form part of those aspects of the strategic alliance which constituted frustrating action are cancelled (which, if the placement is not approved, includes a cancellation of the placement shares and repayment of the subscription moneys to IOOF).

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What is the impact of this decision?

The concept of frustrating action is well-known in the Australian takeover context, particularly in the context of actual or announced takeover bids. In addition, GN12 contemplates that target actions may constitute frustrating action even where an offer is not yet a formal offer under Chapter 6 of the Corporations Act.3 However, this decision of the Takeovers Panel may have extended the operation of the frustrating action concept to an extent not previously contemplated and, in doing so, may have provided potential bidders with the ability to constrain a possible target from undertaking material transactions in circumstances where the bidder has no obligation to make a bid for the target.

In this respect, there are several features of the MCK situation that are worth noting:

  • The AMP proposal was a genuine potential offer, even though the terms of the offer were expressed to be conditional, non-binding, indicative and incomplete.

Conceivably, this means a potential bidder could put a conditional, non-binding, indicative and incomplete proposal to a target company which specifies an indicative price and certain defeating conditions and, by doing so, effectively prevent the target from engaging in any activity that would trigger one of those conditions without seeking shareholder approval. This would be the case even though the potential bidder would have no obligation to make a bid for the target and, even if the bidder did elect make a bid, it could do so on the terms (including price) different to those set out in their indicative proposal.

  • AMP was successful in establishing a frustrating action even when there was no obligation on AMP to bid.

This means that potential bidders, if they are careful, will be able to lock-up a potential target company from undertaking any material transactions without target shareholder approval by putting an indicative proposal to the potential target that does not trigger the 'two month rule' in s631 of the Corporations Act. In other words, the potential target is effectively prevented from undertaking material transactions without target shareholder approval, even though there is no obligation on the potential bidder to proceed with a bid for the target or, even if it does make a bid, there is no requirement to do so on the terms (including the price) set out in that indicative proposal.

This outcome would seem to swing the advantage in favour of potential bidders at the expense of potential targets and their shareholders. In particular, in circumstances where a possible bidder suspects that a potential target may be considering a material transaction (such as an acquisition or disposal, or an equity raising), the bidder may be able to frustrate the target's ability to do so without seeking shareholder approval – by putting a conditional, indicative, incomplete and non-binding proposal to the target which includes a non-exhaustive list of defeating conditions that would be triggered by the target undertaking a material transaction while, at the same time, not creating any obligation to bid for the target. It is conceivable that such an outcome could be value destructive to the target and its shareholders.

For example, it could be clear that a target needs to raise equity in the short term to bolster its balance sheet and a failure to do so may have an adverse impact on the target's share price. A possible bidder could put an indicative and non-binding proposal to the target in a similar manner in which the AMP proposal was put to MCK (eg, by including an indicative price and specifying a non-exhaustive list of defeating conditions) and, as a result, prevent the target from raising capital without target shareholder approval. This would likely have an adverse impact on the target's ability to raise that capital – both from a timing and value perspective – with the potential outcome that downward pressure would be placed on the target's share price. This, in turn, could lead to the result that if the bidder elects to make a takeover bid for the target – which it would not be obliged to do – its prospects of success would increase.

It remains to be seen whether this kind of approach is adopted by bidders as a strategy to increase the prospects of success in any bid. It is conceivable that, if adopted, the use of such a tactic may be to the detriment of target shareholders.

In a sense, instead of providing protection against action that may frustrate a possible bidder, this application of the frustrating action policy may provide scope for a potential bidder to frustrate a possible target.

Footnotes
  1. The no 'prescribed occurrences' condition is a reference to none of the matters referred to in section 652C(1) or (2) of the Corporations Act 2001 (Cth) occurring in relation to MCK.
  2. Section 631 of the Corporations Act contains the 'two-month rule', which provides that it is an offence for a person to publicly propose a takeover bid for securities in a company and then not make a takeover offer for those securities within two months after that public proposal.
  3. See GN 12.2.

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