Participants in private M&A transactions can look to many of the decisions and guidelines applicable to public M&A for approaches to dealing with issues and challenges paralleled in the private M&A context.
In this two-part series, we will identify and discuss a number of the lessons that public M&A rules provide that are relevant for participants in private M&A transactions.
- Part 1 (this paper) will look at fiduciary outs and the 1% guideline on break fees; and
- Part 2 will explore other issues, including matching periods in control transactions and material adverse change conditions.
Regulation of Public M&A in Australia
Public M&A in Australia is primarily governed by Chapter 6 of the Corporations Act 2001 (Cth) (Corporations Act), the Listing Rules of the Australian Securities Exchange (ASX) and the policies, guidelines and decisions of the Australian Securities and Investments Commission (ASIC) and the Takeovers Panel (the Panel).
The Corporations Act’s guiding principles underpinning its regulation of public M&A, which are premised on the Masel and Eggleston principles, 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.
These principles are reflected both in the statutory provisions of the Corporations Act itself, the disclosure rules in the Listing Rules and also in the policies, guidelines and decisions of ASIC and the Panel applicable to control transactions.
In seeking to balance the competing rights, interests and responsibilities of bidders, targets and their respective boards and shareholders, over the years, ASIC and the Panel have identified terms and structures that may be contrary to these principles. Because public M&A, by its nature, is conducted in the public eye, we have the benefit of ASIC’s and the Panel’s approaches to assessing and addressing these issues, as published in the various decisions, guidance notes and policies.
Public M&A Guidance in the Context of Private M&A
While private M&A is not subject to the same degree of regulation and scrutiny as public M&A, and while there are issues relevant to public M&A that are not relevant in private M&A (and vice versa), there is nevertheless considerable overlap and a number of the rules and guidelines applicable to public M&A illustrate and seek to address problems that also manifest in private M&A transactions.
‘Fiduciary-out’ clauses in merger agreements have been in the news recently in the context of Perpetual’s merger with Pendal Group.
A ‘fiduciary out’ is a provision which allows a party (most commonly a target company) to be relieved of exclusivity (or lock-up) obligations to the extent that the fiduciary duties of the directors would require it. In the public M&A context:
- ‘no due diligence’ restrictions, which impose an obligation on the target not to make due diligence available to an existing or potential rival bidder; and
- ‘no talk’ restrictions, which impose an obligation on the target not to enter into discussions or negotiate with a third party concerning a potential rival bid (whether solicited or unsolicited),
generally both require a ‘fiduciary out’ in order for them not to constitute unacceptable circumstances.
In addition, ASIC has recently made it clear that fetters on the operation of the ‘fiduciary out’ may not be acceptable, citing the unacceptable example of an additional obligation on directors to ‘act reasonably’ in assessing the extent of their fiduciary obligations.
Given that all directors (ie in both public and private companies) have fiduciary duties, the board of a target company in a private M&A context should also have regard to similar considerations, particularly in the context of negotiating legally binding deal structuring arrangements such as in a binding memorandum of understanding, exclusivity agreement or a confidentiality agreement which contains exclusivity provisions designed to preclude the target from pursuing competing transactions.
That is not to say that target boards in private companies cannot agree to exclusivity / lock-up arrangements. Rather, public M&A principles and the guidance relating to them provide context and substance for some of the considerations to which target boards of private companies should turn their minds.
In the first instance, the public M&A requirement for a fiduciary out can give private company directors a basis for also insisting on a ‘fiduciary out’ when agreeing to an exclusivity or lock-up provision.
Further, in Guidance Note 7, the Panel indicates that “a no-talk restriction (with a ‘fiduciary out’) is less likely to give rise to unacceptable circumstances if the target has conducted an effective auction process before agreeing to it.” This illustrates considerations that directors of private companies should also think about in deciding whether they are properly agreeing to an exclusivity arrangement. If they have diligently looked for the best available transaction (in GN7 parlance – “conducted an effective auction process”), then they can more comfortably conclude that it is in the best interests of the company as a whole to agree to an exclusivity obligation necessary to get the deal done.
It is common in both (non-hostile) public and private M&A for a target to agree to a break fee, payable in the event that the transaction does not proceed for various reasons (usually for things within the target’s control). Break fees are designed to compensate the acquirer/bidder for the wasted cost and effort it incurs in pursuing the transaction if the transaction is not completed, and are seen as a legitimate use of the target’s funds in securing a transaction that is expected to be beneficial to target shareholders.
This might be fair enough to some extent, but how much is too much? In the National Can Industries decision, the Takeovers Panel held that a break fee of up to 1% of the equity value of the target is generally not unacceptable. However, it is not a “bright-line” test, and an applicant may be able to establish that a break fee within that 1% guideline is nevertheless anti-competitive and coercive if, for example, the triggers for payment of the break fee are not reasonable. That said, the 1% guideline is embodied in the Panel’s Guidance Note 7, and has become relatively standard market practice.
While private M&A is not subject to the Panel’s supervision, parties seeking to agree break fees in private M&A might still look to the Panel’s guidance for direction. The Panel’s 1% guideline is based on, amongst other things, preventing unacceptable levels of coercion of target shareholders. By implication, the corollary is that a target board’s directors can take some comfort that (in the absence of other factors) agreeing to a break fee within the 1% guideline is not an unreasonable use of the company’s resources if it assists in securing an advantageous transaction.
Stay tuned for Part 2 where we will look at other examples of public M&A principles applicable to private M&A transactions.