The Takeovers Panel's recent decision in the National Can Industries Limited case provides a number of important pointers to bear in mind in negotiating break fees. Some of these relate specifically to 'privatisation' or majority buy-out transactions, but others, such as those relating to appropriate triggers for payment of break fees, have more general application.
Michael Tyrrell is the managing director of National Can Industries Limited (NCI). Various members of the Tyrrell family collectively control 51 per cent of NCI.
Mr Tyrrell, through a special purpose bid vehicle—ESK—sought to 'privatise' NCI by acquiring the remaining 49 per cent of NCI from the public via a scheme of arrangement. The initial offer price was $1.40 per share, which valued NCI at $93 million.
Immediately before the proposed scheme was announced, NCI and ESK entered into an Implementation Agreement under which:
- the independent directors of NCI agreed to recommend the scheme to shareholders. However, the directors were entitled to change their recommendation if the independent expert reached the view that the offer was not in the best interests of shareholders. At the time the Implementation Agreement was signed, NCI had not discussed the proposal with an independent expert, but had received advice from its financial advisor that the $1.40 offer price provided an outcome that was in the best interests of shareholders and would be in the expert's range
- NCI agreed to pay a break fee to ESK if the independent directors changed their recommendation, a successful higher bid was made for NCI or NCI breached the agreement. The amount of the break fee was $1 million, which equated to approximately two per cent of the value of shares to be acquired under the scheme and one per cent of the total market capitalisation of NCI (based on the $1.40 price). The evidence indicated that the actual costs incurred by ESK in relation to the scheme exceeded $1 million.
After the Implementation Agreement had been signed, Grant Samuel was engaged by NCI as the independent expert and gave an initial opinion that the $1.40 offer price was below its valuation range for NCI and therefore the scheme was not in the best interests of shareholders. In addition, Visy Industrial Packaging acquired a six per cent shareholding in NCI, which resulted in the NCI share price increasing to well above $1.40.
These factors lead to NCI's directors changing their recommendation to shareholders, triggering NCI's obligation to pay the break fee under the Implementation Agreement. NCI paid the break fee to ESK, and at the same time ESK increased its offer price to $1.55 and agreed to limit any more claims for reimbursement to $100,000.
After the $1 million break fee was paid, Visy sought a declaration from the Panel that unacceptable circumstances had arisen and an order that ESK should repay the fee to NCI.
The initial Panel's decision
The Panel accepted that the amount of the break fee was within the one per cent guideline, and decided that there was no reason to depart from the one per cent guideline even though the transaction involved a scheme of arrangement, rather than a takeover. It also decided that the one per cent guideline should be assessed against the total market capitalisation of the target, rather than value of only the shares the subject of the offer:
'We rejected a submission that the 1% benchmark was inapplicable because the Tyrrell Interests already held over half the shares in NCI. If both bids are full bids, a break fee has the same effect on the respective prices per share paid by the bidder who receives the fee and by a rival bidder who does not receive the fee, regardless of the number of shares each of them holds when the fee is paid or agreed to be paid.'
However, the Panel found that the decision of the independent directors of NCI to pay the fee was 'inappropriate' and gave rise to unacceptable circumstances.
The primary basis for the decision seems to have been the fact that the independent directors of NCI committed to pay the fee (when NCI entered into the Implementation Agreement) at a time when they had not sought the views of the independent expert, and therefore did not have full information. The Panel considered that NCI should have either sought the views of the independent expert before entering into the Implementation Agreement, or included provisions in the Agreement under which the fee would not have been payable in the event of an adverse independent expert's report.
The Panel commented that the commitment to pay the fee might have been justified if there had been a risk of ESK being attracted to other possible targets (in that situation, the NCI directors might not have had time to wait to get a view from the independent expert) but in this case the directors did not need to rush as ESK was a 'captive bidder'.
The Panel initially proposed orders that NCI allow the non-Tyrrell shareholders to vote to ratify the payment of the break fee, and if they did not, ESK would be required to repay the fee.
However, the Panel accepted ESK's undertaking:
- to repay the break fee if a higher bid for NCI succeeded
- to increase the scheme price to $1.565 per share (the 1.5 cent increase being the amount of the $1 million break fee per NCI share)
- not to require or receive payment of the additional $100,000 reimbursement.
Visy applied to the Panel for a review of the decision.
The Review Panel's decision
The Review Panel agreed with the initial Panel's decision, and did not change the undertaking referred to above.
The Review Panel was critical of the fact that the break could become payable upon a change in recommendation of NCI's directors, without reference to NCI's shareholders, and made the following comment:
'... if conduct by the directors of a target, rather than that of its shareholders or a rival bidder, is to be the trigger for payment of a break fee, the relevant agreement should allow the directors to respond to changes in circumstances without triggering a right in the other party to receive (or take action to require payment of) the break fee if the directors do as their fiduciary duties require'.
Probably the most interesting aspect of the Panel's decisions relates to the circumstances in which it is appropriate to pay a break fee. Historically, the standard triggers for payment of a break fee have been:
- a successful superior bid
- the target company breaching its obligations under the relevant implementation or bidding agreement, or
- the target directors failing to make or withdrawing a recommendation that shareholders accept the bid or vote in favour of the scheme.
The comments of the Review Panel set out above suggest that the Panel may take a dim view of a change in recommendation trigger for payment of a break fee, unless it is subject to an exception for a change in recommendation that is required by the fiduciary duties of the target directors. It is possible that the Panel will only be concerned about these change of recommendation provisions where the target directors proceed without full information (such as the views of the independent expert) but, on face value, the Review Panel's comments have wider application. Given that the target directors are only likely to change their recommendation if their fiduciary duties require it, the unfortunate consequence of this approach is that a bidder who has negotiated extensively, and perhaps paid a higher premium than normal, to obtain a favourable recommendation from the target directors, may be left empty handed if the target directors subsequently change their recommendation.
On the other hand, 'shareholder rejection' triggers may now become more common-place. Previously, it was generally thought (on the basis of the Panel's Guidance Note on Lock-Up Devices and the Panel's decision in Ausdoc) that a break fee of any meaningful size should not be payable merely because shareholders reject a proposal, as this can have a coercive effect on the target shareholders. In the NCI case, the initial Panel said:
'it is acceptable for a break fee to become payable if and when a proposal endorsed by the board is rejected by shareholders. In such case, the fee is in effect the price paid to secure the opportunity for shareholders to consider the proposal and it becomes payable only as a result of their decision to reject the proposal'.
The Review Panel commented that a one per cent break fee 'is usually not materially anti-competitive and does not place unreasonable pressure on shareholders', although the size of the fee should also be assessed against other factors such as net profit and dividends.
Finally, it is apparent from the Panel's reasons that it will not hesitate to scrutinise carefully the decision making process of the target directors in committing to a break fee. In this case, the Panel found that the decision of the NCI directors was 'inappropriate', notwithstanding that the amount of the break fee was within the one per cent guideline, the directors acted on the basis of detailed legal and financial advice and honestly believed that the decision was in the best interests of NCI's shareholders. This stands in contrast to the approach in the US and Canada where a form of 'business judgement' rule applies to the actions of the target directors: generally the courts will not second guess commercial decisions made by target directors if they have acted on the basis of proper advice, behaved honestly, considered all relevant information and followed a careful process.
Interestingly, if the Panel does find some fault with the decision making process of the target directors, it is likely to be the bidder that wears the consequences, because the usual order of the Panel to overcome the fault will be to strike down the break fee commitment or order repayment by the bidder. That may have the curious effect of bidder itself having to analyse the decision making process of the target directors to satisfy itself that the break fee arrangement can be enforced.
This article provides a summary only of the subject matter covered, without the assumption of a duty of care by Freehills or Freehills Carter Smith Beadle. The summary is not intended to be nor should it be relied upon as a substitute for legal or other professional advice.