study on the application of directive 2004/25/ec on takeover bids

Study on the application of Directive 2004/25/EC

on takeover bids

Christophe Clerc, Partner Fabrice Demarigny, Partner

Marccus Partners, Paris

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Introduction

The Directive 2004/25/EC on takeover bids (the "Directive") applies to the markets relating to takeover bids for the securities of companies governed by the laws of Member States, where all or some of those securities are admitted to trading on a regulated market.

Article 20 of the Directive provides that five years after the deadline set for its transposition, the European Commission shall examine the Directive "in the light of the experience acquired in applying it and, if necessary, propose its revision".

In the framework of this examination, the European Commission has entrusted Marccus Partners with the performance of a study (the "Study") in order to evaluate the application of the Directive (I).

The completion of the Study incites us to think about the objectives of the European regulation and of the Directives (II).

In this context, it is worth recalling the background of the Directive (III) before reviewing some of the key issues included in the Directive (IV). IMPORTANTE NOTE: The study is not yet in its final form. Any comments are made on a provisional basis only and are subject to further review. Any comments made in this presentation are of the sole responsibility of Marccus Partner and do not bind the European Commission.

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Table of contents

I. Scope of the StudyA - Key expected outcomesB - Geographical scopeC - Economic study

II. Objectives of EU regulations and of the DirectiveA - General EU objectivesB - Objectives of the Directive

III. Background analysisA - Corporate governance backgroundB - Economic analysis

IV. Key issuesA - General principles of the DirectiveB - The mandatory bid ruleC - Takeover defensesD - Squeeze-out and sell-out rulesE - Supervisors, enforcement and litigationF - Overview of certain control structures and barriers

I. Scope of the Study

A - Key expected outcomesB - Geographical scopeC - Economic study

Legal framework of the Directive- acting in concert (2 § 1 d),- exemptions (4 § 5), - mandatory bid rule (5),- board neutrality rule (9), - breaktrough rule (11) and optional

arrangements (12),- squeeze-out and sell-out rules (15, 16)- legal remedies.

Practical implementation of the Directive- general principles (3), - exemptions (5),- takeover defenses (9, 11),- squeeze-out (15) and sell-out (16), - litigation- impact on competitiveness and growth,- impact on jobs, employee protection, inflation,

consumer protection and environment.

A. Key expected outcomes of the European Commission1) Operation of the Directive and international comparison

This includes issues such as:


Control structures and barriers to takeovers not covered

- National legal framework

- Practical implementation

Comparison with major third countries

- Main differences in the legal obligations and practices.

- Impact of the Directive in the international context.

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A. Key expected outcomes of the European Commission

2) Perception by stakeholders of the Directive legal framework

Issues to be addressed:

- clarity of the obligations imposed by the legislation, appropriateness of the legislation, disclosure and takeover bid procedure

- acting in concert (2 § 1 d),

- supervisors (4),

- mandatory bid (5),

- takeover bid defenses (9, 11),

- squeeze-out and sell-out (15, 16),

- employee protection.

Categories of stakeholders:

- supervisors,

- listed companies,

- institutional investors,

- financial intermediaries,

- retail investors,

- regulated markets,

- employee representatives

- other stakeholders' associations.

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B. Geographical scope

i) For the operation of the Directive, 22 Member States have been selected:

5 main EU jurisdictions : France, Germany, Italy, Spain and United Kingdom 17 other EU jurisdictions : Austria, Belgium, Cyprus, Czech Republic, Denmark, Estonia, Finland, Greece, Hungary,

Ireland, Luxembourg, the Netherlands, Poland, Portugal, Romania, Slovakia, Sweden. These countries represent more than 99% of the total EU market capitalization models (1)

This choice corresponds to our perception of the most homogeneous scope of countries, made up of historical EU countries, new Member States having joined the EU in or after 2004 (Slovakia, Romania, Cyprus) and Member States included in the scope of the One Share – One Vote Study (such as Estonia).

(1) Based on July 2010 figures.

Countries Capitalization (in EURO millions) (1) Percentage

EU jurisdictions included in the sample

7,369,326.84 99.79%

EU jurisdictions not included in the sample

15,858.71 0.21%

Total 7,385,185.55 100%

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B. Geographical scope

ii) For the comparison of the Directive legal framework in major third countries, 9 non-EU countries have been selected:

5 main non-EU jurisdictions: Australia, Canada, Hong Kong, Japan and United States 1 European non EU jurisdiction: Switzerland 3 emerging markets: China, India and Russia.

- Hong Kong, through its geographical location, is one of the leading international financial centres in Asia.- India is the world's second most populous country and one of the fastest-growing countries in Asia. - Australia is a Member State included in the scope of the One Share – One Vote Study.

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C. Economic study

For the economic study, Marccus Partners works closely in association with the Centre for European Policy Studies (CEPS), which is one of the largest independent think-tanks in Europe.

II. Objectives of EU regulations and of the Directive

A- General EU objectivesB- Objectives of the Directive

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A. General EU objectives

When creating a set of rules, various interests must be taken into account.

EU positions reflect this diversity of interests.

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A. General EU objectives 1) General principles

The Lisbon Strategy / 2005 Community Lisbon Programme has stated the goal

“to become the most competitive and dynamic knowledge-based economy in the world capable of sustainable economic growth, with more and better jobs and greater social cohesion”.

The Communication from the Commission to the Council and the European Parliament on “Common Actions for growth and Employment: the Community Lisbon program” (2005) confirmed that

“the internal market for services must be fully operational, while preserving the European social model”.

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2) Specific concerns

a) Financial concerns

Financial concerns have been addressed, in specific details, in:

(i) the Financial Services Action Plan (1999), which called for - “a single EU wholesale market”,- in order, in particular, to “enable corporate issuers to raise finance on competitive terms on an EU-wide

basis”, (ii) the EU Company Law Action Plan (2003), which called for the

- “strengthening [of] shareholders rights and third parties protection”, and(iii) the White Paper on Financial Services Policy (2005-2010), which mentioned the need to

- “consolidate dynamically towards an integrated, open, inclusive, competitive, and economically efficient EU financial market”

- and to “remove the remaining economically significant barriers so financial services can be provided and capital can circulate freely throughout the EU at the lowest possible cost”.

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b) Social and environmental concerns

The basis for social and environmental concerns has been laid down in the EU Company Law Action Plan (2003), which stated that

“well managed companies, with strong corporate governance records and sensitive social and environmental performance, outperform their competitors. Europe needs more of them to generate employment and higher long term sustainable growth”.

The Commission’s vision for the single market of the 21st century (February 2007) has stated the intention to make the internal market work better in the interest of, amongst others, a sustainable Europe, recognising “the social and environmental aspects of the single market”.

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c) Stakeholders

The concern of the Commission for all stakeholders has been addressed the White Paper on Financial Services Policy (2005-2010), which favoured “an approach that is practical, ambitious and reflective of stakeholder sentiment”

and committed to share, wherever possible, impact assessment methodologies with relevant stakeholders.

This approach appears consistent with the OECD Principles on corporate governance, which provide that

“Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined”.

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3) Looking ahead

More generally, the Commission’s vision for the single market of the 21st century (February 2007) indicated that

“the Commission proposes that the focus of the single market should shift from its initial emphasis of removing barriers to cross-border trade to one of ensuring that markets function better, to the benefits of citizens and business”.

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B. Objectives of the Directive

The objectives of the Directive, as described by the European Commission, are:

legal certainty on the handling of takeover bids and Community-wide clarity and transparency in respect of takeover bids,

protection of the interests of shareholders, in particular minority shareholders, employees and other stakeholders, when a company is subject to a takeover bid for control, and

facilitation of takeover bids through reinforcement of the freedom to deal in and vote on securities of companies and prevention of operations which could frustrate a bid.

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Based on the analysis of the Directive, its objectives may be described as follows:

a) Promotion of the integration of European capital markets

Objective: promotion of the market for corporate control

Related rules:

- Board neutrality- Breakthrough rule- Squeeze-out rule- Mitigated by the optional arrangements

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b) Protection of minority shareholders

Objective: attract investors and reduce capital costs

Related rules:

- Equality of treatment- Mandatory bid rule- Sell-out rule

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c) Protection of employees

Objective: good corporate governance ; economic efficiency.

Related rules:

- Information of employees or employee representatives- There opinion is made public- Directive is without prejudice to national provisions (e.g. co-determination)

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d) Protection of the target company

Objectives: good corporate governance ; efficiency of the market for corporate control

Related rules:

- General principle regarding the need to take into account the interest of the target company taken as a whole. - Publicity of the offeror’s intentions (future business of the offeree company and likely

repercussions on employment). - Opinion of the board of the offeree company.- Maximum duration of the bid.

III. Background analysis

A. Corporate governance backgroundB. Economic analysis

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A. Corporate governance background

General corporate governance issues structure the debate on takeovers. For instance :

What is a corporation ?

View 1 (Jenson & Meckling) View 2 (legal analysis) Impact on takeovers

- A « nexus of contracts » (investors, management, employees, suppliers, clients, etc)

- Corporations are a fiction

- Corporations are legal entities

- All legal rules are fictions. The most practical fictions should be selected.

- How could a « nexus of contracts » be transferred?

Who owns a corporation?

View 1 (finance) View 2 (legal analysis) Impact on takeovers

- Shareholders own the corporation

- [What about other investors?]

- Corporations (as legal entities or contracts) are not “owned”

- Shareholders hold transferable contractual rights

- Conflict between the “ownership” view and (i) squeeze-out (expropriation) and (ii) obligation to share the control premium.

Are corporations based on “shareholders’ democracy”?

View 1 (finance) View 2 (legal analysis) Impact on takeovers

- Shareholders represent the people, management the government

- Government must be accountable to the people

- Democracy applies “one man, one vote” rule ; corporations don’t.

- Political systems, and economic institutions are completely different.

- Who should have a final say on the merits of a bid?

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1) Three main models

Corporate governance is usually looking at three main models

Shareholder-oriented model (UK)

Company-oriented model(Continental Europe)

Management-oriented model (US)

• Dispersed shareholders • Block holders • Dispersed shareholders

• No takeover defenses • Mild takeover defenses • Strong takeover defenses

• Agency theory (Principal/ Agent or Master/Servant)

• Corporate interest • Fiduciary duties

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A. Corporate governance background2) The debate

Position A Position B

B

A

S

E

S

• Unfettered markets are best placed to monitor companies.

• Block holders are best placed to control companies.

• The fear or take-overs pushes management to act diligently (“disciplinary effect” against “management entrenchment”)

• If the markets discipline managers, who disciplines the markets? (Issues of market rationality and short- termism).

• Focus: shares as a class of assets. Method: “Forecasting the psychology of the market”. (John Maynard Keynes)

• Focus: productive assets. Method: “Forecasting the prospective yield of assets over their whole life” (John Maynard Keynes)

RESULTS

• Shareholders should have the ultimate powers, as they bear the ultimate risks (shareholder primacy). The “no frustration” rule should prevail.

• A system of checks and balances is preferable (consensus formation)*. Company interest must prevail.

• Block holders may misuse their powers. • Transparency rules and appropriate protective laws should address this risk.

* (In addition, shareholders may hedge their risk through a diversification of their portfolio. Other stakeholders such as employees may not).

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Traditional view

Capitalists (shareholders)

Employees

Key concepts:- capital / workforce - antagonist blocks

Result: no developed regulation

Finance view(Jensen & Meckling)

Shareholders

Board

Management

Employees

Key concepts:- alignment of interest - principal / agent (master / servant) theory

Result: « no frustration » rule

Team production view(Blair & Stout)

Key concepts:- team production - firm specific investments - board and management as « mediating hierarchs » - hold-up problem

Result: checks & balances (company interest)

Shareholders

Board

Management

Employees


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Rationally expected: bids should fail. However, in practice, bids succeed. Why ?- Bidders do not act rationally (bid price >> expected synergies)- Target shareholders do not act rationally (short term bias)- Pressure to tender (minority shareholders are forced to tender even though it is not in their best interest). May be linked to: (i) post- bid low liquidity and (ii) high post-bid private benefit of control.

If the issue is to be addressed, possible solutions are: - Increase transparency on synergies- Reduce pressure to tender: (i) increase post-bid minority shareholder protection or (ii) set up an automatic re-opening of successful bids.- Improve bargaining power of the target company.

B. The economic analysis 1) The collective action issue

Pre-bid company value (PBCV) Shares

During the bid After the bid

Post-bid price

Price/ value Price/ value

Shares

Bid price

Sh

Bidder

Shared bidder’s synergies (SBS)

Pre-bid company value (PBCV)



Retained bidder’s synergies (RBS) RBS

RBS

PB CV


Pre-bid company value: A+B+C Minimum bid price with the MBR: A+B+C+D (the block holder will not sell at a price below A+B) As a result, a bid may only be launched: - with the MBR: if E > A + D

- without the MBR: if E > A Impact differs among MS depending on (i) significance of PBC an (ii) shareholding structure Potential impact includes (i) reduced number of bids and (ii) increased size of blockholdings Potential solutions include (i) allowing different prices (private “ownership” of control premiums) and (ii) enhanced

regulations of private benefits.

Price per share/ value

shares

Block holder Minority shareholders

B. The Economic Analysis 2) The MBR as an anti-takeover mechanism

Bid price

C B

A

EBidder’s expected synergies

Private benefit

of control

« Basic » share

price

Shared value of the private benefit of

control

Share price

D


Shareholders

Managers

Employees

Community control

Managers

Employees

Community control gap

Community control gap

Community

Shareholders

Community

B. The Economic Analysis 3) The « community control gap »

1) Risk: increase of negative externalities imposed by shareholders

2) Possible solutions:

a) Restrict the free market for corporate control.

b) Enhance community protection through:

- increased regulation of company activities

- increased accountability of shareholders

c) Management to act in the interest of the company taken as whole.

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B. The Economic Analysis

4) Economics of control enhancing mechanisms (CEMs)

a) CEMS are related to the Directive through the breakthrough rule.

b) A previous review of CEMs showed that: All reviewed countries (15) allowed between five and eleven CEMs.

Even countries which have, to some extent, formally adopted the OSOV principle, such as Belgium, Germany, Estonia, Greece, Spain, Luxembourg and Poland, allow a number of CEMs.

CEMs are also legally available in the three non-European countries that had been reviewed: the US (10 CEMs), Japan (9 CEMs) and Australia (8 CEMs).

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C. Analysis of the economic impact

4) Economics of control enhancing mechanisms (CEMs)c) In this study, the efficiency issue lead to the following comments:

Arguments: CEMs help controlling minority shareholder (a) to monitor management more effectively and (b) to extract more private benefits of control. CEMs can entrench controlling minority shareholder. However, control contestability comes with costs and benefits. Minority shareholder protection does not justify mandatory OSOV; rational investors anticipate extraction by corporate insiders and buy shares at “fair” price. Private ownership choices may deviate from socially optimal rule, but latter varies across firms and countries.

Conclusion: No structure, including OSOV, is uniquely optimal. Mandating OSOV must be motivated by perceived gains from weakening controlling owners; unclear whether these gains materialize:

- Takeovers can be inefficient

- Control contestability can have adverse effects

- Discouraging block ownership empowers managers (absent other effective governance mechanisms)

IV. Key issues

A. General principles of the DirectiveB. The mandatory bid ruleC. Takeover defensesD. Squeeze-out and sell-out rulesE. Supervisors, enforcement and litigationF. Overview of certain control structures and barriers

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IV. Key issues

A. General principles of the Directive

Guiding principles

– Article 3.1 of the Directive contains general principles which the Member States shall ensure are complied with.

– The "general principles" and the CJEU decision (15 October 2009): they are only "guiding principles".

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IV. Key issues


1) Protection of shareholders

a) Equal treatment

Article 3.1 (a) of the Directive: "all holders of the securities of an offeree company of the same class must be afforded equivalent treatment; moreover, if a person acquires

control of a company, the other holders of securities must be protected". Issues:

- different classes (fairness opinion / independent expert?)- exclusionary offers (restrictions to dissemination / tendering)- post-bid acquisitions by the bidder (top-up clauses)

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IV. Key issues



b) Proper information

Article 3.1(b) s. 1 of the Directive: "the holders of the securities of an offeree company must have sufficient time and information to enable them to reach a properly informed

decision on the bid“. Associated rules: articles 6 and 8 (information) ; 7 (1) (duration).

Issue: more harmonization?

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IV. Key issues



c) Market integrity

Article 3.1(d) s. 1 of the Directive: " false markets must not be created in the securities of the offeree company, of the offeror company or of any other company concerned by

the bid in such a way that the rise or fall of the prices of the securities becomes artificial and the normal functioning of the markets is distorted“. Article 3.1(e) s. 1 of the Directive: "an offeror must announce a bid only after ensuring that he/she can fulfil in full any cash consideration, if such is offered, and after taking all reasonable measures to secure the implementation of any other type of consideration“.

No significant issue:- This principle is typically secured through the transposition of transparency requirements and

market abuse prohibitions.- In order to secure a consideration in cash, some Member States either request a bank guarantee or

a bank confirmation

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IV. Key issues


2) Protection of employees

Article 3.1(b) s. 2 of the Directive: "where it advises the holders of securities, the board of the offeree company must give its views on the effects of implementation of the bid on employment, conditions of employment and the locations of the company's places of business“. In addition, information of employees and statement of their opinion.

Issues

- Regarding bidder’s intents: limited prior review (boilerplate statements ; tick the box reviews) and post-bid enforcement.

- Regarding employees: timing issues, expertise costs, direct dialogue with bidder.

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IV. Key issues


3) Protection of other stakeholders

Article 3.1(c) s. 2 of the Directive “the board of an offeree company must act in the interests of the company as a whole and must not deny the holders of securities the opportunity to decide on the merits of the bid". Furthermore, "an offeree company must not be hindered in the conduct of its affairs for longer than is reasonable by a bid for its securities" (article 3.1 (f) of the Directive).

Issues:

- Definition of the “interests of the company as a whole”: shareholders, employees, local communities, creditors, contracting parties (such as sub-contractors) and public authorities.

- Striking the right balance between the two principles: proportionality test ; issue with extreme positions

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IV. Key issues

B. The mandatory bid rule

1) Definition of control

Success of the "threshold" approach (see table on next page)

Issues:

- Meaning of the 30% threshold in different MS (see economic analysis)- Creeping control

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IV. Key issues

B. The mandatory bid rule1) Definition of control

Threshold Actual controlMixed (both threshold and actual control are

provided)

30% 33% or 1/3 Second threshold Czech Republic (presumption if acquiror controls 50% of the voting rights through holding or pursuant to an agreement, or controls the majority of the members of the board of directors).Estonia (presumption of dominant influence if acquiror controls 50% of the voting rights through holding or pursuant to an agreement, or controls the majority of the members of the board of directors).

Denmark (acquiror controls 50% of the voting rights through holding or pursuant to an agreement, or controls the majority of the members of the board of directors, or exercises a controlling influence over the company).

Spain (acquiror obtains 30% of the voting rights or appoints more than half of the board members within 24 months).

AustriaBelgiumCyprusFinlandFranceGermanyIrelandItalyNetherlandsUK

Greece

Hungary

Luxembourg

Poland

Portugal

Romania

Slovakia

Finland (50%)

Poland (66%)

Portugal (50%)

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IV. Key issues


2) Acting in concert

a) Main definitions

Article 2.1 (d) of the Directive: “persons acting in concert' shall mean natural or legal persons who cooperate with the offferor or the offeree company on the basis of an agreement, either express or tacit, either oral or written, aimed either at acquiring control of the offeree company or at frustrating the successful outcome of a bid”.

Article 10(a) of the Transparency Directive, acting in concert is defined as "… a third party with whom that person or entity has concluded an agreement, which obliges them to adopt, by concerted exercise of the voting rights they hold, a lasting common policy towards the management of the issuer in question; …“

The concept of acting in concert is also included in the Acquisitions directive (2007/44/EC), which does not contain a specific definition.

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IV. Key issues


2) Main aproches

Definitions of "acting in concert"

Directive Intermediary Directive & Transparency Directive

Main jurisdictions Italy, UK. France, Germany, Spain.

Other jurisdictions Austria, Cyprus, Denmark, Hungary, Ireland, Luxembourg, Netherlands, Romania, Slovakia.

Czech Republic, Estonia. Belgium, Finland, Poland, Portugal.

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III. Key issues


2) Acting in concert

Specific issues

- Shareholder activism (see “board control-seeking” resolutions); “one shot” concerts

- Nature of agreements (inclusion of consultation procedures)

- Chain addition

- Evidence (issues with fact-finding ; risk of precise rules)

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IV. Key issues


3) Exemptions

a) Discretionary exemptions (decided by supervisory authority or by shareholders through white ways procedures)

b) Defined exemptions Technical exemptions Protection of the interests of the bidder or the controlling shareholder

- No real change of control (temporary change of control, mistake, larger shareholder, intra-group transactions)- Real change of control (no voluntary act, voluntary bid, indirect control, personal events, mere concert)

Protection of creditors (enforcement of security) Protection of other stakeholders. Situations relate to the acquisition of control :

- by an investor in a financially distressed situation- following specific types of corporate transactions (capital increase, merger or division, reorganization, contribution in kind, distribution, scheme of arrangement)- by certain entities (foundations, issuers of depositary certificates)- when the protection of state’s interests is invoked.

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IV. Key issues


3) Exemptions

c) Main cases of exemptions:

- there was no real change of control, as there was a larger (or a larger group) of shareholders holding control- the transaction was intra-group, or- the company was in financial distress

d) Issues:

Large list, not harmonized, with conflicting objectives (contra: flexible system)

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IV. Key issues


4) Determination of the price

Reference to previous acquisitions is protective of minority shareholder, Upward or downward adjustments are seen as useful flexibility Post-bid adjustments are an option (if there are post-bid purchases by bidder)

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IV. Key issues

C. Takeover defences

1) Board neutrality rule Opt-in / opt-out: 14 MS have opted in, 7 have opted out No significant changes: new BNR in three MS (Cyprus, Finland and Greece), enhanced in

some other MS (e.g. new legal basis) Reciprocity rule: 12 MS have opted in, 9 have opted out

2) Breakthrough rule General opting out (except Estonia) Some partial BTR exist (voting caps) Reciprocity rule: 12 MS have opted in.

3) Impact of implementation No evidence of impact: pre-transposition issue, economic crisis Reactive legislation: widespread

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IV. Key issues

D. Squeeze-out and sell-out rules

1) Thresholds and available time period Ownership test / acceptance test 90% vs 95% Issues: facilitation of bids (e.g. ownership test at 90%) vs protection of minority

shareholders ; « block-building blackmail »

2) Fair price The 90% acceptance test: a rebuttable presumption Stock-for-stock takeovers: which review for the fair price? (independent experts, independent

directors…)

3) Combination of Directive procedure with alternative procedures: cash-out mergers, schemes of arrangement, integration procedure

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IV. Key issues

E. Supervisors, enforcement and litigation

1) Guidance by supervisory authorities

2) Enforcement and litigation

Sufficient enforcement Specialised courts No increase in litigation

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IV. Key issues

F. Overview of certain control structures and

1) Cross-shareholdings and pyramid structures Rationale for cross-shareholdings and pyramid structures Legal framework

2) Other potential barriers

A number of legal & economic structures that may be well-justified may be considered as potential barriers. For instance:

Anti-trust regulations Sectoral regulations Public funds Co-determination Employee share ownership

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