• Introduction
• All recent publications
• Mergers & Acquisitions publications
• Mergers & Acquisitions services

Focus: Mergers & Acquisitions – June 2008

Takeovers Panel publishes long-awaited guidance note on collateral benefits

In brief: The Takeovers Panel has published its final position on the giving of collateral benefits in the context of control transactions. Partner Andrew Finch (view CV) and Senior Associate Vida Wongseelashote report.

• Background
• General guidance by the Panel
• The meaning of 'net benefit'
• The Panel's assessment of whether a 'net benefit' has been conferred
• Evidence that might be led to establish no 'net benefit'
• Even with no 'net benefit', unacceptable circumstances may yet exist
• Curing unacceptable circumstances through securityholder approval
• Implications

Background

The regulation of Australian takeovers is underpinned by certain principles contained in section 602 of the Corporations Act 2001 (Cth) (the Act). These include the principle that, so far as practicable, all holders of securities in a class have reasonable and equal opportunity to participate in benefits to be conferred on any holder of securities in that class under any proposal for the acquisition of a substantial interest in the target company. This is known as the equality principle.

One of the principal mechanisms for giving effect to the equality principle is the collateral benefits prohibition in s623 of the Act. That section prohibits the giving (or offering or agreeing to give) a securityholder (or associate) a benefit not provided for under the relevant takeover bid if the benefit is likely to induce the securityholder to accept the bid or otherwise dispose of its bid-class securities.

On 9 November 2005, the Takeovers Panel (the Panel) published an issues paper seeking public comment on the giving of collateral benefits in control transactions¹. The issues paper followed a number of Panel decisions that dealt with the s623 prohibition on collateral benefits, as well as the effect of such benefits from a policy perspective.

These decisions sought to apply the concept of the 'net benefit', which had originally been developed by the courts in considering the collateral benefits prohibition under former s698 of the Corporations Law (the predecessor to current section 623). In short, the Panel's decisions to date appear to suggest that conferring a 'net benefit' on a target securityholder would give rise to unacceptable circumstances. The Panel, however, provided little guidance in its decisions as to the meaning and import of the 'net benefit' concept, or how this concept was to be reconciled with the element of inducement that had been introduced into s623.

Almost two-and-a-half years after publishing the issues paper, the Panel has finalised its position on collateral benefits. Guidance Note 21 has been prepared to assist market participants to understand the Panel's approach to collateral benefits.

General guidance by the Panel

Guidance Note 21 suggests that the factors that will influence the Panel when considering whether a collateral benefit gives rise to unacceptable circumstances include:

• whether it was offered, given or received when a control transaction was contemplated;
• whether it will be given or received regardless of the outcome of the control transaction;
• whether it and the control transaction are linked (eg through bid conditions or an understanding);
• whether there is a pre-existing relationship or series of independent transactions explaining it; and
• whether securityholders have approved the benefit.

The meaning of 'net benefit'

In part, many of the elements outlined in the previous section factor into an assessment of whether a benefit conferred on a securityholder amounts to a 'net benefit'. As the name suggests, a 'net benefit' is the result of netting off the benefit received by a securityholder against any rights or benefits which that securityholder has given up in order to receive the benefit. If there is overall disparity in favour of the securityholder receiving the benefit, the securityholder will receive a 'net benefit' or a prohibited collateral benefit. To the extent that a 'net benefit' has been conferred, the Panel's position is that the equality principle has been offended (unless demonstrated otherwise).

For example, mere earlier payment to a selected securityholder in return for their securities would not result in a 'net benefit' to the securityholder, as earlier payment means relinquishing the securities and the rights that go with them at an earlier date². On the other hand, unconditional, immediate payment made to one securityholder in return for securities in the context of outstanding, extendable and conditional offers under a bid would result in an overall disparity in favour of the securityholder that cannot be negated merely by the fact that the securityholder has relinquished the securities and rights that go with their securities at an earlier date³.

The Panel's assessment of whether a 'net benefit' has been conferred

Guidance Note 21 elaborates on the analysis undertaken by the Panel to determine whether a 'net benefit' has been conferred. The Panel states that a 'net benefit' will be assessed by reference to the commercial balance of advantages flowing to and from the securityholder. Factors that will affect the Panel's view as to the 'balance of advantages' include:

• the substance and commercial reality of the side dealing;
• the context in which the benefit is given or the consideration for the benefit that is given by the securityholder;
• the overall effect of the side dealing; and
• an objective assessment by the Panel of the side dealing (as opposed to the parties' intentions).

In particular, Guidance Note 21 elucidates three principles that the Panel will consider in its assessment:

• A side dealing at fair market value will not, of its own, be a 'net benefit'. However, even if fair market value is established (by independent valuation), the benefit conferred may still amount to a 'net benefit' once the substance and commercial reality of the side dealing is taken into account. For example, if a bidder offers to sell an asset to a securityholder at fair market value, the Panel is more likely to find that the collateral benefit is a 'net benefit' if the asset is of 'special value' (also as established by independent valuation) to the securityholder. An asset may be of 'special value' to a person when, for example, it cannot be replicated or substituted, or if synergies are available to the potential acquirer.
• In exceptional cases, a benefit provided to a securityholder who starts with interests different to those of other securityholders may not be a 'net benefit'. For example, the Panel's view is that no 'net benefit' would arise if a bidder offers to acquire another (non-bid) class of securityholders' securities at an independently assessed fair price. However, a 'net benefit' will be likely to arise if the bidder also fails to make similar offers to other holders of those non-bid class securities, or if the securityholder is the only holder of the non-bid class securities.
• The Panel will not accept the argument that, but for the benefit, there would have been no offer (or a lower offer) to all other securityholders. The Panel has confirmed the position it stated in its issues paper, namely that such 'necessary collateral transactions' might open too easy a pathway to avoidance of the policy of s623.

Evidence that might be led to establish no 'net benefit'

The Panel suggests that in seeking to establish that a side dealing does not confer a 'net benefit' on a securityholder, a person might:

• undertake 'market testing' of the side dealing, ie open, transparent testing of the price to be paid for the collateral benefit (eg by a public sale process);
• obtain an independent valuation of the side dealing (the Panel may require a valuation as part of its proceedings); or
• obtain an expert's opinion on whether there is a 'net benefit' (the Panel may question the methodology, even in the absence of manifest error).

The Panel's view is that, even though it considers market testing to be the preferable way to seek to establish that there is no 'net benefit' (if this method is not used, the reasons should be explained), combining the methods above will be more effective in satisfying the Panel that the side dealing does not confer a 'net benefit'.

Even with no 'net benefit', unacceptable circumstances may yet exist

Even if a benefit provided to a securityholder is not a 'net benefit', the Panel makes it clear that it may still find that the benefit gives rise to unacceptable circumstances, on two bases:

• Benefits that offend the principle of an efficient, competitive and informed market. A benefit – even if not a 'net benefit' – may offend the principle of an efficient, competitive and informed market if the benefit has the effect of dissuading alternative bidders or buyers from coming forward. Guidance Note 21 gives as an example the situation where a debt owed by a securityholder to the target is agreed to be taken over by the bidder from the securityholder and is discounted. In this case, the Panel suggests that the agreement should contemplate that a higher bidder is entitled to the same arrangement. The Panel also makes it clear that a bidder who does not fully disclose the side dealing giving rise to the benefit, as well as the benefit itself, risks a declaration of unacceptable circumstances on the same basis.
• Benefits that are likely to induce acceptance of an offer. In contrast to former s698 under the Corporations Law, s623 of the Act requires that a prohibited collateral benefit has the effect of being likely to induce a securityholder to accept an offer under a bid, or otherwise dispose of its bid-class securities. This element has proved difficult to reconcile with the use of the 'net benefit' concept, with past Panel decisions suggesting that a collateral benefit likely to induce acceptance of an offer under a bid will not give rise to unacceptable circumstances if it cannot be characterised as a 'net benefit'.⁴

The Panel has now made it clear that a benefit that is not a 'net benefit' may still give rise to unacceptable circumstances if it has the requisite element of inducement. In deciding if a side dealing is likely to induce an acceptance of an offer, the Panel will look at the following factors:

• The likely effect of the side dealing. In its issues paper, the Panel noted that, although neither s623 nor the equality principle depend on a bidder's intentions, several court and Panel decisions took into account that the bidder appeared not to have intended the side dealing to induce an acceptance. The Panel states that, in coming to a view on the question of inducement, it will objectively assess whether the side dealing was likely to affect the securityholders' attitude towards the bid.
• How independent of the bid the side dealing appears to be. For a benefit to be a collateral benefit, it must have some connection to a control transaction, temporal or otherwise. The more connected to a control transaction a benefit appears to be, the more likely it will be regarded as offending the equality principle.
• Timing. The time at which the benefit is conferred is relevant to whether it is likely to induce acceptance of offers under a bid. The Panel also makes it clear that while s623 applies during the offer period and s621(3) (minimum bid price rule) applies in the four months before the date of the bid, the policies and purposes set out in s602 have no time limit. Therefore, a benefit given more than four months before a bid may still give rise to unacceptable circumstances (but the Panel would require more cogent evidence that it was connected to the bid).
• Materiality and whether there is any 'net benefit'. A benefit is material if the securityholder may take it into account when making its decision whether to accept the bid (in other words, is induced by the benefit to accept the bid). The Panel provides the example of a risky loan on favourable terms to the target being repaid to a controlling securityholder – this may be seen by the Panel as removing a detriment to that shareholder, rather than as an inducement.

Curing unacceptable circumstances through securityholder approval

One proposal that the Panel put forward in its issues paper was whether a side dealing would be acceptable if the dealing or the bid was conditional on one or other of:

• acceptances for a majority of the securities; or
• the side dealing being approved at a meeting of bid-class securityholders, analogous to a resolution under item 7 of s611 of the Act; or
• the side dealing being approved by a ballot of bid-class securityholders (eg if the ballot papers were distributed with the bidders' statement or an electronic voting facility was put in place).

The Panel now states that it is prepared to accept, by analogy to item 7 of s611, that approval of the collateral benefit by fully informed, non-associated securityholders at a general meeting is likely to avoid a collateral benefit giving rise to unacceptable circumstances. In limited circumstances, where a meeting is impractical, the Panel may accept other forms of majority non-associated consent, such as the written agreement or a form of ballot. It would not accept, however, the combining of a ballot for a side dealing with an acceptance form as this would not afford the securityholder independent choice on the approval of the collateral benefit.

Implications

Any proposal under a control transaction (ie a 'side dealing') that would give a securityholder a benefit not provided to all securityholders in the bid class, must be carefully scrutinised against the Takeover Panel's latest guidance. The new guidance note makes it clear that the Panel will focus on the substance of any such benefit and will assess both the benefit proffered and whether that benefit is likely to induce an acceptance of an offer under the bid.

The Panel will continue to use the 'net benefit' concept in determining whether a collateral benefit gives rise to unacceptable circumstances. In doing so, the Panel will consider a number of factors, including the context in which the benefit is being conferred, the commerciality of the side dealing and the overall effect of the benefit on the recipient's behaviour. In measuring whether a 'net benefit' has been conferred, the Panel will be influenced (in order of preference) by market testing, an independent valuation, and an expert's opinion.

The Panel has also indicated that unacceptable circumstances may exist even if a collateral benefit does not confer a 'net benefit' on a securityholder. For example, where a securityholder is offered a benefit that is likely to induce it to accept the offer, and there is some doubt about the objectivity or measurability of the benefits conferred, the Panel may be inclined to declare the circumstances unacceptable.

The Panel has confirmed that unacceptable circumstances will not arise if a collateral benefit is consented to by non-associated securityholders.

Footnotes

1. 'Control transactions' include proposals for the acquisition of a substantial interest, and are commonly taken to mean takeover bids. The Panel does not usually consider benefits if they will be subject to scrutiny by a court under a scheme of arrangement – see St Barbara Mines Ltd [2000] ATP 10.
2. Sagasco Amadeus Pty Ltd & Anor v Magellan Petroleum Australia Limited (1993) 177 CLR 508.
3. Boral Energy Resources Ltd v TU Australia (Queensland) Pty Ltd (1998) 43 NSWLR 638.
4. See eg Re PowerTel Limited (No 3) [2003] ATP 28.

For further information, please contact:

• Andrew FinchPartner, Sydney
  Ph: +61 2 9230 4720
  Andrew.Finch@aar.com.au
• Ewen CrouchPartner, Sydney
  Ph: +61 2 9230 4958
  Ewen.Crouch@aar.com.au
• Jon WebsterPartner, Melbourne
  Ph: +61 3 9613 8832
  Jon.Webster@aar.com.au
• Andrew KnoxPartner, Brisbane
  Ph: +61 7 3334 3356
  Andrew.Knox@aar.com.au
• Tim LesterPartner, Perth
  Ph: +61 8 9488 3841
  Tim.Lester@aar.com.au
• Matthew BarnardInternational Partner, Hong Kong
  Ph: +852 2903 6212
  Matthew.Barnard@aar.com.au

Bookmark with What are these?