contingent value rights in public takeovers: analysis under swiss

Contingent Value Rights in Public Takeovers:Analysis under Swiss Law

by

Frank Gerhard*

The use of stock as acquisition currency entails the risk that the price of the acquirer’s stock fluctuates significantly between the announcement and theclosing of the deal, or even after the deal closes. A collar, setting a fixed valuewhich pinpoints the exchange ratio at closing, may protect the target share-holders against stock price fluctuations prior to the closing of the deal. A con-tingent value right (“CVR”) offers a collar-like protection for a certain periodafter the deal closes. Given the increased volatility in the stock market, the useof hedging and protection devices designed to mitigate such future stock pricevariations could become more popular. After defining the CVR (I. 1.) and outlining its basic terms (I. 2.) – as well as its benefits and drawbacks (I. 3.–4.),we will determine its legal qualification under Swiss law (II. 1.) and analyseits various legal regimes, namely under corporate (II. 2.), takeover and secu-rities (II. 3.) and finally, criminal law (II. 4.). This article shows that a properstructuring may help to overcome the legal uncertainties accompanying theuse of CVRs.

Table of Contents ECFR 2006, 249–286

I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2501. Definition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2502. Basic terms of the CVRs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2513. Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2604. Drawbacks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262

II. Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2651. Legal qualification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2652. Corporate law treatment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2673. Takeover and securities law treatment . . . . . . . . . . . . . . . . . . . . . . . . 2794. Criminal law treatment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 283

III. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285

* Dr. iur. LL.M. (Columbia), Attorney-at-law, Zurich.

I. Introduction

1. Definition

Used in an exchange offer (or a cash offer with a share component), a CVR isa commitment by its issuer (usually also the acquirer) to grant additional con-sideration to the target shareholders (CVR holders) – generally in the form ofcash or stock (or a combination thereof) – equal to the difference between themarket price (reference price) of a particular stock (underlying) and a targetprice (target price) at some point in the future after the closing of the trans-action (maturity date). Also known as “variable common rights” or “valuesupport rights”, CVRs are economically intended to compensate the targetshareholders for future declines in the underlying stock price; they are struc-tured so that their value increases if the value of the underlying stock de-creases (and vice versa). This article focuses on CVRs used in M&A trans-actions, particularly in takeover offers. However, CVRs have also been usedin equity investments, debt restructurings, bankruptcy reorganisations andlawsuit settlements.

CVRs were used the first time in the United States in the merger betweenDow Chemical and Marion Laboratories in 1989;1 thereafter, they were usedby Rhône-Poulenc in its acquisition of Rorer Group in 19902 and by Viacomin its well-publicised acquisitions of Paramount Communications and Block-buster Entertainment, both in 1994.3 In the latter, Viacom won a bidding con-test against QVC for the right to acquire Paramount and reportedly won the contest because of its willingness to include CVRs in the transaction. InEurope, CVRs began to be used in the mid 1990’s by French companies;4

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1 Dow Chemical Company/Marion Laboratories proxy statement/offer prospectus datedOctober 30, 1989. For a US legal analysis, see Bab, Andrew L., ‘Contingent ValueRights’, in: Insights, The Corporate & Securities Law Advisor, Vol. 15, Number 5, May2001. For an economical perspective, see Chatterjee, Sris/Yan, An, Contingent ValueRights: Theory and Empirical Evidence, Fordham University 2004.

2 Rhône-Poulenc/Rorer Group proxy statement/offer prospectus dated March 22, 1990.3 Viacom/Paramount Communications proxy statement/offer prospectus dated June 6,

1994; Viacom/Blockbuster proxy statement/offer prospectus dated August 31, 1994.4 See the list of transactions in Actes pratiques, Ed. du Juris-Classeur, ‘Les certificats de

valeur garantie’ , Sept./Oct. 2001, 5–17 and following contributions: Desclèves, Arnaud/Halley, Stéphanie, ‘Le certificat de valeur garantie’, Revue de Droit Bancaire et de laBourse, 1998, 207–218; Decocq, Georges, ‘Une nouvelle forme de valeur mobilière: lescertificats de valeur garantie’, JCP 1997, Ed. E, 181–185; Le Bars, Benoît, ‘Pour uneapproche juridique du certificat de valeur garantie’, Bull. Joly Bourse 1998, 811–826; Pel-tier, Frédéric, ‘La sécurisation du paiement en actions des acquisitions d’entreprises’,

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interestingly however, they are almost non-existent in the United Kingdom.5

In Switzerland, the first and only attempt to use CVRs was the hostile take-over offer launched by InCentive Capital for Sulzer in 2001.6

2. Basic terms of the CVRs

a) Purposes

An empirical analysis of CVRs leads to a distinction between “offensive” and“defensive” CVRs, depending on the purpose aimed at by its issuer.

aa) “Offensive” CVRs

The “offensive” or “attractive” CVRs are offered by the acquirer to the targetshareholders with the aim of inducing them to tender their shares in the take-over offer and to accept the shares offered in exchange, granting them an additional consideration if the stock of the acquirer or the equity value of thecombined firm declines in the future. Often there will be a “floor” on howlow the actual share price can fall for purposes of computing the CVR con-

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JCP, Entreprises et Affaires 2001, 61; Trébulle, François-Guy, ‘De la nature des certificatsde valeur garantie’ (CVG), JCP, Entreprises et Affaires 1999, 114–118; Viandier, Alain,‘OPA/OPE et autres offres publiques’, Paris 1999, No. 954–956.

5 See, however, the acquisition in 2005 by Cable & Wireless (C&W) of Energis, a privateUK fixed line operator, for £ 594 million. In the third year following the completion ofthe deal, C&W will pay up to a further £ 80 million to former Energis shareholders, de-pendent on C&W’s share price. For every penny the price is above the price at the timeof the deal (135p), the firm will pay £ 1.25 million to Energis shareholders. For a UKlegal analysis, see von Haartmann, Annika, ‘Collars, CVRs and Other Derivatives in UKTakeovers’, Journal of International Banking and Financial Law 2005, 229–232 (part I)and 259–265 (part II).

6 InCentive/Sulzer offer prospectus of March 30, 2001, amended on April 9, 2001. Weknow of at least one other downside protection device previously used in a public take-over in Switzerland: in December 1996, Walter Fust, the majority shareholder of Dipl.Ing. Fust AG, made a public offer to acquire the Fust shares still in circulation inexchange for Jelmoli Holding AG shares. The minority shareholders of Fust were giventhe choice of exchanging each of their Fust shares either for a share in Jelmoli HoldingAG or for a share in Jelmoli Holding AG accompanied by European-type put optionsissued by the bank of the bidder and American-type call options in favour of the bidder.The rights underlying the options expired 2.5 years after the closing of the offer (see thedecision of the Commission for Regulation of December 6, 1996, summarised in SZW1997, 110–112).

Contingent Value Rights in Public Takeovers

sideration which enables the issuer to limit its financial exposure by setting acap to its disbursement in the event of a severe fall of its stock price.

The takeover offer of InCentive for Sulzer in spring 2001 provides a usefulexample of such offensive CVRs. For each Sulzer share tendered, InCentiveoffered either (i) CHF 430 in cash or (ii) one InCentive share and one CVR.Each CVR paid out to its holder at maturity (20 months after the launch ofthe offer) the excess (if any) between CHF 400 (target price) and the greaterof the reference price of the InCentive stock at maturity (weighted average ofall paid prices during the 5 trading days prior to maturity) and CHF 300(floor). The floor price provided for a cap of CHF 100 (25% of the targetprice) per CVR corresponding to a maximum liability of CHF 300 m. If theInCentive stock price dropped, for instance, to CHF 250, the value of theexchange offer consideration at maturity would only be equal to CHF 350(i.e. CHF 100 for the CVR, plus 1 × CHF 250 for the InCentive share alreadytendered). However, for instance, if the InCentive stock soared to CHF 450,the value of the exchange offer consideration at maturity would equal CHF450 because the CVR would be worth nothing in such a case. The CVR wasthus guaranteeing that the value of the per share exchange consideration, 20 months after the launch of the offer, would be at least CHF 400 (subject tothe floor) regardless of the performance of the InCentive stock. In France, thetakeover offers of AXA for UAP in November 19967 and of BNP for Paribasin July 1999 8 were prominent examples of such “offensive” CVRs. More re-cently, CVRs have also been used in cross-border takeovers, e.g. when FranceTélécom acquired a majority stake in the Dutch company Equant in Novem-

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7 SBF Avis n° 96-3689, November 12, 1996. AXA proposed to the shareholders of UAP toexchange 5 UAP shares against 2 AXA shares and 2 CVRs. At maturity (32 months afterthe launch of the offer), each CVR paid out to its holder the excess (if any) between FF392.50 (target price) and the greater of the reference price of the AXA stock at maturityand FF 312.50 (floor), providing thereby for a cap of FF 80 (20.38% of the target price).No payment was finally due under the CVR. See Finanz und Wirtschaft, February 8,1997, 13: ‘In Europa werden erstmals Fusionsderivate eingesetzt’.

8 CMF decision n° 199C0872, July 8, 1999. BNP proposed to the shareholders of Pari-bas to exchange 20 Paribas shares against 29 BNP shares and 13 CVRs. At maturity (24 months after the launch of the offer), each CVR paid out to its holder the excess (if any) between EURO 100 (target price) and the greater of the reference price of theBNP stock at maturity and EURO 80 (floor), providing thereby for a cap of EURO 20(20% of the target price). BNP issued the maximum of 107 mio CVRs incurring therebya maximal aggregate liability under the CVRs of approximately EURO 2.14 billion.

Frank Gerhard

ber 20009 or when the French advertising company Publicis acquired its UKcompetitor Saatchi & Saatchi in September 2001.10

bb) “Defensive” CVRs

If the bidder only wants to acquire a controlling stake, for instance, because itwants to keep the target listed11 or if it does not want to increase its stake butis obliged to make an offer because it has exceeded the threshold triggeringthe mandatory offer,12 it may offer to the target shareholders the less usual“defensive” or “dissuasive” CVRs in order to encourage them not to tender(all) their shares by compensating them an extra amount if the stock of thetarget declines in the future. Such defensive CVRs aim to minimise the costsof the mandatory takeover. Not only do they dispense the bidder from pay-ing upfront (or even entirely) an additional amount of cash (CVRs with deferred contingent payment in a cash offer) or from issuing additional newshares (CVRs with anti-dilution effect in an exchange offer) – both in pro-portion to the non-tendered shares, but they also relieve the bidder from pay-ing such a price at maturity of the CVRs in the event that the market price ofthe target company shares exceeds the target price.

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9 France Télécom offered one CVR to the minority shareholders of Equant for eachshare they held. The CVRs entitled their owners to receive, 3 years after issuance, a cashamount equal to the difference, if negative, between the Equant reference share price atthat time and EURO 60, up to a maximum of EURO 15 per CVR, leading to a maxi-mum exposure of approximately EURO 2.07 billion. At maturity, France Télécom hadto pay the maximum amount.

10 CMF decision n° 2000-3822, September 1, 2000. Publicis offered one CVR to theshareholders of Saatchi & Saatchi for each Publicis share offered in exchange for Saatchi& Saatchi shares. At maturity (18 months after the launch of the offer), each CVR paidout to its holder the excess (if any) between EURO 43.20 (target price) and the greaterof the reference price of the Publicis stock at maturity and EURO 38.98 (floor) pro-viding thereby for a cap of EURO 4.32 per share (10 % of the target price). Despite thisincentive, Publicis’ share price dropped after the deal, and Publicis had to pay the fullcap up to EURO 195 mio.

11 E.g. takeover offer of Unaxis Holding AG for ESEC Holding AG (offer prospectus dated July 6, 2000), where ESEC and Unaxis tried – unsuccessfully – to reach this goalby introducing an individualised and timely-limited opting-out provision in ESEC’s articles of incorporation.

12 E.g. takeover offer of Pelham Investment SA for Jelmoli Holding AG (offer prospectusdated June 2, 2003).


The present article will not deal primarily with the defensive CVRs sincetheir use is less frequent. They appeared for the first time in France in 1995 inan intra-group reorganisation. Prior to merging with its subsidiary Spie Ba-tignolles,13 Schneider proposed to the minority shareholders of the subsidiaryeither (i) to tender their shares immediately for a price of FF 227 per share or(ii) to receive a CVR for each non-tendered share. Each CVR paid out, at maturity (25 months after the launch of the offer), the excess (if any) betweenthe offer price capitalised at a rate of 7.5% per year, i.e. FF 262 and the refer-ence price of the Spie Batignolles stock at maturity. The CVRs were success-ful in convincing the shareholders to tender their shares in the subsequentmerger rather than in the prior quasi-mandatory offer. The French exchangeoffer of Rallye for Casino in 199714 provides a useful example of a defensiveCVR with an anti-dilution effect. Rallye proposed one CVR for each non-tendered share to the shareholders of Casino who would tender only oneshare out of two. Each CVR paid out, at maturity (26 months after the launchof the offer), the excess (if any) between FF 400 and the greater of the re-ference price of the Casino stock at maturity and FF 280 (floor) providingtherefore for a cap of FF 120 (30 % of the target price).

Some defensive CVRs have also been issued with the right for their holders tosell the underlying shares at maturity. Despite launching its mandatory offerfor all outstanding shares of Assurances Générales de France (AGF) in1998,15 Allianz still wanted to maintain a sizeable free float. Thus, it proposedto the shareholders of AGF either (i) to tender their shares immediately at a price of FF 320 per share or (ii) to receive for each tendered share and eachnon-tendered share, one CVR to induce them to keep at least half of theirshares. These CVRs provided for two types of guarantees at maturity. First,if, at maturity, the reference price of the AGF stock exceeded the takeoverprice (FF 320), the holder of the CVRs would keep its AGF share, and eachCVR would pay out to its holder the excess (if any) between FF 360 (targetprice) and the reference price of the AGF stock at maturity providing therebyfor a cap of FF 40. Second, if, at maturity, the reference price of the AGFstock was equal to or below the takeover price (FF 320), the holders of CVRscould tender an AGF share and a CVR and would receive, in consideration,FF 360 (target price) in cash. At the closing of the offer, Allianz held 51% ofthe share capital of AGF. By adding such a put option to the CVR, the issuerprevents the risk of a lack of liquidity in the non-tendered shares, the share-holder is certain to exit the target for the guaranteed stock price. A similar

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13 SBF Avis n° 95-1177, May 4, 1995.14 CMF decision n° 122558-OP062-A07, September 29, 1997.15 SBF decision n° 198C0158, February 12, 1998.

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type of protection has also been offered in takeover offers in Switzerlandwhere the bidder has offered a put option to the target shareholders entitlingthem to sell their target shares for the offer price after the settlement of the takeover offer, for instance, if the target is delisted within a certain time period thereafter16 or if certain target shareholders decide, e.g. for tax reasons,to sell their shares to the bidder only after the offer.17

b) Underlying

CVRs usually guarantee the performance of a company’s stock price – eitherthe stock of the bidder (offensive CVRs) or the stock of the target (defensiveCVRs) – and provide thereby a downside price protection. However, manyCVRs or similar securities provide a participation in the upside potential enabling their holders to benefit from the better performance of the underly-ing in the future. These instruments often track other indicators like an indexor a basket of securities,18 a company’s earnings or revenues,19 the outcome ofa contingent asset or liability such as a pending drug approval20 or an ongoinglitigation,21 or even the proceeds of an ongoing disposal. These instrumentsare structured to deliver value to shareholders if a positive event occurs post-closing, which is difficult to value at the time of closing but which could havea substantial impact on the value of the target. This is fundamentally differentfrom CVRs, which are used to guard against the inherent downside risk that

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16 See takeover offer of EnergyGroup Holding AG for Leclanché S.A. (offer prospectusdated April 3, 2006, I.7).

17 See takeover offer of REWE-Beteiligungs-Holding International GmbH for Bonappétit Group AG (offer prospectus dated September 2, 2003, D.4).

18 E.g. when Lufthansa acquired Swiss International Air Lines, the consideration con-sisted in part of appreciation rights issued by Lufthansa which were referenced to a basket of shares of comparable airlines (offer prospectus of May 4, 2005).

19 E.g. when Hewlett-Packard (HP) acquired the remaining 87 % of the outstanding shares of Indigo, a Dutch digital-printing company in September 2001, it offered toeach Indigo shareholder either (i) USD 7.50 in HP common stock, or (ii) USD 6 in HPcommon stock plus one non-transferable CVR entitling its holder to a cash paymentincreasing from zero to USD 4.50 per share if Indigo’s revenues increased from USD 1billion to 1.6 billion over a three-year post-closing period.

20 E.g. takeover offer of OSI Pharmaceutical for Cell Pathways, where the CVRs entitledtheir holders to additional OSI stock if, within 5 years following closing, a specific newdrug application is accepted by the FDA (offer prospectus of March 6, 2003).

21 E.g. takeover offer of Symphony Technology and Tennenbaum Capital for InformationResources, Inc. (offer prospectus of July 14, 2003), where the CVR was linked to theoutcome of an antitrust litigation.


the combined entity’s stock turns out to be less valuable than expected in astock-for-stock combination. Rather, these instruments are similar to earn-outs and are not dealt with in this article.

c) Price structure and price adjustments (anti-dilution)

The majority of CVRs guarantee that the bidder’s stock price will not fall below the takeover price during a certain period of time after closing. A va-riation thereof sets the target price by fixing a growth rate. For instance inFrance, the target price of the Schneider CVR started at FF 227 and increasedat a 7.5 % annual growth rate ending at FF 262 after 25 months. While thismay not be substantially different from the more familiar CVR pricing struc-tures, other variations, such as the InCentive CVR, subtract from the targetprice the value of all distributions (in cash or in shares) made on the under-lying stock prior to the settlement. In addition, the value of CVRs is closelylinked to the portion of the market capitalisation represented by each under-lying share. The same is true, for example, for warrants or convertible bonds.Therefore, the anti-dilution provisions of CVRs are often similar to those found in the latter instruments. Typically, an issuance, subdivision, consoli-dation or reclassification of shares or a free distribution of shares by way ofcapitalisation of reserves or otherwise, which are carried out by the issuerafter the issuance of the CVR are events which lead to an adjustment of thespread of the CVR usually by multiplying the reference price by an adjust-ment coefficient.22

d) Duration, extension of maturity and early termination

aa) Duration

The duration of the CVR should permit its holder to have a sufficient under-standing of the evolution of the price of the underlying security to allow himto better value the new entity. We know from the option pricing theory that,all else being equal, contingent claims are worth more the longer the time tomaturity. Thus, one role for maturity would be to adjust the relative amountsof immediate and deferred cash payments required in the takeover – a longer

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22 E.g. BNP/Paribas (note 8), Art. 1.11.7 of the offer prospectus; France Télécom/Equant(note 9), Art. 2.2.8 of the offer prospectus; Publicis/Saatchi & Saatchi (note 10), Art.C.7 of the terms of the CVR.

Frank Gerhard

maturity would reduce the amount of upfront cash needed. A second con-sideration is the signalling implication of committing to contingent paymentsover a longer or a shorter time period. A shorter maturity indicates the bid-der’s confidence to generate sufficient cash to make the necessary contingentpayments; they would therefore be interpreted as “good news”. Typically,CVRs have a maturity of one to three years from the launch of the offer.

bb) Extension of maturity

CVRs are already difficult securities to understand, but many CVRs arestructured with even greater complexity. For instance, many CVRs give theissuer an option to extend the maturity date and thereby, to defer the payoutof the additional consideration. In the Viacom transaction, Viacom could, forinstance, on only one business day’s notice, elect to extend the maturity datefrom the first anniversary of the CVR to its second anniversary. Such an elec-tion would constitute a bet by Viacom that its stock price would increaseover the next year and that, therefore, the present value of the payout on thesecond maturity date would be less than the payout on the first maturity. Themessage conveyed by an extension is, therefore, an implicit statement that theissuer is bullish on its own stock. However, in most cases, the target and floorprices increase when the maturity is extended. For instance, on the first maturity date, the Viacom target and floor prices were USD 48 and USD 36,respectively. On the second maturity date, they were USD 51 and USD 37,respectively.23

cc) Early termination

Another mechanism that an issuer can include in its CVRs is an early ter-mination provision that causes the CVRs to expire if the average market priceof the underlying stock exceeds the target price of the CVR for a specific period.24 This “up and out” option should not create problems for CVRs holders, for they could have sold their underlying stock during such a period

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23 Viacom did not exercise the extension option and paid out on the first maturity date in July 1995 the amount of USD 1.44 in cash for each CVR issued for a total of ap-proximately USD 80 million.

24 E.g. CVRs issued by Markel Corporation in its acquisition of Terra Nova Holdings Ltd(2000) or by EchoStar to Vivendi Universal to induce the latter to purchase shares inEchoStar for USD 1.5 billion to help financing a portion of the attempted merger ofEchoStar with Hughes Electronic Company.


at a higher price than the guaranteed price. In addition, the measurement period is usually long enough to eliminate the risk that an abrupt spike in thestock price will de-activate the CVRs.25 Finally, if the CVRs do terminate under this provision, it is because the underlying stock price hit its target, andassuming that the CVRs holders have not yet sold the underlying stock thatthey received in the acquisition, they should be quite happy that the targetwas reached earlier than expected.

e) Redemption by the issuer

Issuers of CVRs occasionally maintain a degree of flexibility by building insome redemption rights before maturity.26 The redemption would cor-respond to a period when the CVR has a low market value (i.e. when the underlying shares have a high price). It aims to limit the risk that the guar-antee can be drawn at maturity. Typically, the redemption price would be a value equal to the target price of the CVR less the underlying share’s price atthe date of redemption discounted from the maturity date; in other words,the redemption payout is simply the present value of the assumed payout atmaturity. It gives the issuer the ability to cut its payout costs if it thinks itsstock price is not likely to grow at more than the discount rate by maturity.Unlike the maturity extension right, this type of flexibility cannot ordinarilybe exercised without conveying a negative message about the issuer’s stockperformance.

f) Holder protections

In order to enhance its flexibility with respect to the terms and conditions ofthe CVRs, the issuer often replicates a complete set of rules instituting thepossibility for a contractual CVR holders’ meeting with competences similarto such of a bondholders’ meeting. For instance, in case of a downturn in thebusiness of the company, one could imagine that the issuer would be able to

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25 The CVRs issued by Markel in its acquisition of Terra Nova Holding had a 20-con-secutive-day measurement period; the measurement period of the EchoStar CVR wasin fact 90 consecutive days.

26 E.g. AXA/UAP (note 7); BNP/Paribas (note 8); France Télécom/Equant (note 9); Publicis/Saatchi & Saatchi (note 10).

Frank Gerhard

modify the terms of the CVRs with the approval of a majority of only two-thirds of the CVRs represented.27

Furthermore, the CVR agreement usually contains many of the same cov-enants found in debt indentures including the provisions of periodic reportsby the issuer to the trustee, events of default, representations and warranties,and remedy provisions. For instance, if the issuer disposes of all its assets or isacquired by a third party before the maturity of the CVRs, the holder will bepaid the present value of the target price unless the acquirer or the new entityagrees to assume all the CVR obligations. For example, if Viacom had beenacquired for USD 50 per share exactly six months before the second maturitydate of the CVR, any CVR holder would have received approximately USD0.96 per CVR since the second target price was USD 51 and the discount rateset in the CVR agreement was 8 %. Alternatively, one could imagine a solu-tion where the CVR holder may give the CVR back to the issuer if there is achange of control of the issuer.28

Finally, perhaps the most critical protection is the prohibition for the issuerfrom purchasing the underlying stock during the valuation period or evenduring a specific period of time prior to such a period. This is the period overwhich the market value of the underlying stock is determined for the purposeof calculating the payout. The higher the stock price during the valuation period, the lower the payout on the CVR – by prohibiting an issuer frombuying its own stock during this period, holders are protected from an arti-ficially inflated stock price.

Finally, if a subsidiary or a special purpose vehicle issues the CVRs, the issuerwill generally provide a guarantee from its parent.29

g) Reference price, exercise and settlement

The reference price is calculated on a valuation period of approximately 10 to 30 trading days prior to maturity. The weighted average of all paid (e.g. InCentive/Sulzer), opening (e.g. AXA/UAP) or closing (e.g. BNP/Paribas)share prices during the reference or valuation period are usually taken into

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27 E.g. AXA/UAP (note 7), Art. 7.2.7 of the prospectus; BNP/Paribas (note 8), Art. 1.11.6of the prospectus.

28 E.g. Dow Chemical/Marion Laboratories (note 1).29 E.g. in the Hewlett-Packard/Indigo transaction (note 19), the CVR was issued by a

German subsidiary of Hewlett-Packard and guaranteed by the parent company. TheInCentive CVR was even guaranteed by the bank of the issuer.


account. Usually, holders of CVRs can exercise their right only at maturity(during e.g. 1 to 15 days).30 Unexercised CVRs will lapse and lose all value.Alternatively, the CVRs can also mature without any further actions by theirholders.

3. Benefits

a) Additional value

CVRs provide additional value for both the issuer and the holder. For the issuer, the CVR has the added value of being capped, deferred and contin-gent. The payment (if any) will never exceed the amount that would havebeen paid if the bidder had paid upfront, and, in any case, if the payment hasto be made, it enables the bidder to postpone the need to raise additional cashuntil the maturity of the CVR. For the holder, CVRs provide a quantifiableadditional value as well.31 Therefore, if the issuer has guessed right, it willhave provided the target shareholders with real value without having to makeany actual payout. If it has guessed wrong, the payout is at least delayed untilthe maturity of the CVR.

b) Certainty and insurance

CVRs – through the insurance they provide – may help to overcome the inherent uncertainty of mergers and acquisitions.32 In a stock deal, the targetshareholders can never be sure that the value they are receiving for theirshares will be sustained for any period of time – particularly where marketsare volatile, where it is uncertain whether the combined entity will be able torealise the synergies promised or where the shares offered in exchange are

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30 E.g. the InCentive CVR was exercisable only on the expiry date on December 13, 2002;the BNP CVR was exercisable between July 1, and July 15, 2002.

31 E.g. InCentive/Sulzer offer prospectus (March 30/April 9, 2001), 3, where the reviewbody estimated the theoretical value of each CVR between CHF 15.20 and CHF 20.27using the Black/Scholes method; Markel/Terra Nova Holdings Ltd (note 25) jointproxy statement/offer prospectus, 23; BNP/Paribas (note 8), Art. 1.14.1 of the prospec-tus; France Télécom/Equant (note 9), Art. 2.4.4 of the prospectus.

32 Willens, Robert, ‘Contingent Stock Acquisitions Should Gain Popularity in UncertainTimes’, BNA Mergers & Acquisitions Law Report, Vol. 6, No. 26, June 30, 2003, 523–525.

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illiquid.33 A good example is the two-steps Dow Chemical/Marion Laborato-ries transaction.34 In the first step, Dow made a cash tender offer for 39 % ofMarion’s outstanding shares. In the second step, Dow voted its Marion sharesin favor of merging Marion with Dow’s wholly owned subsidiary, MerrellDow Pharmaceutical. In the merger, Dow transferred to Marion all of itsstock in Merrell Dow as well as one CVR for each minority share of Marionremaining after the takeover. In exchange, Dow received additional shares ofthe new corporation, Marion Merrell Dow, increasing its ownership to 67 %.Subsequently, Marion Merrell distributed the CVRs to its minority share-holders. At the end of this transaction, the original Marion shareholders wereleft not only with some cash from the tender offer, but also with stock in acompany that had just combined with a relatively unknown one (Merrell wasa wholly owned subsidiary of Dow before the transaction). Dow’s CVRs (based on Marion Merrell’s stock price) mitigated at least some of the risks to the Marion Merrell minority shareholders by insuring that at least for 22 months, holders of CVRs could expect to receive the difference betweenthe market value of the Marion Merrell shares at maturity and USD 45.77(adjusted closing price), subject to an overall maximum payment of USD15.77 per CVR. While the fact that the first step tender offer was greatly over-subscribed could indicate that shareholders wanted to be cashed out ratherthan hold the remaining share plus the CVR, the fact that shareholders ultimately approved the transaction indicated that the CVRs helped themovercome any concerns they might have had with holding the remaining shares.

c) Signal of confidence

An acquirer who is willing to include a CVR in the consideration package,e.g. in a competitive bid situation, is telling the market that he strongly be-lieves that the transaction will be beneficial and that he is willing to “put itsmoney where its mouth is”. By guaranteeing a minimum stock price after ayear or two, the issuer is effectively predicting what kind of growth it expectsto achieve. In fact, the use of CVRs can also be explained on the basis of thesignalling theory whereby the bidder communicates to the target sharehold-ers, who are outsiders of the issuer, private information on the true value ofthe combined firm. The shareholders’ cost to the “good” firm is low (even

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33 In the InCentive/Sulzer takeover offer, 87% of the shares of InCentive were held bycore shareholders. This may not have been appreciated by potential target shareholdershesitating to accept the exchange offer.

34 Reported by Bab (note 1), 5–6.


zero if the CVRs expire out-of-the-money) while mimicking the “good” firmcan be expected to be costly for the “bad” firm.

d) Liquidity

CVRs are initially granted to shareholders, but they are usually issued astransferable securities that their holders can sell although there are some exceptions.35 In order to favour such negotiability, CVRs are often listed on astock exchange so that their holders can realise the value embodied in theCVRs by selling them separately at prevailing market prices prior to theirmaturity. Consequently, someone could easily hold either the share or theCVR without holding the other instrument. InCentive, for instance, intendedto list its CVRs on the Swiss Exchange. The France Télécom CVRs were listed on the Euronext in Paris and were also traded on the New York StockExchange as American depositary CVRs. Because of this listing and the factthat the CVRs are immediately separable from the underlying stock, a marketwill generally develop for the CVRs, and holders will gain valuable liquidity.

4. Drawbacks

a) Complexity

Probably the biggest disadvantage of the CVR is its complexity. Few instru-ments increase in value when the underlying asset loses value, and not manypeople outside the financial community are familiar with puts and short-selling. Moreover, it is unusual to use derivatives as acquisition currencymainly because their value is speculative. Layered on top of all this are the various bells and whistles – floors, redemption rights, early terminationclauses, extension rights – that make both valuation and comprehension ofthis instrument so difficult. Sometimes even the basic terms of the CVR arecomplicated. For example, the CVR issued in the Viacom/Blockbuster dealhad a two-tier pricing structure whereby the target price increased if theunderlying Viacom stock price reached a certain level. It is hard to believethat this type of security can be valued in any meaningful manner even by financial sophisticates, let alone understood by an average shareholder.

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35 E.g. in circumstances where there is only one target shareholder (e.g. when acquiringPillsbury on December 31, 2001, General Mills granted to the seller Diageo a USD 670mio CVR placed in escrow) or where the CVR is expressly declared non-transferable(e.g. in the Hewlett-Packard/Indigo transaction (note 19) or the Vivendi/Echostartransaction (note 24)).

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b) Loopholes

One of the problems with the inherent complexity of the CVR is that thereare bound to be loopholes in its terms. For instance, if the issuer spins off toits shareholders its principal asset, e.g. a subsidiary, under the usual terms ofthe CVR, any such (non-cash) distribution would reduce the target price inan amount equal to the value of the distributed asset. If the CVR does nottrade separately from the underlying stock, this provision would make sense –the shareholder who received value through the distribution of the subsidiaryshould not also be entitled to an unadjusted CVR value. Very often, however,one or two years after the issuance of the CVR, it is unlikely that the originalholders still hold the CVR. Indeed, since the CVR is an investment for thosewho are bearish on the underlying stock, one might expect the CVR investorsto be a different group than the investors in the underlying stock. In such acase and in strict application of the CVR agreement, the CVR target pricewould be reduced despite the fact that the actual holder of the CVR wouldnot benefit from such a distribution since he might not be a shareholder.36

c) Credit risks

The target shareholders receiving CVRs are being asked to bear the credit riskassociated with the bidder in the event that the latter delays or defaults on discharging the promised contingent consideration. For instance, the maxi-mum payout under the Viacom CVR corresponded to 20 % of Viacom’s mar-ket capitalisation, and Viacom was not a first rate debtor. Of course, if the alternative is no deal at all or the CVR is the only difference between twootherwise similar bids, the credit risk may be worth assuming. In order tomitigate that risk, the issuer could strengthen the value of its CVRs by hav-ing, for example, a bank guarantee its payout. The issuer must also take intoaccount the fact that many of the same events that could impair its ability topay out on the CVR could also adversely affect its own stock price, therebyincreasing its obligations under the CVR and creating a boomerang effect. AsBarry Diller, chairman of QVC rivalling the bid of Viacom for Paramount,said, “It may work out. But what if the US starts a war and stock go down?What if interest rates go up? [...] You’d owe USD 1 billion you didn’t have.”37

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36 For US litigation, see Society National Bank v. Brooke Group Ltd., 1993 Del. Ch. LEXIS 215 (September 24, 1993).

37 Alison L. Cowan, Rival Bidder Diller Says, ‘It’s History’, NY Times, February 16,1994, D5.


If the payout is to be paid in stock of the acquirer, such a boomerang effectwould even be doubled by the dilution effect. Finally, a large payout couldcause the issuer’s stock price to decline and trigger a downward spiral.

d) Arbitrage

In takeovers, merger arbitrageurs buy in after the announcement of an agreedtransaction in an effort to lock in the spread between the offer price and thediscount to the offer price at which the target will trade because of the riskthat the transaction will not close. In an exchange offer, the arbitrageur will take a long position in the target and will shorten the acquirer’s stock inorder to lock in its return. When the target’s shares are converted into the acquirer’s share, the arbitrageur then uses these shares to cover its short posi-tion. Publicly traded CVRs can have a dramatic impact on the arbitrageur’strading strategy and the post-closing stock price of the combined entity. Forinstance, arbitrageurs held very significant positions in both the Viacom/Paramount and Viacom/Blockbuster CVRs – as much as 50 % of each issue.38

Because of the desire of investors to get cash quickly, the arbitrageurs wereable to buy them up at discounts to their intrinsic value. To lock in their profits, the arbitrageurs also accumulated the underlying Viacom stock,which pushed up the stock price even higher, ensuring a profitable position ifthe stock rose and the CVRs fell. As the maturity of the CVR approaches, thearbitrageurs have to unwind their hedges (i.e. sell or shorten Viacom stock) torealise their locked-in profits. This can result in a downward pressure on theacquirer’s stock price, which is more unappealing than usual when a CVR isin place, because the payout on the CVR could be much higher than it mightotherwise have been. The bidder may prevent the risk of arbitrage activity by having the option to extend the term of the CVR. Nearing maturity, thearbitrageurs will not know whether the bidder will extend the term of theCVR. Therefore, they cannot take significant short positions in the acquirer’sstock because if the bidder elects to extend the maturity date for a year, an arbitrageur would not be able to cover the short position in a short time period if the shares underlying the CVRs were not issued. If there is the pros-pect that the arbitrageur would need to sit on its short position for a year, theinvestment is less attractive because the arbitrageur cannot get out of the investment and into its next investment.

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38 Finanz und Wirtschaft, February 8, 1997, Praktikus, Zur Börsenlage, 13.

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II. Analysis

1. Legal qualification

a) CVRs as independent guarantee

The obligation evidenced by the CVR is different from the obligation attach-ed to a traditional debt instrument: first, CVRs are not granted to their holders in exchange for the transfer of any funds to the issuer; second, CVRsdo not yield any interest or other periodical (capitalised) payment; and finally, the issuer’s payment obligation (and the CVR payout) is neither cer-tain nor for a fixed amount but only conditional upon the target price ex-ceeding the market price of the underlying at maturity. Thus the CVR repre-sents a guarantee (subject to the floor) by the acquirer/issuer in favour of thetarget shareholders that the shares offered as consideration in the exchangeoffer or the shares of the combined firm (underlying) will have a certain minimal value (target price) at a certain time in the future (maturity). Further-more, the guarantee represented by the CVR is not accessory to a principalobligation, but it provides its holder with a direct and genuine (conditional)claim against the issuer independent from a principal contractual relation-ship. Such an independent guarantee – as a conditional payment obligation ofthe issuer – is valid from a contract law perspective because the amount pay-able upon occurrence of the risk is determinable in the CVR instrument.39

If, at maturity, the reference or market price of the underlying is below thetarget price, the insured risk has materialised, and the CVR holder will be-come an unsecured creditor ranking equally with all other unsecured credi-tors of the issuer. If, at maturity, the underlying gained instead of losing valueand exceeds the target price, the holder of the CVR will have no claim againstthe issuer and the CVR will lapse worthless. In such a case, the CVR has onlybeen a mere guarantee deactivated by the non-occurrence at maturity of therisk covered or by a “deactivating barrier” if the underlying stock has exceed-ed the target price during a certain measurement period prior to maturity.

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39 Gauch, Peter/Schluep, Walter R./Schmid, Jörg/Rey, Heinz, Schweizerisches Obligatio-nenrecht, Allgemeiner Teil, vol. II, 8th edn., Zurich 2003, No. 4153 ss, in particular No. 4165; Honsell, Heinrich, BSK-OR I, 3rd edn., Basel 2003, Art. 197 No. 17; Böckli,Peter, ‘Gewährleistungen und Garantien in Unternehmenskaufverträgen’ in: Tschäni,Rudolf (ed.), Mergers & Acquistions, Zurich 1998, 59–111, 93.


b) CVRs as cash-settled, tradable, European-style put options

The complexity of the CVR, namely the reference to an underlying, the factthat its value increases when the value of the underlying decreases, the en-titlement to receive a future payment based on the share price of a stock andthe element of embedded guarantee, leads us to establish a link with deriv-ative instruments, in particular options.40 At (European style) or until (Ame-rican style) a specific date (maturity or expiration date), such options can pro-vide for physical settlement, i.e. actual delivery of the underlying, or for cashsettlement, i.e. payment of a cash amount corresponding to the differencebetween the strike price and the market price at maturity. While the SwissSupreme Court has never resolved the ongoing controversy about the legalqualification of options,41 the majority of the legal authors qualify the optionright as a “Gestaltungsrecht” enabling its beneficiary to enter into the mainagreement simply by exercising the option.42

CVRs, by entitling their holders to receive additional consideration in a valueequal to the difference between the strike price (target price) and the currentmarket value (reference price) of the underlying share at maturity, put theirholders in the same economic position as if they had exercised a put optionand sold their shares to the issuer for the target price. The fact that the holdersdo not sell the underlying stock in exchange for the payment and that the issuer of the CVRs does not accept delivery of the underlying stock from theholders but only makes a payment equivalent to the difference of value ischaracteristic of a put option with cash settlement. In addition, CVRs fre-quently trade separately from the stock from the moment they are issued. Allthis, added to the fact that usually the holder of the CVRs can exercise hisright only at maturity, leads us to qualify the CVRs as cash-settled, tradable,European-style put options. Commentators have very often emphasised this

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40 In general, Häusler, Tom, Die vertraglichen Grundlagen im Bereich des Handels mitderivaten Finanzinstrumenten: unter besonderer Berücksichtigung des Schweizer Rah-menvertrages für over-the-counter (OTC) Derivate, Zurich 1996, 110; Pulver, Urs,Börsenmässige Optionsgeschäfte: Auftrag und Abwicklung, Zurich 1987, 205; Giger,Peter, Der OTC Handel mit Finanzderivaten aus rechtlicher Sicht, Zurich 1998, 23;Halter, Daniel, Der Einsatz von derivativen Finanzinstrumenten im Nichtbanken-bereich, Zurich 2004, 12.

41 BGE 113 II 31, 115 II 385 and 122 III 15.42 See only Bauer, Börsenmässige Termingeschäfte und Differenzeinwand im schweizeri-

schen und deutschen IPR, Basel 1988, 130 ss; Gauch/Schluep/Schmid/Rey (note 39),No. 487; Häusler (note 40), 114 ss and 121–122; Pulver (note 40), 209 ss and 243, andGiger (note 40), 24.

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derivative43 or option-like 44 character. This qualification is also confirmed bythe fact that CVRs are usually valued using an option pricing method. CVRswill, therefore, be in the money when the post-closing price of the underlyingfalls below the reference price. In the finance language, finally, a CVR can beviewed as a European bearish put spread because the CVR has a floor with along position at the target price and a short position at the floor price. Themaximum payoff is the difference between the target and the floor prices.

2. Corporate law treatment

a) CVRs and the purpose clause of the articles of incorporation

For the bidder, the main disadvantage of using CVRs is the potential financialexposure they create. If it turns out post-closing that the bidder’s share pricehas gone down due to a poorer than expected performance of the target com-pany and/or the absence of anticipated synergies, this triggers the payment ofthe additional consideration, i.e. the bidder ends up paying even more forwhat has turned to be a poor acquisition.45 Therefore, the issuance of CVRscontains a speculative element; indeed, the issuer of the CVRs takes the riskthat, at maturity, the market price of its own share will not fall below the target price.

The making of profit through issuance, purchase and sale on a standalone basis of derivative instruments based on own shares of the company which isunconnected with the main business of the company is generally not coveredby the purpose clause of the articles of incorporation of a Swiss company.46

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43 E.g. Desclèves/Halley (note 4), No. 9, 209; Trébulle (note 4), 116; Desjardin, C.,‘Comptabilité Audit: vers un régime restrictif pour les CVG?’, Option finance, August31, 1998, No. 512, 24 ; Tassin, H., ‘Des outils optionnels originaux: les CVG protègentbien de la baisse’, Le journal des finances, October 3, 1998, 11.

44 E.g. Tschäni, Rudolf/Iffland, Jacques, ‘Ausarbeitung eines öffentlichen Übernahme-angebotes’, in: Tschäni, Rudolf (ed.), Mergers & Acquisitions IV, Zurich 2002, 121–221,142–143; Roman, D., ‘Utiliser les CVG pour jouer la baisse’, Le journal des finances,August 8, 1998, 1134. The qualification as a put option is also the prevailing view setforth in US disclosure documents, based on a ruling by the Internal Revenue Service,Rev. Rul. 88–31, 1988-1 C.B. 302; see also Zander, Carolyn, Note: ‘Contingent ValueRights and the Taxation of Contingent Payment Obligations’, 30 Harv. J. on Legis.(1993), 201–251.

45 E.g. Dow Chemical paid out USD 1 billion under the CVRs it issued to Marion Labor-atories shareholders on the merger of Marion with Merrel Dow because the shares inthe combined entity failed to perform.

46 See only Halter (note 40), 106.


However, a connection between the financial operations and the main activ-ities of the company should only be refused in exceptional cases.47 Further-more, the courts have been very tolerant when assessing the conformity of anactivity with the purpose clause of the company. It is recognized that only actions that are expressly prohibited by the purpose clause exceed the powerof representation of an officer of the company.48 In addition, the board of directors may, and even must, examine whether the writing of put options onown shares may favour the activities it is entrusted with by the shareholders,for example, because they permit to hedge certain risks or permit to reducecertain costs. The guarantee provided by CVRs enhances the attractiveness ofthe bid and increases its chances of success; it also could lead to a reduction –or at least to a postponement – of the costs of a transaction. Therefore, whenaccompanying a takeover offer that is itself in the interest of the company, theissuance of CVRs is as such legitimate.

b) CVRs and the interest of the company

Pursuant to Art. 717 CO, the members of the board of directors must carryout their duties with due care and must duly safeguard the interest of thecompany. The interest of the company cannot be described in abstracto.49 Theboard of directors must make its decisions within a framework, whereby itmust weigh the interests involved including interests of other stakeholders,50

with the ultimate goal of enhancing in the long term the value of the companyand thereby, the value of the participation of the shareholders.51 In any event,

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47 Halter (note 40), 106; Forstmoser, Peter/Meier-Hayoz, Arthur/Nobel, Peter, Schweize-risches Aktienrecht, Bern 1996, § 21 No. 5; Böckli, Peter, Schweizer Aktienrecht, 3rd edn.Zurich, 2004, § 13 No. 497.

48 See e.g. BGE 116 II 323 rendered in connection with Art. 718a CO.49 Lambert, Claude, Das Gesellschaftsinteresse als Maxime des Verwaltungsrates der

Aktiengesellschaft, Bern 1992, 211.50 Forstmoser/Meier-Hayoz/Nobel (note 47), § 28 No. 26; Watter, Rolf, BSK-OR II, 2nd

edn., Basel 2002, Art. 717 OR No. 38; Homburger, Eric, ZK-Kommentar, Zurich 1997,Art. 717 OR No. 800 ss. Recently, some voices have advocated a stricter shareholder value oriented position, i.e., a board that would not ultimately pursue the interest of the shareholders would breach its duty of care (see, e.g. Groner, Roger, Erwerb eigenerAktien, Basle 2003, 15–16).

51 BSK-OR II-Watter (note 50), Art. 717 OR, No. 16 and 37; ZK-Homburger (note 50),Art. 717 OR No. 772 ss. As to the similar situation in both the UK under the new “enlightened shareholder approach” and Germany under § 76 AktG cf. Schall, Alexan-der/Miles, Lilian/Goulding, Simon, ‘Promoting an Inclusive Approach on the part ofDirectors: The UK and German positions’, (2006) Journal of Corporate Law Studies,

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the board has a wide judgment in making its decisions. Provided that thereare no conflicts of interests, the business judgment rule developed in direc-tors’ liability cases mandates that, when reviewed in hindsight, the decisionsof the board must be (i) taken in good faith in the interest of the company, (ii) based on an adequate information process and (iii) taken independentlyby the board without being influenced by external elements and third parties.In such cases, the cognition of the court is limited to an irrationality test.52

This means that the board may not enter into transactions that bear risks thatare disproportionate or inappropriate for the company or, if materialised,would put the existence of the company at risk (Klumpenrisiko).53 However,speculative transactions are not per se always disproportionate or inappro-priate. The board must carefully balance the advantages of the speculativetransaction on the one hand and the probability and magnitude of the occur-rence of the risk to the detriment of the company on the other hand. In thepresence of a risky transaction, the decisive criterion will be whether the occurrence of the risk will have a material impact on the company or if theboard of directors may accept the risk in view of the potential limited damage. The smaller the effects of a materialisation of the risk will be, themore liberté de manoeuvre the board will be granted when entering into atransaction provided that the speculative transaction does not qualify as apure waste of assets.

Shareholders of the bidder could, however, question the justification of theCVR to increase the chances of success of the takeover offer. The question isdelicate since the interest of the company is, as mentioned above, a multi-faceted concept attached with a lot of incertitude. In addition, the question iscertainly also delicate because it might be difficult to value – at the time of theissuance of the CVRs – what claim (if any) the CVRs will incorporate at maturity. In view of the foregoing, only some guidelines can be suggested.First, it is certainly wise to include a floor in the bear spread which will capthe subsequent (contingent) liability of the issuer at the maximum amount

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forthcoming, asking whether or not this means the dawning of the age of shareholdersupremacy as predicted by Hansmann, Henry/Kraakman, Reinier, ‘The End of Historyfor Corporate Law’, 89 Georgetown Law Journal 439–68 (2001).

52 In general on the business judgment rule, see Grass, Andrea, Business Judgment Rule:Schranken der richterlichen Überprüfbarkeit von Management-Entscheidungen in aktienrechtlichen Verantwortlichkeitsprozessen, Zurich 1998, 49 ss and Bärtschi, Harald,Verantwortlichkeit im Aktienrecht, Zurich 2001, 391 ss. In Germany, see § 93 (1) 2AktG; BGHZ 135, 244.

53 Böckli (note 47), § 12 No. 545; Rusch, Arnold, Interzession im Interesse des Aktionärs,Zurich 2004, 176 ss; BGE 113 II 52 c.3, BGE 2A.79/2002 c.3.1.


the company could pay out as dividends. Second, the extra-costs triggered bythe CVRs must be calculated as precisely as possible and be compared to thebenefit expected from a successful offer. Finally, a fairness opinion con-firming the economical justification of the additional (contingent) costs trig-gered by the CVRs could probably give the board the comfort required insuch a situation.54

c) CVRs and the repurchase of own shares

Any rules on the repurchase and holding of own shares aim in particular atprotecting the company’s equity, limiting the carrying of the shareholders’risk by the company, avoiding an undue influence of the board on the share-holders’ meeting and ensuring transparency towards the market and the in-vestors.55 Therefore, when purchasing their own shares, a Swiss companymay do so only if (i) freely disposable equity in the amount necessary for thisacquisition is available and (ii) the total nominal value of these shares does notexceed 10 % of the share capital (Art. 659 CO). The voting rights of own shares and the rights connected therewith are suspended (Art. 659a (1) CO).In addition, the company must show a separate reserve in an amount cor-responding to the acquisition value of the own shares it holds (Art. 659a (2)CO). Finally, the company must disclose in the notes to its financial state-ments all transactions performed on its own shares as well as the number ofown shares it holds (Art. 663b para. 10 CO).

Strictly speaking, CVRs do not lead to a repurchase of own shares since thecompany is only obliged to pay out the difference between the market priceand the exercise price of its own shares at maturity. However, the questionarises whether the rules on the repurchase of own shares are nevertheless applicable to such a cash-settlement structure. Certain authors do subjectcash-settled put options on own shares to Art. 659 CO because the company– and no longer the shareholder – carries the economic risks of its own shares.56 Since the shareholder who holds the put options has given up its

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54 For general guidelines when dealing with Klumpenrisikos, see Rusch (note 53), 180.55 See in general Böckli (note 47), § 4 No. 194 ss; Groner (note 50), 87 ss.56 Bösch, René, ‘Eigene Aktien im Handelsbestand der Banken’, AJP 1995, 745–757, 753;

Fischer, Konrad, ‘Oberstes Organ der Aktiengesellschaft ist die Generalversammlungder Aktionäre’, SZW 1998, 231–237; Oertli, Reinhard, ‘Zum Erwerb eigener Aktien’,SZW 1994, 261–272, 264; von der Crone, Hans-Caspar, ‘Auf dem Weg zu einem Rechtder Publikumsgesellschaft’, ZBJV 133 (1997), 93–94.

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position as a risk bearer (subject to the floor), these authors argue that thisshareholder no longer has any interest to influence the development of thecompany and therefore would no longer exercise its voting rights, or, if itwere to do so, it would probably follow the motions of the board of direc-tors. Such a transfer of risk from the shareholder to the company makes thelatter the shareholder holding the actual economical interest. Therefore, theseauthors argue that a “purchase” pursuant to Art. 659 CO should cover alltransactions, whereby the company carries the economic risk of its ownshares,57 e.g. a forward purchase of own shares, securities lending or the is-suance of a put option on own shares with a minimal price, and such trans-actions should trigger the suspension of the voting rights attached to the shares.

We believe that the mere fact that CVRs may constitute a repayment of paid-in capital to shareholders is not sufficient to subject them to the rules on therepurchase of own shares. Indeed, in addition to the protection of the paid-in capital – which is also protected by Art. 678 (2) CO on the prohibition ofhidden distributions and Art. 680 (2) CO on the prohibition of the repay-ment of paid-in capital – one of the purposes of Art. 659 CO is, in particular,to avoid the dilution of the voting rights of the shareholders and the board ofdirectors taking control on the decisions to be made in the shareholders’meeting.58 Therefore, according to a teleological interpretation of the rule, inorder to qualify as a “purchase” of own shares, a transaction must not onlytransfer the economic risk of the shares from the shareholders to the com-pany – as do cash-settled put options, but it must also be able to dilute thevoting rights of the shareholders and enable the board of directors to influ-ence the exercise of the voting rights attached to the shares of the company.59

This may, for instance, be obtained by the concurrent entering into an agree-

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57 Bösch (note 56), 753; Fischer (note 56), 235, 236; Oertli (note 56), 264; von der Crone(note 56), 93 ss.

58 Message of the Federal Council on the new Swiss corporate law dated February 23,1983, Separatum, 66 (Federal Gazette 1983, 1 ss); Groner (note 50), 89 and 102 ss; Peter,Henry/Bahar, Rashid, ‘Rachat et options de rachat par une société de ses propres actions (en droit des sociétés)’, Journée de droit bancaire et financier 1999, 15–59, 24and 49.

59 In its unpublished decision of September 2, 1996, in the matter BK Vision AG vs. SwissBank Corporation, the commercial court of the canton of Zurich rejected the theory ofthe carrying of the economic risks as a reason for excluding the voting rights in case ofa forward sale of own shares to the company because such exclusion is incompatiblewith the law and does not contemplate the legal position of the seller, who is still the registered owner of the shares.


ment between the shareholder and the company whereby the shareholderundertakes to follow the voting instructions of the company.60

Even though CVRs transfer the economic risks and benefits attached to theshares from the shareholders to the company – indeed the company could beobliged to pay the CVR spread to its holders, CVRs do not transfer to thecompany the voting rights attached to the shares and do not grant the boardof directors the power to influence the shareholders’ meeting. Therefore, therules on the repurchase of own shares should not be applicable to cash-settledequity derivatives that provide only for a stock price guarantee.61 Finally, thetwo other consequences of a repurchase of own shares, i.e. the constitution ofa separate reserve in the balance sheet in the amount corresponding to the acquisition value of the own shares and the disclosure in the financial state-ments of the company of all transactions in own shares, would not justify tosubject the issuance of CVRs to Art. 659 CO either. First, the constitution ofa reserve whose purpose is to evidence a reduction of the available substanceof the company (because own shares do not constitute assets that might berealized like inventories or receivables) does not make sense – at least for thisreason – since the company has not spent any money for the issuance of theCVRs. Second, contingent liabilities represented by the CVRs have to be disclosed in the financials of the company pursuant to Art. 663b para. 1 COanyway, so that the disclosure commended by the rules applicable to the

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60 See the decision of the commercial court of the canton of Zurich, dated September 2,1996 (note 59); Forstmoser/Meier-Hayoz/Nobel (note 47), § 24 No. 88e; Hofstetter,Karl, ‘Erwerb und Wiederveräusserung eigener Aktien durch börsenkotierte Gesell-schaften’, in: Aktienrecht 1992–1997: Versuch einer Bilanz, Zum 70. Geburtstag vonRolf Bär, Bern 1998, 141; Roth, Urs/Länzlinger, Andreas, ‘Die Ausübung des Stimm-rechts in der Generalversammlung. Depotvertretung in der eigenen Generalversamm-lung und eigene Aktien’, SZW 1999, 27–33, 30; von Planta, Andreas/Lenz, Christian,BSK-OR II, 2nd edn., Basel 2002, Art. 659a OR No. 2c; Groner (note 50), 110.

61 See Groner (note 50), 130; Peter/Bahar (note 58), 49; Böckli (note 47), §4 No. 377, whoexplains that the 10 % limit of Art. 659 CO is not applicable to stock price guaranteesbecause they are not a repurchase of shares; Giger, Ernst, Der Erwerb eigener Aktien,Bern 1995, 32, who does not qualify a stock price guarantee as a share repurchase either.In Germany also, authors have recently excluded cash-settled put options on own shares from the scope of application of § 71 AktG on the repurchase of own shares, seeIhrig, Hans-Christoph, ‘Optionen auf eigene Aktien’, in: Habersack, Mathias/Hom-melhoff, Peter/Hüffer, Uwe/Schmidt, Karsten, FS Peter Ulmer, Berlin 2003, 829–845,834; Mick, Markus, ‘Aktien- und bilanzsteuerrechtliche Implikationen beim Einsatzvon Eigenkapitalderivaten beim Aktienrückkauf’, DB 1999, 1201–1206, 1204; Schmid,Hubert/Mühlhäuser, Felix, ‘Rechtsfragen des Einsatzes von Aktienderivaten beim Aktienrückkauf’, AG 2001, 493–503, 495; Weiss, Günther, ‘Put Option auf eigene Aktien kraft Gesamtrechtsnachfolge?’, AG 2004, 127–134, footnote 11.

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holding of own shares do not provide for more protection either. The ruleson the prohibition of hidden distributions or the prohibition of the reim-bursement of paid-in capital shall be sufficient to protect the equity of thecompany.62

d) CVRs and the prohibition of hidden distributions

CVRs may lead to a distribution of assets to shareholders which may notcomply with the legal requirements for such a distribution, i.e. the rules onthe capital reduction (Art. 732 ss CO), the rules on the distribution of divi-dends (Art. 675 (2) CO) and the rules on the liquidation of the company (Art.739 ss CO) which all require, amongst other things, a resolution by theshareholders’ meeting. Therefore, we need to examine whether the payoutunder the CVRs may breach the prohibition of hidden distributions. Indeed,Art. 678 (2) CO states that shareholders, board members and persons relatedto them must reimburse to the company distributions that are not formallydeclared as distributions to the extent that the performance of the company isobviously disproportionate in light of the consideration for such paymentsand the financial condition of the company. Pursuant to the authors, the disproportion against the financial condition of the company has no inde-pendent meaning when assessing whether there is a reimbursable distribu-tion.63 Therefore, Art. 678 CO does not per se prohibit the company fromentering into transactions with its shareholders in general or even to guar-antee a certain performance in relation with these transactions as long as suchtransactions are made at arm’s length,64 i.e. as if entered into with a third party

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62 See also Tschäni, Rudolf, M&A Transaktionen nach Schweizer Recht, Zurich/Basel/Geneva, § 5 No. 81 and Rusch (note 51), 93–99, for a similar reasoning for not subject-ing the upstream guarantees in LBOs to the rules applicable to the repurchase of ownshares.

63 Böckli (note 47), § 12 No. 557; Kurer, Peter, BSK-OR II, 2nd edn., Basel 2002, Art. 678OR No. 16; Rusch (note 53), 116. The new Art. 678 (2) CO according to the prelimi-nary draft of the revision of the corporate and accounting law in the Code of Obliga-tions dated December 2, 2005, has also expressly dropped this requirement.

64 BSK OR II-Kurer (note 63), Art. 678 OR No. 14; Rusch (note 53), 105 ss. For Germanlaw, see Bayer, Walter, Münchner Kommentar zum Aktiengesetz, 2nd edn., Munich 2003,§ 57 No. 26–37; Henze, Hartwig, Grosskomm AktG, 4th edn., Berlin 2000, § 57 No. 35;Hüffer, Uwe, Aktiengesetz, 7th edn., Munich 2006, § 57 No. 8–12; Ihrig, (note 61), 841;Lutter, Marcus, Kölner Kommentar zum Aktiengesetz, 2nd edn., Cologne 1988, § 57 No. 15 ss.; Mick (note 61), 1202 s.; Schmid/Mühlhäuser (note 61), 496 and Weiss (note61), 131, who examine options issued by a company on its own shares for an arm’slength premium, and which therefore do not fall under the prohibition of § 57 AktG.


pursuant to prudent rules of doing business. The third party test fails, how-ever, if the transaction by nature can only be entered into between the com-pany and its shareholders (e.g. a stock price guarantee). In such cases, themere objective lack of balance between each party’s obligation is alreadysufficient to qualify the transaction as a prohibited distribution.

As long as the acquisition itself is in the interest of the bidder, the tender bythe target shareholders of their shares will also be in the interest of such a bidder. As a general rule, the latter will, however, not guarantee the value ofits own shares offered in exchange. Even though this rule is not written inSwiss corporate law, it is a consequence of the system of the protection ofequity which allows payments to shareholders in connection with their statusas shareholders only in the limited situations provided by the law. However,we have seen above the requirements for such a company interest to exist and what guidelines the bidder should follow in order to comply therewith:limitation of the maximum payout under the CVRs to the free available re-serves, proper risk assessment and fairness opinion regarding the value of thetotal consideration (including maximum payout under the CVRs).65 This lastitem also helps to avoid that the payout under the CVRs be considered a hidden distribution. In any event, the board of directors of the bidder is welladvised to clearly state and explain such an enhanced interest and the para-meters of the measures implemented when resolving upon the issuance of theCVRs. Indeed, very often the new shares of the bidder will be issued by theboard under the authorized capital without approval by the general meeting,which, therefore, will not have the opportunity to approve the issuance of theCVRs.

e) CVRs and the prohibition of repayment of paid-in capital

aa) Introduction

Even though a transaction is entered into at arm’s length and therefore, doesnot lead to a hidden distribution, it may still lead to a prohibited repaymentof paid-in capital. Indeed, Art. 680 (2) CO is designed to protect the com-pany’s equity against payments to shareholders by denying the shareholdersany right to claim repayment of their capital contribution (Rückforderungs-verbot) and by prohibiting any distribution by the company out of its pro-

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65 See supra II., 1., a) in fine.

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tected equity (Rückerstattungsverbot) 66 either on the basis of a provision inthe articles of incorporation, a resolution of the shareholders’ meeting or acontractual arrangement.67 Such a prohibition encompasses not only openbut also hidden repayment of non-available equity to shareholders, i.e. bytransactions that are not entered into at arm’s length.68

A CVR is, in fact, a stock price guarantee which transfers the risk of the shareprice to the issuer. Stock price guarantees are barely treated in the legal doc-trine. Some examples of transactions mentioned in connection with stockprice guarantees are the deferred purchase of own shares by the company69

(i.e. the selling shareholder is “guaranteed” a fixed purchase price, irrespec-tive of the development of the share price between signing and closing), theguarantee given in an exchange offer by a bidder to a third party against lossin the share price of its own stock in order to induce such a third party topurchase the stock of the bidding company 70 (such purchases supporting theprice of the stock of the bidder to be offered as consideration in the exchangeoffer), or the guarantee provided by a company to induce prospective share-holders to subscribe for new shares when raising additional capital 71. Thecommon argument made against the validity of such stock price guarantees isthat they allocate automatically any profit to the third party and any loss tothe company and that they transfer the investment risk from the investor tothe company, thereby violating the fundamental principle of the protection ofthe paid-in capital 72. We believe that this argument is a little too stretched andthat the validity in principle of a put option on own shares granted by thecompany to its shareholders has the better side of the law on it. In our view,

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66 BSK-OR II-Kurer (note 63), Art. 680 OR No. 17; Forstmoser/Meier-Hayoz/Nobel(note 47), § 50 No. 107; Binder, Peter, Das Verbot der Einlagenrückgewähr im Aktien-recht, Bern 1980; Müller, Thomas, Der Schutz der Aktiengesellschaft vor unzulässigenKapitalentnahmen, Bern 1997, 45 and authors mentioned at footnote 534 thereof; seealso BGE 35 II 308, 65 I 147, 148 und 109 II 128, 129.

67 Widmer, Christoph, Die Liberierung im schweizerischen Aktienrecht, Diss. Zürich1998, 61; BSK OR II-Kurer (note 63), Art. 680 OR No. 16; Binder (note 65), 27.

68 Cf. Böckli (note 47), § 12 No. 553; BSK-OR II-Kurer (note 63), Art. 680 OR No. 17and No. 22 ss. In that respect, Art. 680 (2) CO is analogous to the prohibition pursuantto Art. 678 (2) CO with the difference, however, that the latter is already applicablewhen the distribution is made out of free available equity.

69 Groner (note 50), 144.70 Böckli (note 47), § 4 No. 376.71 Bayer (note 64), Art. 57 AktG No. 41; Henze (note 64), Art. 57 AktG No. 68–69; Lut-

ter (note 64), Art. 57 AktG No. 31. See also BFH, decision of October 17, 1984, WM1985, 537.

72 Böckli (note 47), § 4 No. 377, referring to Art. 706b para. 3 CO. Against its admissibil-ity but undifferentiated, Müller (note 66), 104–105.


CVRs should be valid if their issuance is in the interest of the company, are issued at arm’s length and if the company has free available equity pursuant toArt. 680 (2) CO in the amount of the maximal payout, i.e. the difference between the market price of the shares of the company at maturity and thetarget price set in the CVR multiplied by the aggregate number of shares attached to it.73

bb) Requirement of free available equity

If the legality of the CVRs is per se admitted, the question arises when thecompany must have sufficient free available equity in order not to violate Art.680 (2) CO. Is it at the time of the execution of the (contingent) commitment,i.e. at the issuance of the CVRs, or at the time of completion of the commit-ment, i.e. at maturity of the CVRs? The legal authors in Switzerland do notaddress this question specifically in connection with stock price guaranteesbut in connection with other transactions that might constitute a repaymentof equity, e.g. the granting of upstream guarantees by the company. In such acase, the authors admit that the relevant moment to determine the free avail-able equity is not at the time of grant but at the time of the realisation of thesecurity.74 The amount of the free available equity would then have to be determined by the auditors, and the payout of the CVRs could not exceedsuch an amount. Applied to CVRs, this means that the requirement of Art.680 (2) CO would only be applicable at maturity and not at the time of the issuance of the CVRs. If at maturity the payout exceeds the amount of thefree available equity, the transaction would be null and void ex tunc pursuantto Art. 20 CO only to the extent the target shareholder did not tender its shares and was allocated, or purchased them later, in good faith.75 Such nullitywould prevent the company from disbursing the payout under the CVR andthereby protects the paid-in capital. However, to the extent the payout doesnot infringe upon the paid-in capital, such payment shall be due (partialnullity pursuant to Art. 20 para. 2 CO).

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73 This view is also shared by Groner (note 50), 144–145 and Oertli (note 56), 264.74 Rusch (note 53), 125 and 144; Tschäni (note 62), 205, footnote 54.75 See Forstmoser/Meier-Hayoz/Nobel (note 47), § 50 No. 107 ss, 174; BSK-OR II-Ku-

rer (note 63), Art. 680 OR No. 24; Binder (note 66), 37 and Müller (note 66), 45. Withrespect to similar issues in connection with the repurchase of own shares, see Böckli(note 47), § 4 No. 366 and Peter/Bahar (note 58), 36; Groner (note 50), 100 (purchase ofown shares) and 130 (grant of options on own shares).

Frank Gerhard

From a practical point of view, it will be difficult to limit in advance thepayout under the CVR to the amount of sufficient available equity at matur-ity. This would probably not be accepted by the market and would annihilateall value purported to be embedded by the CVRs. Therefore, the limitationup to the free available reserves of the company at maturity may be relevantfrom a liability point of view, i.e. triggers the question whether the companyor the board of directors could become liable for not fulfilling the contractualobligations towards the shareholders or for breaching its fiduciary duties, re-spectively. We believe that as long as the board of directors acted in good faithwhen it issued the CVR, i.e. the company had freely disposable equity in themaximum amount of the CVR payout, and has not negligently or intention-ally distributed equity that would hinder the company to perform the CVRagreement, the company and the board members could evade liability. Insuch a case, the company and the board of directors could allege non-faultysubjective impossibility pursuant to Art. 97 CO76 and will not be liable fordamages in case of non-performance. From a practical point of view, an effi-cient way for the board of directors to avoid entirely being in breach of its fiduciary duties is to limit the maximum payout under the CVR and, when issuing the CVR, to establish a reserve in the balance sheet of the company inan amount corresponding to such a maximum payout.77

f) CVRs and the principle of equal treatment of the shareholders

One consideration that a company intending to issue CVRs should keep inmind is that its existing shareholders will generally not be allocated CVRsand thus, will be in a riskier position than the new shareholders receivingCVRs (i.e. the target’s old shareholders). The problem is even worse if the issuer’s shareholders are not called upon to approve the deal (and the issuanceof the CVRs) in a shareholder’s meeting. The flip side is that the CVRs –which may expire unpaid – could have saved the issuer and its existing share-holders from greater immediate cost or dilution. Therefore, the principle ofequal treatment of shareholders (Art. 706 (2) para. 3 CO and 717 (2) CO)may be another obstacle to the issuance of CVRs. However, the company

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76 See Groner (note 50), 100–101, examining this rule in connection with the repurchase ofown shares. Pursuant to the dominant view, the subjective impossibility is governed byArt. 97 CO, whereas the objective impossibility is governed by Art. 119 CO, see, e.g.Wiegand, Wolfgang, BSK-OR I, 3rd edn., Basel 2003, Art. 97 OR No. 7, 9 and 11 andArt. 119 OR No. 1.

77 Peter/Bahar (note 58), 40; Rusch (note 53), 180 for upstream guarantees.


must only treat shareholders equally who are in same circumstances; 78 thelaw adopts a functional approach and requires only a relative equal treatmentof the shareholders. A discrimination among shareholders is permitted if (i) the company has an objective cause (sachlicher Grund) to do so, (ii) thisobjective cause is in the interest of the company and (iii) the violation of theprinciple of equal treatment is proportionate, i.e. necessary but not burden-some.79 In a takeover situation, the bidder will have an objective cause to allocate CVRs to a specific class of (future) shareholders only, i.e. the targetshareholders, if, without the granting of the CVRs, they would not be in-duced to tender their shares to the bidder and therefore would not make thetransaction possible. Actually, these CVRs are offered as supplemental con-tingent consideration for the shares tendered. A fairness opinion delivered inconnection with the exchange offer would give the necessary comfort that theissuance of the CVRs is economically justified and that the total considera-tion, including the CVRs, is fair. Further, the issuance of the CVRs must be inthe interest of the company, i.e. must contribute to the increase of the enter-prise value of the bidder; in other words, the unequal treatment must have alegitimate business purpose. Subject to certain features (floor, reduction ofthe dilution), it would probably be possible to justify that the granting ofsuch a guarantee is compatible with the interest of the company since it couldbe demonstrated that the CVR is precisely the additional chip that will inducethe target shareholders to tender their shares in the bid. Finally, in most cases,it will be possible to demonstrate that the CVRs are necessary but not bur-densome to effect the aimed takeover since they could even lead to savings forthe bidder but could never lead to a financial charge higher than the one thatthe company committed at closing.

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78 BGE 69 II 246 and 102 II 265; Forstmoser/Meier-Hayoz/Nobel (note 47), § 39 No. 61 ss; BSK-OR II-Watter (note 50), Art. 717 OR No. 23.

79 Idem. See also, Hofstetter, Karl, ‘Die Gleichbehandlung der Aktionäre in börsennotier-ten Gesellschaften’, SZW 68 (1996), 222 ss, 227, who concludes that an unequal treat-ment is permitted if reasonable parties (i.e., shareholders interested in the increase of value of their shares) would approve the transaction.

Frank Gerhard

3. Takeover and securities law treatment

a) CVRs and the nature and sufficiency of consideration

aa) Nature of consideration

In the InCentive/Sulzer takeover offer, the Swiss Takeover Board qualifiedthe CVR as an independently marketable security80 allocated in addition tothe shares of the bidder to the shareholders of the target who accept theexchange offer. As an additional contingent component of the offer priceequally offered to all owners of the listed shares of the target, the offensiveCVR complies with the requirements of equal treatment, transparency andfairness of the offer, which are the core elements of Swiss takeover law.81

The use of CVRs in an exchange offer may raise some concern as to the per-missible consideration in these types of offers. In exchange offers, Swiss law,however, does not require that cash be mandatorily offered to the targetshareholders as an alternative consideration. Actually, even though the word-ing of Art. 39 SESTA-FBC82 could lead to the conclusion that only securitiesrepresenting equity may be offered in exchange offers, debt securities can also be offered to the target shareholders. The limitation set by Art. 39 SESTA-FBC is considered by the legal doctrine as a clerical error.83 Indeedfrom the viewpoint of the target shareholders, the protection provided by a debt security is even better than the protection provided by an equity secu-rity of the bidder. Therefore, the bidder should be free to offer any type ofsecurities either representing equity or debt and either issued by the issuer itself or by a third person.84 The Takeover Board has endorsed this view byrecognising the use of the CVRs in the InCentive/Sulzer exchange offer.

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80 See InCentive/Sulzer, Recommendation V of the Takeover Board, dated April 18, 2001,c.2.2: ‘Das CVR ist ein selbständig handelbares Wertrecht.’

81 See InCentive/Sulzer, Recommendation V of the Takeover Board, dated April 18, 2001,c.2.2.

82 Art. 39(1) SESTA-FBC: ‘The offer price may be settled by cash payment or in the formof an exchange of equity securities’.

83 See Tschäni/Iffland (note 44), 142.84 See Tschäni/Iffland (note 44), 142; Köpfli, Christian, Die Angebotspflicht im schweize-

rischen Kapitalmarktrecht, Zurich 2000, 229–231.


bb) Sufficiency of consideration

Pursuant to Art. 20 (1) SESTA-TOB, the offer prospectus must contain aconfirmation by the review body that sufficient financing means are availableto finance the offer. If not-yet-existing securities are offered, the bidder mustconfirm that all actions necessary in order to create such securities have beentaken (Art. 20 (2) SESTA-TOB). According to the prevailing practice, thisconfirmation does not have to be very elaborate. For instance, in the InCen-tive/Sulzer takeover offer, the review body merely declared that the CVRswill be issued by the bidder, will be guaranteed by the banks advising thetransaction and that all necessary measures to create the CVRs offered havebeen taken.85 From these three elements, the guarantee provided by the banksseems to be the most innovative. CVRs may lead to an actual debt of the issuer in approx. 18–24 months from their issuance. Depending on who theissuer is, such debt may have to be secured by a third party. This would forinstance be the case if the issuer were a special purpose vehicle of the bidder;in fact, financial debt instruments are often issued by off-shore finance com-panies for tax reasons. A bank guarantee can be one of the means to reach thisgoal. Alternatively, the parent company could provide such a guarantee aswell.

cc) Minimum price rule

Pursuant to Art. 32 (4) SESTA, the price offered in a takeover offer for morethan 331/3 percent of the share capital of the target must correspond at least tothe stock exchange price and must not be more than 25 percent below thehighest price paid by the bidder in the previous 12 months for equity secu-rities of the target. If the bidder offers securities instead of, or in addition to,cash, special rules apply (Art. 40 and 42 SESTO-FBC). Whether the offeredsecurities are listed or not, the review body must confirm their valuation either because it must merely review the valuation (if the securities are listedand the market of such securities is liquid) or because it must value them (ifthe securities are not listed, which is typically the case with CVRs, or becausethe securities are being traded on an illiquid market) (Art. 42 SESTO-FBC)).In order to perform such a valuation, the review body in the InCentive/Sulzer takeover offer used the option pricing model of Black/Scholes.86

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85 See InCentive offer prospectus supplement of April 9, 2001, 3.86 See InCentive offer prospectus supplement of April 9, 2001, 3.

Frank Gerhard

b) CVRs and disclosure of shareholdings

Pursuant to Art. 20 SESTA, anyone who directly, indirectly (e.g. through nominees or intermediary companies) or in concert with third parties ac-quires or sells securities in a Swiss company listed in Switzerland and therebyreaches, exceeds or falls below the thresholds of 5, 10, 20, 331/3, 50 or 662/3

percent of the voting rights must report these participations to the companyand to the stock exchange on which the shares are listed. The rule applies alsoto the acquisition or sale of call options and the granting (writing) of put options to the extent they provide for or allow actual delivery.87 However, therule does not apply to the granting (writing) of call options and to the ac-quisition or sale of put options.88 In addition, options that provide for a cashsettlement only are not subject to disclosure either because they do not confer control (voting rights) over, or proprietary interest in, the underlyingshares (irrespective of whether the counterparty of the option purchases theunderlying shares in order to hedge its position). Therefore, neither the issuernor the target shareholders who have been allocated CVRs are subject to theobligation to disclose CVRs under Art. 20 SESTA.

c) CVRs and best price rule

The SESTA also requires the bidder to treat the target shareholders equally.With respect to the offer price, this rule is reflected in the “best price rule”which requires a bidder who, from the publication of the offer until sixmonths after the expiration of the additional acceptance period, acquiresequity securities of the target for more than the offer price, to offer that higher price to all those who have accepted the public offer (Art. 10 (6) OTB).The Swiss Takeover Board has decided that the granting of a put option to thetarget shareholders is a supplemental consideration, which may be valued inmoney (geldwerte Leistung). In view of the equal treatment principle, such a put option may therefore not be granted to certain selected target share-holders only,89 unless the position of such shareholders is so different as tojustify an unequal treatment.90 This was, for example, the case in the takeoveroffer for Bon appétit Group AG where the tender of the shares in the take-

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87 Art. 13(1)(a) and (b) SESTO-FBC.88 Art. 13(4) SESTO-FBC.89 See Recommendation of the Takeover Board in the matter Leclanché S.A. of March 31,

2006, c.5.1.90 See Recommendation of the Takeover Board in the matter Bon appetit Group AG of

August 28, 2003, c.4.1.4.


over offer by the beneficiary of the put option would have triggered adversetax consequences for the latter.91 In such an event, however, the best price rulecommends that the strike price of the option may not be above the offerprice, and the Takeover Board may also extend the scope of validity of thebest price rule in that respective case from 6 months up to 3 years.

d) Defensive CVRs and the mandatory offer

Defensive CVRs function in fact as an anti-mandatory offer device. Thequestion arises, therefore, whether such an instrument is permissible in Switzerland since Art. 32 (1) SESTA provides that anyone who directly, in-directly or acting in concert with third parties acquires equity securities and,by such an acquisition taken together with the equity securities that personalready holds, exceeds the threshold of 331/3 percent of the voting rights of a target company (whether or not such voting rights may be exercised) mustsubmit an offer for all listed equity securities of such a company. Providedthat the bidder complies with the best price rule (Art. 10 (6) SESTA-TOB)and with the minimum price rule (Art. 32 (4) SESTA) and provided that theprices offered – if the target has several classes of equity securities outstand-ing – are reasonably related to each other (Art. 32 (5) SESTA), the bidder isfree in setting the price. The price (and the offer as such) must, however, betransparent:92 the recipients of the offer must be able to make an informed de-cision. In order to meet that requirement, the offer price must be determinedon the basis of clear criteria. Even though defensive CVRs may frustrate a takeover bid, we believe that they are not prohibited by Swiss takeover law ifthey are clearly disclosed in the offer prospectus and offered equally to allshareholders.

e) Listing of the CVRs

In order to be attractive, CVRs must be admitted to a recognized stockexchange. For instance, InCentive intended to list the CVRs on the SWXSwiss Exchange concurrently with the settlement of the takeover offer. Thesame incentive is necessary when the bidder offers own shares as part of the

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91 Id.92 See Recommendations of the Takeover Board in the matters India Investment of April

11, 2000, c.1, Altin AG III of July 13, 2001, c.3, Sopafin of January 24, 2002, c.4.3 andc.5, InCentive of April 16, 2003, c.3.1 and Bon appetit Group AG of August 28, 2003,c.4.1.3.

Frank Gerhard

consideration.93 In the case of CVRs, the rules on the listing of derivativeswill, therefore, be of relevance.94 In order to be listed, such derivatives mustbe associated with underlying securities that are regularly priced in the marketplace,95 which is the case for equity securities listed on the SWX or onan internationally recognised stock exchange. In addition, CVRs can only belisted if they are issued96 or guaranteed 97 by a person, that is, either (i) subjectto the Swiss Banking Act or, as a securities dealer, to the SESTA or (ii) subjectto a foreign supervisory authority comparable to the Federal Banking Com-mission. In addition, at the time of the submission of the listing application,the market capitalisation of the derivative instrument must amount to at leastCHF 1 million.98 Finally, the issuer will have to prepare a listing prospectusthat contains all material information with respect to the issuer, the derivativesecurity and the underlying instrument.99 Depending on the circumstances,the offer prospectus used in the takeover offer could also serve as a listingprospectus provided that it fulfils all the requirements thereof.

4. Criminal law treatment

a) Market manipulation

Art. 161bis of the Swiss Criminal Code prohibits anyone from publishing mis-leading information or from performing fictive trades in listed securities(wash trades or matched orders) in order to manipulate the price of a stock.100

The offering of CVRs as part of the consideration in a takeover offer shouldnot, in itself, trigger the risk of market manipulation being committed by the

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93 See Crucell N.V. offer for Berna Biotech (prospectus dated December 15, 2005) pro-viding for a listing of the Crucell shares on the SWX Swiss Exchange upon closing ofthe takeover offer.

94 See Directive for the Listing of Derivatives of March 1, 2000/May 17, 2006, based onArt. 29 of the SWX Listing Rules.

95 Id., para. 28.96 Id., para. 19.97 Listing Rules, Art. 11.98 Directive for the Listing of Derivatives dated March 1, 2000/May 17, 2006, para. 39.99 Id., para. 56.

100 See Iffland, Jacques, ‘La notion de manipulation de cours illicite après l’arrêt Fonda-tion F. et l’entrée en vigueur de l’art. 161bis CPS’, Journée 1997 de droit bancaire et financier, Bern 1997, 67 ss, 78 s; Schmid, Niklaus/Baur, Richard, BSK-Kapitalmarkt-recht, Basel 1999, Art. 161 bis CPS, N 9; Stratenwerth, Günter/Jenny, Guido, Schwei-zerisches Strafrecht, Besonderer Teil I: Straftaten gegen Individualinteressen, 6th edn.,Bern 2003, § 21 No. 40.


bidder since (i) such an arrangement is made public in connection with theannouncement of the offer; (ii) the bidder enters into such an arrangement forthe purpose of purchasing an asset that it genuinely wants and not to induceothers to deal in its securities or to change the market price of its securities;and (iii) the information, namely the price information, given to the market inconnection with the announcement of the offer normally would affect themarket price of the bidder’s share anyway.

The bidder would normally enter into hedging transactions with third partiesto offset its exposure to the CVRs. Such hedging transactions could also amount to market manipulation. However, as long as the bidder enters intothe hedging transactions after the announcement of the offer (including theterms of the CVR), discloses its intention to enter into the hedging trans-actions in connection with the announcement and has a genuine and legi-timate commercial purpose for entering into the hedging transactions, its behaviour should not amount to market manipulation.

Usually the issuer of CVRs is prohibited to trade in its own shares during,and for a certain period before, the valuation period. This prohibition avoids that the issuer is held liable for market manipulation for fictive tradingactivities in the underlying stock. Practically, such an undertaking could conflict with a share repurchase programme that is ongoing at the time of maturity. A compromise could be to carve out such repurchase programmesto the extent that the volume of transactions is not modified during the measurement period. However, the issuer could, for example, release too-optimistic economic data at the critical time periods for the purpose of artifi-cially and temporarily inflating the price of its stock. By reducing the payoutunder the CVR, this would deprive the holders from a substantial portion ofthe consideration they reasonably expected to receive in exchange for the tender of their shares.101 By doing so, the issuer could be subject to criminalsanction for market manipulation. In addition, if there is information reten-tion or deference, the rupture in the information level could also constitute a violation of the ad-hoc publicity rules under Art. 72 of the Swiss ListingRules.

Finally, the complexity of the CVR may also engender litigation against theissuer for acts it takes that may affect the value of the CVR even though theremay have been a valid business reason unrelated to the CVR for taking those

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101 See, e.g. for US litigation Rossdeutscher v. Viacom, Inc., Del., No. 444, 1999, decisionof March 9, 2001, where the plaintiff alleged that Viacom had manipulated its stockprice in order to decrease its liability under the CVRs from USD 687 mio to USD 83mio.

Frank Gerhard

actions. For instance, Dow Chemical’s motivations in taking the actions thatresulted in CVR related litigation are not as clear.102 The value of Dow’s CVRwas based on Marion Merrell’s stock price. Certain CVR holders sued Dow,alleging that Dow first signalled to the market that it intended to buyadditional shares of Marion Merrell, thereby inflating Marion Merrell’s stockprice and lowering the value of the CVR during the valuation period and then redeeming the CVR at an artificially low price. Even though Dow was pro-hibited from actually buying Marion Merrell shares during the valuation period, it was not prohibited from telling analysts it was considering a take-over offer for Marion Merrell’s stock, from increasing its lines of credit toMarion Merrell by USD 3 billion and projecting that Marion Merrell’s in-come would grow significantly over the next several years. Whether or notDow engaged in fraud as the plaintiffs alleged, CVR issuers need to be parti-cularly careful that their actions could not be viewed as an attempt to depriveCVR holders from a bargained-for value.

b) Insider dealing

In connection with the issuance of the CVRs, insider dealing should not be aparticular issue since the bidder will not enter into an arrangement whereby itoffers a CVR as part of the consideration until after the offer has been an-nounced, including all price-sensitive information.

As regards the hedging transactions, as long as the bidder enters into thehedging transactions after the announcement of the offer (including the termsof the CVR), it should not encounter difficulties with insider dealing laws either.

Finally, a risk for the CVR holder is the repurchase of the CVR itself by theissuer if the latter knew that the price of the underlying would drop. The misuse of this information asymmetry could indeed constitute prohibited insider trading by the issuer.

III. Conclusion

Given the increased volatility in the stock market and the increased competi-tion in the market for corporate control, the use of hedging and protectiondevices designed to mitigate future stock price variations and to differentiate

ECFR 3/2006 285

102 See Harry Lewis v. The Dow Chemical Company, 1992 U.S. Dist. LEXIS 15792 (Dist.Del. Sept. 11, 1992).


a bid in a contested acquisition could become more popular. While CVRs arenot the only way to mitigate these risks and to increase the attractiveness ofan offer, they have already been tested (mainly in foreign jurisdictions butalso in Switzerland) and generally have fared well. In Switzerland in particu-lar, despite the legal uncertainties and risks in using CVRs, the present contri-bution shows that a careful structuring allows for such instruments to be partof the consideration offered in a takeover bid or a business combination.

286 ECFR 3/2006Frank Gerhard

contingent value rights in public takeovers: analysis under swiss

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