In the second part of the ‘Public M&A Lessons for Private M&A’ series, we look at the rules and guidelines on matching periods and material adverse change conditions, and consider their relevance in the private M&A context.
In Part 1 of this series, ‘Public M&A Lessons for Private M&A: Part 1 – Fiduciary Outs and Break Fees’, we outlined some lessons and guidance drawn from public M&A that are relevant for participants in private M&A transactions.
To reiterate, the guiding principles underpinning the regulation of public M&A include that:
- the acquisition of corporate control should take place in an efficient, competitive and informed market;
- target shareholders and directors should have enough time and information to assess the merits of a proposal; and
- as far as practicable, target shareholders should have a reasonable and equal opportunity to participate in the benefits accruing to shareholders under a control transaction.
Rules and guidelines have been developed over the years to balance the competing rights, interests and responsibilities of bidders, targets and their respective boards and shareholders in accordance with these principles.
Implementation agreements for public M&A transactions frequently contain matching rights in favour of the bidder, giving it the opportunity to put forward an equivalent or superior proposal to a competing bidder that might emerge during the transaction. The time period for a bidder to exercise its matching rights is known as the matching period.
Both the Australian Securities and Investments Commission (ASIC) and the Takeovers Panel (the Panel) have indicated that prolonged matching periods in control transactions are unacceptable lock up devices due to the anti-competitive effect of such provisions.
In Ross Human Directions Ltd1, the Panel held that any material extension to a 5 business day matching period is likely to be unacceptable because of the effect that such a provision has on the potential willingness of a third party to put forward a competing proposal. From ASIC’s perspective, as reported in its Corporate Finance Update of September 2022:
- a further 3 business day extension to a 5 business day matching period to provide a bidder with a second opportunity to put forward an equivalent or superior proposal is likely to be an unacceptable lock-up device which may inhibit the acquisition of control taking place in an efficient, competitive and informed market; and
- the anti-competitive effect of any matching period may be further exacerbated where the bidder has an existing or substantial interest in the shares of the target.
These findings are relevant to considering the implications of pre-emptive rights provisions in private M&A transactions, because they illustrate the effect matching rights can have on a potential buyer’s willingness to engage in a sale process.
While such provisions can feature in sale and purchase agreements, they are very common in shareholders agreements regulating the governance and control of private companies. In particular, they are often seen in disposal/transfer provisions which restrict a shareholder’s right to sell its shares in a private company to a third party. Shareholders agreements will often grant the other existing shareholders:
- rights of first refusal (ROFR), allowing the existing shareholders to offer to purchase a shareholder’s shares before those shares can be offered for sale to a third party; and/or
- rights of last refusal (ROLR), allowing the existing shareholders to match a competing offer from a third party before a shareholder can sell to the third party.
Such rights are matching rights: depending on how the right is drafted, they can enable the holder of the right to match any other offer the grantor receives for its shares. At a practical level, this can seriously impede a shareholder’s ability to sell its shares, as potential third party buyers may be deterred from investing the time, effort and money in negotiating and conducting due diligence on a deal if another party (the holder of the ROFR or ROLR) can trump whatever deal is negotiated. This is particularly the case with ROLRs but can also arise with ROFRs.
While there are also very good reasons for shareholders agreements to contain ROFRs or ROLRs, the operation and duration of such rights needs to be carefully considered. In general terms:
- ROFRs will be less detrimental to the person granting the ROFR than ROLRs. That is because ROFRs are generally triggered and either exercised or lapse at the outset of a proposed sale process, rather than lingering (as ROLRs do) as a potential defeating condition until the end of the process; and
- the shorter the exercise period allowed to the person holding the matching right, the less detrimental the matching right is likely to be to the person granting it.
A material adverse change (MAC) condition enables a party to a transaction (usually the bidder) to terminate the transaction prior to completion if the other party (usually the target) undergoes or suffers an adverse change or deterioration in its business or future prospects.
In principle, that sounds reasonable, but the devil is of course in the detail, and the operation of MAC conditions in practice is very dependent on exactly what “material” and “adverse” actually mean in the context of the particular transaction.
Public M&A rules set the standard. The expectation in public M&A transactions is that MAC conditions should be objectively quantifiable and not circular in definition. Otherwise, they risk contravening the prohibition on conditions that turn on a bidder’s or associate’s opinion.2
As reported in our paper titled “Musk, M&A and Material Adverse Change”, MAC clauses in a private context can be expressed in qualitative terms (for example, a change that has material and adverse effect on the financial condition, operations or prospects of the target business), in quantitative terms, (for example, a change based on a specified (ie quantified) drop in revenue, earnings, asset value or other financial thresholds), or a combination of the two.
In private M&A, it is common for MAC clauses to appear as a condition precedent, as a warranty in relation to the target (eg. that no MAC has occurred since its last accounts date) or both.
While MAC clauses in the private M&A context are not subject to the same limitations prescribed in the public M&A context – so that qualitative and subjective formulations are permissible – public M&A’s insistence on clarity and measurability for MAC clauses is instructive: uncertainty rarely benefits either party to a transaction.
A party holding a right to terminate or claim for a MAC will want to know whether it is actually entitled to exercise that right, and a party against whom a MAC clause can be exercised will want to know when it is exposed. Agreeing measurable and objective parameters for MAC clauses in private M&A transactions is commonly the best approach.
Chapter 6 of the Corporations Act (which contains the takeovers provisions), and ASIC’s and the Panel’s application of the legislation, is predicated on certain principles, including those outlined at the beginning of this Focus Paper. Because they focus on objectives such as fairness, disclosure, certainty and equality of opportunity, those principles and the rules that embody them can be just as relevant in a private M&A context. In particular, they can assist private M&A participants – and especially the directors of companies involved in private M&A – in weighing the often competing interests of different stakeholders.
1  ATP 8 at –
2 s629 of the Corporations Act 2001 (Cth) and Goodman Fielder Limited 01 (2003) 44 ACSR 254.