Takeover- a better understanding


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Takeover- a better understanding

  1. 1. 1818 • The Ukrainian Journal of Business Law | September 2006 • T erms such as “poison pill”, “shark repellent” and “scorched earth defence” might conjure up images of old action movies. Yet they are more than real in this era of economic warfare. In this connection designing strategies for mergers and acquisitions and planning defences against hostile takeovers now preoccupy many corpo- rate managers. This article examines some of the steps that a company should take to plan and implement defence strategy against unfriendly takeover. It will focus on open joint stock companies since such com- panies are usually the battlefield in the corporate war. I. The warning signals There are some signs that tell you that the hunt for your company has begun and a predator is coming: 1. Suddenly minority shareholders start to get interested in the business af- fairs of the company and start asking for copies of certain documents. 2. The company becomes the object of various inspections carried out by bodies of the state controll that are particularly interested in reviewing the company’s register of shareholders, the list of major clients and creditors, information on as- sets of the company, etc. 3. The company and its executives be- come the target of negative publicity. 4. The number of small transactions in shares of the company has consider- ably increased. 5. Other companies in your industry have been attacked by raiders. 6. Unsolicited offers to sell the shares in the company have been received dur- ing the last few months. Katerina S. Kokot is a senior attorney with PricewaterhouseCoopers in re by Katerina S. KOKOT TheThe ArtArt of Takeover DefenceDefence S.Riabokon
  2. 2. 1919• The Ukrainian Journal of Business Law | September 2006 • takeover defence | in re 7. The company is ambushed with law suits, often with absurd claims for protection of the rights of minority share- holders. II. Defence techniques Preventive measures Preventive measures against hostile takeovers are much more effective than reactive measures implemented once takeover attempts have already been launched. The first step in a company’s defence, therefore, is for management and controlling shareholders to begin their preparations for a possible fight long before the battle is joined. There are several principal weapons in the hands of target management to prevent takeovers, some of which are described below. Control over the register The raider needs to know who the shareholders of the target are in order to approach them with the offer to sell their shares. With joint stock companies this information is contained in the share register. In particular, the share register provides for the possibility to identify the owners of the shares, quantity, nominal value and type of shares held by share- holders. So it is very important to ensure that non-authorized persons do not have access to the share register of the com- pany by taking the following steps: • Careful consideration is needed when choosing the registrar; the pref- erence should be given to a reputable registrar; • Check the track record of the share registrar in regards to its involvement in hostile takeovers in the past; • Check who controls the registrar company. In case of transfer of shares to a nominee holder (custodian or depository) information on the ben- eficiary owners of shares is not stated in the share register. Instead, the share register contains informa- tion on the nominee hold- ers1 . This makes it much more difficult for the raider to identify who is the real owner of the shares. Control over debts Creditor indebtedness of the company may be used by a raider as the principal or auxiliary tool in the process of hostile takeover. In particular, the raider may employ so-called “contract bankruptcy” in order to acquire the assets of the target. In connection with this the following cau- tionary measures should be taken: • Monitor the creditors of company carefully; • Prevent overdue debts; • If there is indirect evidence that a bankruptcy procedure is about to be launched, the company should do its best to pay all outstanding debts; • Accumulate all the debts and risks relating to commercial activity of the company on a special purpose vehicle that does not hold any substantial assets. Cross shareholding Several subsidiaries of a company (at least three) have to be established, where the parent company owns 100% of share capital in each subsidiary. The parent transfers to subsidiaries the most valuable assets as a contribution to the share capital. Then the subsidiaries issue more shares. The amount of these should be more than four times the initial share capital. Subsidiaries then distribute the shares among themselves. The result of such an operation is that the parent owns less that 25% of the share capital of each subsidiary. In other words the parent company does not even have a blocking shareholding. When implementing this scheme it is important to ensure that the management of the subsidiaries is loyal to the parent company. In this way the raider who proceeds with a takeover may find himself deprived of the very objec- tive of his ambitions. Golden parachute This measure discourages an un- wanted takeover by offering lucrative benefits to the current top executives, who may lose their job if their company is taken over by another firm. The “trigger- ing” events that enable the golden para- chute clause are change of control over the company and subsequent dismissal of the executive by a raider provided that this dismissal is outside the execu- tive’s control (for instance, reduction in workforce2 or dismissal of the head of the board of directors due to the decision of the general meeting of shareholders provided such additional ground for dismissal is stated in the labour contract with the head of the board3 ). Benefits written into the executives’ contracts may include items such as stock options, bonuses, hefty severance pay and so on. Golden parachutes can be prohibitively expensive for the acquiring firm and, therefore, may make undesir- able suitors think twice before acquiring a company if they do not want to retain the target’s management nor dismiss them at a high price. The golden parachute defence is widely used by American companies. The presence of “golden parachute” plans at Fortune 1000 companies increased from 35% in 1987 to 81% in 2001, according to a survey by Executive Compensation Ad- visory Services. Notable examples include ex- Mattel CEO Jill Barad’s USD 50 million departure payment, and Citigroup Inc. John Reed’s USD 30 million in severance and USD 5 million per year for life. 1 The nominee holder discloses the beneficial shareholders to the registrar only in specific cases set forth in Ukrainian legislation. 2 Under para 3 art. 36 of the Labor Code of Ukraine (“CLL”) the change of ownership over the company does not result in termination of an employee’s labor relations with a company. However, labor contract may be terminated by employer in case of reduction in workforce (clause 1 para 1 art. 40 of CLL). Under Ukrain- ian legislation and according to court practice, a company has the right to determine how many employees it needs and which jobs or job functions it will keep, so it may not be called upon to justify its decision in court. 3 Under art. 65 of the Commercial Code of Ukraine conclusion of a labour contract with the head of the board of directors is manda- tory. Under art. 21 of CCL the parties to the labour contract may agree on, inter alia, term of the contract, rights, obligations and respon- sibilities of the parties, grounds for termination of the labour contract, includ–ing early termi- nation. Preventive measures against hostile takeovers are more effective than reactive
  3. 3. 2020 • The Ukrainian Journal of Business Law | September 2006 • Change of control clauses (“Shark Repellents”) The company may include in loan agreements or some other agreements conditional covenants that in the event of the company passing under the control of a third party, the other party to the agree- ment has the right to accelerate the debt or terminate the contract. The result of such agreements is that a potential raider may not be sure whether it will be able to ben- efit from important advantages enjoyed by the target. Although one of the effects of change of control clauses is to discour- age raiders, their purpose is legitimate: to protect creditors from being placed in a worse position than they visualised. Post takeover defence It is essential that the company starts to react immediately after the takeover attempt is launched. Otherwise the com- pany may find itself at a strategic and tac- tical disadvantage that may prove fatal. Litigation Bringing administrative claims or court proceedings against the raider is regarded as one of the most common anti- takeover measures. A target of a hostile offer should search for any regulatory, se- curities law or other skeletons in the closet of the attacker. Court action can consider- ably lengthen the period of time needed to complete the takeover and reduce its chances of success by increasing the cost and by allowing time for the target to so- licit competing bids or put up defences. Self-tender Under the Business Associations Act of Ukraine, a joint stock company has the right to acquire the paid up shares from the other shareholders only by sums that exceed the share capital. A corporate buy-back of its own shares increases the relative voting power of those sharehold- ers friendly to management who do not tender their shares. However, if the charter of the compa- ny provides that the decision on buy-back of own shares falls within the competence of a general shareholders meeting, self- tender may prove to be a rather time- consuming exercise. In such a case the law requires that of shareholders should be noti- fied about the general share- holders meeting at least 45 days in advance. The period of time necessary for proper convening the shareholders meeting may be enough for the raider to accumulate a sufficient quantity of shares to block the decision on buy- back of shares. It should also be kept in mind that such shares must be disposed of or cancelled within a period of one year. During this period voting and determination of a quorum on the general shareholders meeting will be made without taking into account own shares bought by the company. Pacman defence This defence, named after the video- game, consists of a counter-purchase by the target of the shares against its attacker. In some cases it will suffice to buy even a small fraction of shares of the attacker to be able to initiate legal claims against the attacking company in the ca- pacity of minority shareholder. Sometimes the company will be un- able to buy the shares of a raider due to the lack of readily available funds or for some other reasons, e.g. the shares of the attack- er are consolidated in the hands of share- holders friendly to the attacker. In this case the company or the persons affiliated with the company may start to acquire other tools of influence on the attacker or the business group it belongs to, e.g. rights of claim, debts, bills of exchange. Propaganda The company is well advised to make use of media to let the public know its arguments against a takeover. The com- pany may strengthen its positive image and emphasize its importance for the region/country and, at the same time, to put stress on the means of takeover tactics used by the raider that fall within the “grey” area of law or contradict the law altogether. A skilfully organized PR campaign may significantly influence the position of state bodies, shareholders and general public in favour of the company. White Knight A White Knight is a company (the “good guy”) that gallops to rescue the company that is facing a hostile takeover from another company (a “Black Knight”) by making a friendly offer to purchase the shares of the target company. The target may seek out a white knight by itself or with the help of investment bankers. People Pill Here, management threatens that in the event of a hostile takeover, the man- agement team and the core specialists will resign at the same time en masse. This is especially useful if they are highly quali- fied employees who are crucial in identi- fying and developing business opportuni- ties of the company. Losing them could seriously harm the company, especially if the company operates in hi-tech business where talented human resources are the main asset of the company. On the other hand, hostile takeovers often result in the management being fired anyway, so the effectiveness of a people pill defence de- pends on the specific situation. III. Concluding remarks Hostile takeover defence is an art, not a science. Careful advance preparation is necessary to ward off the unfriendly bids, as being prepared can well make the dif- ference between success and failure. It is also important to remain flexible in responding to changing dynamics of takeover techniques. A company must have an efficient defence strategy in place to provide maximum flexibility in deal- ing with whatever the attacking company might throw its way. There is no “one size fits all” strategy to make the company takeover-proof. Therefore, a regular review of the takeo- ver environment is essential as is keeping the available defences up to date. in re | takeover defence It is important to remain flexible in responding to changing dynamics of takeover techniques.