The financial markets crisis has brought renewed focus to Material Adverse Change (MAC), or Material Adverse Effect (MAE), clauses. MAC or MAE clauses are present in virtually all merger and stock purchase agreements and are often a central feature in negotiations between the parties. MAC clauses are provisions that allocate risk in an interim period either between the date of the latest financials and the execution of a merger or acquisition agreement or between such execution and the closing of the transaction. Typically, a MAC closing condition allows either party to cancel the transaction in the case of, for example, a “change, event, circumstance or development that has or would have a material adverse effect on the assets and liabilities, financial condition or business of that party and its subsidiaries, taken as a whole.” The provisions then enumerate an expansive list of exceptions to this definition.
Changes in MAC Clauses Show a Reaction to Recent Markets Crisis
In years past, MAC clauses have been marked by ambiguity, and courts have largely refrained from clarifying the precise boundaries of their use other than to put the bar to invoking a MAC very high in requiring a material adverse effect on the earnings potential of a target company over a durationally significant time measured in years, rather than months. In the recent Hexion v. Huntsman decision, the Delaware Court of Chancery stated that it was “not a coincidence” that Delaware courts had never found a MAC to have occurred in the context of a merger agreement, and confirmed that the burden of proving a MAC is on the party seeking to avoid the agreement. The onset of the credit crunch in early 2008 has resulted in increasingly specific MAC clauses, as a number of parties have sought to better define their obligations under merger agreements in light of market uncertainties.
Additional Carve-Outs to the Definition of a MAC
The typical definition of a MAC will exclude certain events, such as changes in laws or economic conditions. A recent review of more than 40 transactions in 2008 valued at more than one billion dollars, however, indicates that most recent agreements have included a number of new and often deal-specific carve-outs as described below so that such events will not constitute or contribute to a MAC.
Changes in Commodity Prices
Negative impacts of the changes in commodity prices have been specifically excluded so that commodity price fluctuations cannot contribute to a MAC. For example, in the April 2008 Delta-Northwest merger agreement a “Material Adverse Effect” excluded “adverse Effects arising out of or relating to U.S. or global economic or financial market conditions, including…commodity prices and fuel costs...” The July 2008 merger agreement between InBev and Anheuser-Busch broadly excluded “effects resulting from changes in the economy or financial, credit, banking, currency, commodities or capital markets generally in the United States or other countries in which the Company conducts material operations or any changes in currency exchange rates, interest rates, monetary policy or inflation...”
Cost of Capital
Any increase in the costs of obtaining capital have been specifically excluded. The June 2008 stock purchase agreement between Safety Products Holdings and Honeywell International excluded “any increased cost of capital or pricing related to any financing for the transactions contemplated hereby…” The February 2008 merger agreement for the sale of Getty Images excluded “changes generally affecting…the economy or the credit, debt, financial or capital markets, in each case, in the United States or elsewhere in the world, including changes in interest or exchange rates…” Similarly, the merger agreement between Fertitta Holdings and Landry’s Restaurants excluded “any increase in the cost or availability of financing to Parent or MergerSub…”
Failure to Meet Projections
Virtually all of the deals reviewed explicitly excluded the seller’s failure to meet projections—internal or external—from the definition of a MAC. For example, the October 2008 merger agreement between Eli Lilly and ImClone Systems excluded “any failure by the Company to meet any internal or published industry analyst projections or forecasts or estimates of revenues or earnings for any period ending on or after the date of this Agreement…” The September 2008 agreement between Bank of America and Merrill Lynch excluded the “failure, in and of itself, to meet earnings projections, but not including any underlying causes thereof…” The Apax Partners-TriZetto agreement in April 2008 excluded “the failure of the Company to meet its projections or the issuance of revised projections that are more pessimistic than those at the time of this Agreement…” Similarly, the July 2008 agreement between Teva Pharmaceutical Industries and Barr Pharmaceuticals states that “any failure by the Company to meet internal projections or forecasts or third party revenue or earnings predictions for any period shall not be considered when determining if a Company Material Adverse Effect has occurred…”
Carve-outs from the MAC definition for disruptions in credit, equity and financial markets have been present in the most recent merger agreements. The Safety Products–Honeywell stock purchase agreement excluded “changes in, or circumstances or effects arising from or relating to, financial, banking, or securities markets…including…any disruption of the foregoing markets, [and]…any decline in the price of any security or any market index...” Additionally, the February 2008 merger agreement for the sale of Getty Images to ABE Investment set forth an exclusion from MAC for “the suspension of trading generally on the New York Stock Exchange or the Nasdaq Stock Market...”
Additional Risk-Allocating Provisions in Recent Agreements
Recent agreements also reflect a willingness on the part of sellers to accede to increased closing conditions, akin to MAC clauses, that allocate certain material risks to the selling company.
Debt Ratings Requirements
Several of the agreements reviewed contained provisions requiring the selling company to maintain a certain minimum debt rating. The September 2008 agreement between Constellation Energy Group and MidAmerican Energy Holdings Company contained a closing condition requiring that “On the Closing Date, all unsecured senior debt of the Company shall be rated investment grade or better with no less than a stable outlook by Moody’s Investor Service, Inc., Standard & Poor’s Ratings Group, Inc., and Fitch, Inc.” Likewise, the June 2008 agreement between Allied Waste Industries and Republic Services, Inc., required that “Republic shall have received written confirmation from the applicable agency that…the senior unsecured debt of Republic…will be either (i) rated BBB- or better by Standard & Poor’s and Ba1 or better by Moody’s, or (ii) rated Baa3 or better by Moody’s and BB+ or better by Standard & Poor’s.”
Limited Due Diligence Rights
The review also revealed novel uses of termination provisions to provide buyers with an opportunity to withdraw from the merger in the event the parties had not completed their due diligence efforts at the time the agreement was executed. For example, the Constellation Energy Group agreement provided the buyer with a “Limited Due Diligence Termination Right,” which allowed the buyer to terminate the transaction if it determined, at its sole discretion, that “the retail and/or wholesale businesses or assets of the Company, its Subsidiaries and the Company Joint Ventures taken as a whole have materially deteriorated.” The agreement further stated that “an adverse change in the net economic value of such businesses or assets in excess of $200 million from June 30, 2008 shall be deemed material.”
Several agreements conditioned the buyer’s obligation to consummate the transaction on the selling company’s ability to maintain a minimum EBITDA. For example, the February 2008 agreement between private equity firm Heller & Friedman and Getty Images contained a provision stating that “Consolidated EBITDA…for the twelve (12) month period ending March 31, 2008 (or, if the Closing Date shall occur on or after September 2, 2008, for the twelve (12) month period ending June 30, 2008) shall not be less than $300,000,000.”
No Bankruptcy Provisions
Finally, recent agreements have included as conditions to closing that certain parties to the agreement not be subject to any bankruptcy or insolvency proceedings. The Delta–Northwest merger agreement contains a specific condition to closing stating that “No proceeding shall have been instituted and not dismissed by or against [either party] seeking to adjudicate it bankrupt or insolvent, or seeking liquidation, winding up, reorganization, protection or other relief of it or its debts or any similar relief under any law relating to bankruptcy, insolvency or reorganization or relief of debtors...” If either party were subject to such a proceeding, the counter-party would not be obligated to effect the merger. The October 2008 Wells Fargo–Wachovia merger agreement included a similar provision as part of the conditions to closing, stating that neither Wachovia “nor any of its Significant Subsidiaries has filed for bankruptcy or filed for reorganization under the U.S. federal bankruptcy laws or similar state or federal law, become insolvent or become subject to conservatorship or receivership.”
Given the significant recent changes in drafting MAC clauses, as well as recent litigation regarding how they should be interpreted, it is now good practice to draft MAC provisions with greater specificity to minimize uncertainty in uncertain times.
This article was originally published as a McDermott On the Subject.
In September 2007, the European Parliament and the European Council adopted the Acquisitions Directive, which sets out procedural rules and evaluation criteria for the prudential assessment of acquisitions and increases in shareholdings in the financial sector. The Directive must be implemented into national law in European Union member states before March 21, 2009. HM Treasury and the Financial Services Authority (FSA) have recently published a joint consultation paper on implementing the Directive in the United Kingdom.
It was perceived that the extent of cross-border acquisitions in some financial services sectors in the European Union was relatively low, compared to those purely within national boundaries, and that one factor explaining the low level of consolidation across borders could be the regulatory framework for supervisory approvals of acquisitions. There was concern that the criteria for assessment of the suitability of the acquirer and the procedure for assessment of acquisitions was insufficiently clear and applied inconsistently in different member states of the European Union.
The rationale for the adoption of the Directive was to increase the level of cross-border merger activity in the financial services sector, to prevent member states from inhibiting acquisitions of financial services firms for protectionist reasons and to create a common consent and approval process across the European Union. The Directive aims to ensure absolute consistency in the approval of acquisitions in the following three financial sectors: credit institutions, insurance and securities. The Directive is a maximum harmonization measure (this means that member states cannot superimpose additional or more stringent criteria when implementing it).
It is envisaged that the Directive should benefit financial institutions of all sizes wishing to move into other member states’ markets. It has been welcomed as good news for EU-authorized financial institutions and their controllers, by providing legal certainty, clarity and predictability.
Key Components of the Directive
- It sets out the procedure to be applied by supervisory authorities in every member state of the European Union when assessing acquisitions on prudential grounds.
- It contains an exhaustive list of prudential criteria to be applied.
- It sets deadlines within which supervisory authorities must make their decisions.
Key Changes to the UK Rules
The primary differences from the existing UK controllers regime under the Financial Services & Markets Act 2000 (FSMA) are threefold.
Who Is a “Proposed Acquirer?”
There will be greater clarity as to who is regarded as a “proposed acquirer” (therefore having an obligation to notify the FSA). This will include any person or persons acting in concert who have taken a decision either to acquire or increase, directly or indirectly, a holding in a certain type of financial services firm (credit institutions, insurance, assurance and reinsurance undertakings, investment firms and undertakings for collective investment in transferable securities management companies).
The use of the term “acting in concert” replaces the existing UK concept of an “associate” (which was defined by reference to connected persons). Thus, going forward, any concert relationship will arise, and be determined, by reference to the actions of the acquirer rather than his or her connections.
It should be noted that the interpretation of the words “acting in concert” in this context is a matter of EU law rather than English law (and so, is not necessarily to be interpreted in the same manner as in the UK Takeover Code). Guidance on its meaning has been proposed in draft guidelines on the Directive produced by the EU Lamfalussy Level 3 Committees as follows:
Persons are ‘acting in concert’ when each of them decides to exercise his rights linked to the shares he intends to acquire in accordance with an explicit or implicit agreement made among them. It makes no difference whether this agreement is made in writing or verbally, or whether it becomes apparent only ‘de facto’, or whether the persons acting in concert are otherwise linked with each other. Notification of the voting rights held collectively by these persons will have to be made to the competent authorities by each of the parties concerned or by one of these parties on behalf of the group of persons acting in concert.
When Does the Notification Obligation Arise?
Greater clarity also will be achieved in assessing when the obligation to notify arises. Currently it is triggered when a person “proposes to take a step” that would result in that individual acquiring control. It was often unclear whether this criteria had been triggered. This will be replaced with the clearer requirement that the person has “taken a decision” to acquire control.
Alteration to UK Thresholds
Increases in a shareholding will be relevant for notification purposes if the proportion of the voting rights or the capital held would reach or exceed 10 percent, 20 percent, 30 percent or 50 percent, or if the voting rights result in the ability to exercise significant influence over management or if the acquired firm would become its subsidiary. In the United Kingdom, this will involve a reduction of one of the existing thresholds of 33 percent to 30 percent.
The New Rules Governing the Assessment Process
Changes of note to the assessment process include the following:
- An exhaustive list of prudential criteria for the assessment is provided.
- The time period in which the supervisory authority must make its assessment is shortened from 90 calendar days to 60 working days. A decision to object to an acquisition or to approve it subject to conditions must be notified to the proposed acquirer within two working days of the decision having been made.
- The “clock” may only be stopped once by a request for further information, no later than the 50th working day and for no longer than 20 days. Other requests for information may be made, but without stopping the clock.
- The maximum interruption period can extend to 30 working days if the proposed acquirer is situated or regulated outside the European Union or is a person not authorized under the EU single market directives.
New Exhaustive List of Prudential Criteria
Supervisory authorities will be required to assess the financial soundness of a proposed acquisition and the suitability of a proposed acquirer by reference to the following criteria:
- The proposed acquirer’s reputation
- The reputation and experience of any person who will direct the business of the financial institution as a result of the proposed acquisition
- The financial soundness of the proposed acquirer, in particular in relation to the type of business pursued and envisaged in the financial institution in which the acquisition is proposed
- The ability of the financial institution to comply on an ongoing basis with applicable prudential requirements
- Whether the group of which it will become part has a structure that renders it possible to exercise effective supervision, effectively exchange information among supervisory authorities and determine the allocation of responsibilities among them
- Whether there are reasonable grounds to suspect that in connection with the proposed acquisition, money laundering or terrorist financing is being or has been committed or attempted, or the acquisition could increase the risk of this happening
Presently, permission to acquire can be refused on both prudential and consumer-interest grounds. In the future, only prudential criteria can be considered, but as these include the reputation of the proposed acquired, the change is unlikely to affect detrimentally the FSA’s power to prevent unsuitable acquisitions.
The following voting rights are exempt from the scope of the Directive:
- Voting rights held by a firm acting in a custodial capacity (provided that the custodian can only exercise voting rights pursuant to written or electronic instructions) or acquired for the sole purpose of clearing and settling within a short settlement cycle
- Voting rights held by an investment firm or credit institution in connection with underwriting services or placing of securities on a firm commitment basis
In addition, the UK government has recognized the likelihood that fund managers will regularly cross the 10 percent threshold, which would impede their ability to respond to market movements and jeopardize their positions and balance between funds. Accordingly, the UK government intends to continue to allow fund managers to pre-notify proposed acquisitions, by providing the FSA with a statement of what they plan to acquire in the course of their investment activities and the FSA may grant approval of such changes for a period lasting up to a year.
Proposed Ancillary Simplifications in the United Kingdom for Businesses Not Covered by the Directive
In the United Kingdom, certain other business sectors are currently subject to the full existing FSMA controllers notification regime, but not by virtue of any European directives. These include mortgage intermediaries, pre-paid funeral providers, occupational pension scheme firms, home reversion and home purchase plan providers and intermediaries, credit unions, some authorized professional firms, some commodity brokers and dealers, non-UCITS scheme operators and some investment advisers, receivers and transmitters who do not hold client assets (non-Directive firms). The UK government proposes to apply a single 20 percent threshold to all such non-Directive firms (with the exception of holdings in an investment exchange, which will continue to be subject to two primary thresholds—20 percent and 50 percent).
It is envisaged that these proposals will reduce costs for non-Directive firms, in moving from a four threshold regime to a single threshold regime of 20 percent.
Another advantageous change includes the UK government’s proposal to apply the new assessment deadlines, criteria and other provisions of the Directive to non-Directive and insurance mediation directive firms, so that firms engaged in both Directive and non-Directive business will not be subjected to two different processes.
The financial crisis has hit the Milan stock exchange much like it has any other major stock exchange. With stock prices at historical lows, controlling shareholders of Italian listed companies are now taking the opportunity to buy out minority shareholders and take these once-listed companies private. More than a dozen companies were delisted from the Italian stock exchange in 2008, and six more are currently in the pipeline, including such prominent names as Ducati motorcycles and ERGO life insurance. The liberal legal framework, which was enacted only one year ago (Legislative Decree no. 229 of November 19, 2007, “Transposition of directive 2004/25/EC concerning public tender offers,” published in the Official Gazette no. 289 of 13 December 2007), makes take-private transactions particularly attractive in Italy. However, the new legislation still lacks important procedural rules, which Consob, the Italian stock exchange authority, should have enacted by June 2008. As a consequence, the legal uncertainty of the procedural details makes strategic planning challenging for both buyers and sellers.
No Minimum Listing Period or Minimum Buyout Price
Italian law does not provide for a minimum listing period after the initial public offering (IPO), nor for a black-out period during which a company’s stock cannot be listed again after having obtained a delisting. Consequently, owners of medium-sized businesses may have an incentive to take a company public when markets are bullish and to delist it when stock prices are down. This mechanism works because the law does not impose minimum prices in delisting procedures, so that controlling shareholders may buy back the shares at a price lower than at issuance. Marazzi, for instance, was listed on the Italian stock exchange in 2006 with an issuance price of EUR 10.25 per share, and in August 2008 it was taken private at a price of EUR 7.15.
Regular Delisting and Squeeze-Out
Italian law allows for a delisting procedure when a shareholder comes to own more than 90 percent of the capital stock of the listed company. In such cases, minority shareholders are entitled to sell their shares to the majority shareholder (the sell-out right). Regardless of whether or not any sell-out rights are exercised, the shares will be delisted. In addition, should a shareholder come to own at least 95 percent of the listed stock as a result of a tender offer or exercise of sell-out rights, the shareholder can force the remaining minority shareholders to sell their shares (squeeze-out right).
90 Percent Threshold: Sell-Out and Delisting
Normally, the 90 percent threshold is exceeded through the launch of a tender offer. But there is no need to offer too generous a price, because if the bidder does not manage to acquire more than 90 percent of the issuer’s share capital as a direct result of the tender offer, the bidder can still reach its goal by purchasing the missing shares in the market. These subsequent market purchases can also be made at a higher price, without any impact on the price of the preceding tender offer.
Once the 90 percent threshold has been exceeded, minority shareholders are entitled to their sell-out rights. Details of the sell-out procedure, in particular price determination and timing, remain subject to Consob regulation. The law provides that Consob shall determine a “fair” price by “also taking account of the price of a preceding tender offer and the weighted average stock market price during the past 6 months.” (Only where the 90 percent threshold was exceeded as a direct result of a tender offer, which was accepted by minority shareholders representing at least 90 percent of the outstanding shares, is the sell-out price the same as the bid price of the preceding tender offer.) Consob, in turn, has clarified that it gives little importance to the average stock market price, as that is regularly spoiled by the preceding tender offer and, after the offer, by the lack of liquidity of the stock. Instead, Consob looks more closely at the issuer’s net equity adjusted to current value and to its earnings results and prospects. The uncertainty regarding the weight Consob will attribute to each criteria in each given case, and regarding the time it will take to make its determination, provides the ground for arbitrage and “behind the curtain” negotiations between institutional investors and the majority shareholder.
95 percent Threshold: Squeeze-Out
If the majority shareholder, as a result of the tender offer or the subsequent exercise of any sell-out rights, comes to own at least 95 percent of the capital stock of the listed company, the majority shareholder can force the minority shareholders to sell it the remaining 5 percent of the stock of the company. As Consob ruled in September 2008, it is not necessary that the 95 percent threshold be reached exclusively through the exercise by minority shareholders of their sell-out rights; Consob counts equally the shares that the majority shareholder has voluntarily purchased in the market during the same period. Although the wording of the law seems to suggest the contrary, there is now a precedent demonstrating that the squeeze-out right is also available if the 90 percent sell-out threshold was not exceeded as a direct result of the initial tender offer, but only after the tender offer and through subsequent purchases in the market. In the case of the take-private of Ducati motorcycles, the majority shareholder had acquired only 86 percent of Ducati through the tender offer. In the four months that followed, the majority shareholder purchased another 6 percent in the market, thereby triggering sell-out rights. This sell-out rights procedure closed on December 12, 2008, resulting in the majority shareholder acquiring more than 95 percent of Ducati. With the formal approval of Consob, the majority shareholder of Ducati has now exercised its squeeze-out rights, and the company has been delisted.
What still remains uncertain, however, is if the same squeeze-out right would have applied if the 95 percent threshold had not been reached through exercise of the sell-out rights, but only through subsequent stock purchases in the market. Again, the wording of the law suggests the contrary, and the Ducati case has not resolved the issue.
One would expect that game is over at least for those bidders that have not acquired, through the launch of the tender offer, sufficient shares to realistically exceed the 90 percent threshold. But in those cases, there are still ways to force a delisting—namely, by implementing corporate transactions that indirectly result in the delisting of the shares. These tactics are referred to as a cold delisting. The most effective cold delisting strategy is to merge the listed company into a non-listed company. Recently, this strategy was implemented by the majority shareholder of Lavorwash after the tender offer had not been successful enough to cross the 90 percent threshold. Where the merger is properly prepared, neither Consob nor the company’s minority shareholders can prevent the cold delisting.
In theory, a merger of a listed company into a non-listed company can be implemented by any shareholder owning or controlling at least two-thirds of the corporate capital of the listed company, since this is the necessary majority approval level for the merger resolution. However, the risk is high that minority shareholders may challenge the merger resolution as being abusive if the majority shareholder has not previously launched a tender offer in order to offer minority shareholders an exit at fair conditions. But even a tender offer may not protect against such allegations. For example, minority shareholders challenged the merger of I.Net with British Telecom Italia in 2007 despite the previous launch of a tender offer, making the allegation that the tender offer had been launched at an unfair price and that the exchange ratio offered in the merger was unfair as well. While a decision on the merits is still outstanding in that case, the court argued a decision on a motion for injunctive relief that the merger documentation revealed a lack of sound business reasons and that the majority shareholder had clearly approved and caused the merger for the sole purpose of obtaining the delisting.
Despite this recent ruling, it must be considered whether delisting itself cannot be a sufficient business reason for a company to resolve on a merger. In fact, small or medium-sized companies may benefit from a delisting, particularly in times of a general economic downturn:
- The general trend of the market may result in an undervaluation of the individual company and thereby worsen its refinancing possibilities.
- Non-listed companies are better able to retain and reinvest profits, as minority shareholders of listed companies usually claim dividends.
- Mandatory disclosure requirements applying only to listed companies may jeopardize confidential reorganization projects.
- Higher thresholds for minority shareholders’ rights in non-listed companies reduce the risk of being blackmailed by minorities.
In fact, recently companies have been declaring the delisting more openly as an important reason for the merger. Most times, however, additional arguments and business reasons are added and presented supporting the merger, such as shortening the control chain or realizing synergies.
Conclusions and Outlook
The stock ownership threshold to obtain a delisting is 90 percent. While minority shareholders can resist a squeeze-out if they own or control at least 5 percent, but not more than 10 percent, such minority shareholders may end up with illiquid, non-listed shares. And, notwithstanding the 90 percent ownership threshold to obtain a delisting, minority shareholders generally still have the risk of a cold delisting. Consequently, even if minority shareholders view the consideration offered in a tender offer as inadequate, there remains pressure to tender in order to avoid the risk of ending up with non-listed shares without a public resale market. Majority shareholders strategically declare the possibility of a cold delisting openly and clearly in the tender offer prospectus in order to increase the pressure. The recent boom of going-private transactions shows these tactics have received the attention and increased scrutiny of Consob. According to market rumors, Consob is currently preparing new rules to strengthen minority shareholders’ rights in squeeze-out situations. However, Consob’s possibilities are limited, as it cannot go beyond the limits set by law, which can only be amended by the Italian Parliament. Accordingly, it may be expected that the new rules will remain limited to transparency requirements, while more effective measures will require the intervention of the Parliament. As minority shareholders’ rights do not appear to be the major concern of the Parliament in these times of economic troubles, it may be expected that the boom of going-private transactions will continue as robustly in 2009 as they did in 2008.
On August 27, 2008, the U.S. Securities and Exchange Commission (SEC) voted unanimously to adopt revisions to its cross-border tender offer, exchange offer and business combination rules. The final rule will become effective on December 8, 2008.
The amended rules are designed to expand and enhance the utility of the cross-border exemptions for business combination transactions and rights offerings and to encourage offerors and issuers to permit U.S. security holders to participate in these transactions on the same terms as other target security holders. The exemptions help bridge conflicts and inconsistencies between U.S. and foreign regulations and facilitate the inclusion of U.S. investors in cross-border transactions. Many of the rule changes the SEC adopted codify existing SEC interpretive positions and exemption orders in the cross-border area.
After considering comments, the SEC adopted the amendments to the cross-border exemptions and beneficial ownership rules substantially as proposed in May 2008, but with certain modifications. The SEC also adopted two changes to rules applicable to all tender offers, including those for U.S. target companies, where the SEC determined that the rule modifications proposed in the cross-border context would be useful and beneficial if applied to all tender offers.
The key rule changes resulting from the newly adopted rules include the following.
Modifications to the Look-Through Rules
When the SEC first adopted the cross-border exemptions in 1999, it established a threshold eligibility test for the use of the exemptions based on the percentage of target shares beneficially owned by U.S. persons. Under existing rules, the look-through analysis requires the acquiror to “look through” securities held of record by nominees in (i) the United States, (ii) the subject company’s jurisdiction of incorporation and that of each participant in the business combination transaction, and (iii) the primary trading market, to identify those held for the accounts of beneficial owners located in the United States. If, after “reasonable inquiry” the acquiror is unable to obtain information about the location of the beneficial owners, the rules allow the acquiror to assume that the customers are residents of the jurisdiction in which the nominee has its principal place of business. Currently, acquirors are required to calculate U.S. ownership as of the 30th day before the commencement of a tender offer or solicitation for a business combination. In its new rulemaking, the SEC acknowledged the practical limitations and challenges posed by the current look-through analysis, especially in the case of non-negotiated (e.g., “hostile”) transactions.
While the revised rule adopted by the SEC does not change the threshold percentages of U.S. ownership for exemption eligibility, it fixes the reference date to the “public announcement” of the tender offer or business combination. Under the revised rules, to avail itself of the cross-border exemptions, an acquiror may calculate U.S. ownership of the subject securities as of any date no more than 60 days before and no more than 30 days after the public announcement of the cross-border transaction. In instances where the 90-day period may not provide sufficient time in some foreign jurisdictions for an acquiror to complete the look-through analysis, the revised rules allow such an acquiror to use a date within 120 days before the public announcement.
As a result of the early starting point, parties to a business combination will be able to make a U.S. ownership determination and inform the markets of the treatment of U.S. security holders at an earlier stage in the process. Moreover, the U.S. ownership calculation can be made before the target security holder base is affected by the public announcement. By creating a 30-day post-announcement window, the rule also helps address concerns that where an analysis must be conducted before announcement, it may compromise the confidentiality of the transaction.
In addition to modifying the timeline for calculating U.S. ownership, the SEC modified the look-through rules for calculating U.S. ownership. The revised rules no longer require that individual holders of more than 10 percent of the subject securities be excluded from the calculation of U.S. ownership. The SEC expects that this change will significantly expand the number of cross-border business combinations eligible for exemptions while still providing appropriate investor protection.
Alternate Test for Determining Exemption Eligibility
Recognizing that circumstances exist in which acquirors are unable to conduct the look-through analysis, the SEC adopted an alternate test for determining eligibility to rely on the cross-border exemptions. Acquirors or bidders in all non-negotiated transactions will be able to rely on the alternate test. In certain (limited) circumstances, even acquirors or bidders (or issuers in self-tenders) in negotiated transactions will be able to rely on the alternate test when it is simply impractical or impossible to conduct a look-through analysis (e.g., target securities held in bearer form). The SEC emphasizes in the adopting release that bidders must make a good faith effort to conduct a reasonable inquiry into ascertaining the level of U.S. beneficial ownership; however, the need to dedicate time and resources to the look-through analysis will not itself excuse conducting the analysis. Additionally, concerns about the completeness and accuracy of the information obtained from the look-through analysis will not necessarily justify the use of the alternate test.
The alternate test takes a three-pronged approach:
- Average Daily Trading Volume. The first prong is based on a comparison of average daily trading volume (ADTV) of the subject securities in the United States, as compared to worldwide ADTV, and is satisfied where the ADTV for the subject securities in the United States over a 12-month period ending no more than 60 days before the announcement of the transaction is not more than 10 percent (40 percent for Tier II) of ADTV on a worldwide basis. The test provides acquirors with a range of dates by which they may do the comparison of U.S. and worldwide trading volumes. The timetable, like the look-through test, is aimed at providing an appropriate level of flexibility for acquirors and is tied to the public announcement of the transaction—it must stretch over a 12-month period ending no more than 60 days before the public announcement of the transaction. As ADTV is an objective measure, the SEC did not believe there should be any concerns about compromising confidentiality by doing the calculation prior to the announcement of the transaction. As a result, there was no need to extend the calculation timetable beyond the date of the public announcement. In order for the acquiror in a negotiated transaction to be able to rely on the alternate test, the rule also requires that there be a “primary trading market” for the subject securities. The SEC viewed the existence of a primary trading market as important because it is designed to ensure that there is a primary foreign regulator with oversight over the transaction.
- Annual Reports and Other Annual Information. The test’s second prong is that the acquiror must consider information about U.S. ownership levels that appear in annual reports or other annual information filed by the issuer with the SEC or with the regulator in its home jurisdiction. Since the transaction planning process may be disrupted by filings made at a late stage, only annual reports or other annual information filed before the public announcement must be taken into consideration.
- “Reason to Know.” The third and final prong of the test—the “reason to know” element—provides that an applicable cross-border exemption which otherwise might be available will not be available if the acquiror “knows or has reason to know” that U.S. beneficial ownership levels exceed the limits for the exemption. An offeror is deemed to have reason to know the U.S. ownership of the subject securities that appears in any filing with the SEC, the home country regulator or the regulator in the primary trading market. The revised rule provides additional specific sources of information which will also be attributed to the acquiror, including information about U.S. ownership available from the issuer or readily available from reasonably reliable sources.
The modifications to the calculation eligibility test—both the look-through rules and the alternate test—also apply to rights offerings.
Expanded Relief Under Tier I for Affiliated Transactions
Exchange Act Rule 13e-3 establishes specific filing and disclosure requirements for certain kinds of affiliated transactions. However, as the SEC noted in its proposing release, the scope of the current Tier I exemption from Rule 13e-3 does not apply to some transaction structures commonly used abroad (e.g., schemes of arrangement, cash mergers and compulsory acquisitions for cash). The SEC acknowledged that the form of the transaction structure should not prevent an otherwise-eligible issuer or affiliate from relying on the Tier I exemption from Rule 13e-3. In the revised rules, the SEC expanded the scope of the Tier I exemption from Exchange Act Rule 13e-3 to include these different transaction structures.
Changes to Tier II Exemptions
The SEC adopted a number of rule changes to the Tier II exemptions in an effort to alleviate practical difficulties that often resulted in the need for companies to request specific exemptive or no-action relief. The Tier II exemptions represent targeted modifications to U.S. tender offer rules with the purpose of bridging differences between U.S. and foreign practice in cross-border tender offers. The revisions to the Tier II exemptions include the following.
Expansion of the Tier II Exemption
The SEC clarified that the Tier II exemptions are available for tender offers subject only to Section 14(e), in addition to transactions subject to Rule 13e-4 or Regulation 14D.
Multiple Foreign Tender Offers
The Tier II cross-border exemptions currently in place allow a bidder to conduct two separate but concurrent tender offers if one is made only to U.S. target security holders and another open only to foreign holders of the target securities. The revised rules permit the use of more than one offer outside of the United States for tender offers conducted under Tier II. The SEC also amended the rule to allow a bidder in a cross-border tender offer conducted under Tier II to make the U.S. offer available to all holders of American Depositary Receipts (ADRs) (including non-U.S. holders of ADRs) and to enable the inclusion of U.S. target security holders in a foreign offer conducted under Tier II. The adopting release states that these amendments are not intended to permit the use of separate proration pools where a multiple offer structure is used in the context of a partial cross-border tender offer.
Termination of Withdrawal Rights While Tendered Securities Are Counted
The Exchange Act requirement that bidders provide back-end withdrawal rights if tendered securities have not been accepted for payment within a certain date after the commencement of a tender offer has created problems in cross-border tender offers because of the differences in the manner in which securities are tendered in many non-U.S. jurisdictions and the process for counting those securities. In recognition of these difficulties, the SEC adopted a revision that, if certain conditions are met, will allow a bidder in a cross-border tender offer conducted under Tier II to suspend withdrawal rights after the expiration of an offer during the counting of tendered securities and until those securities are accepted for payment.
Subsequent Offering Period Changes
The SEC adopted several changes to the rules applicable to subsequent offering periods:
- Elimination of 20-Business Day Time Limit. Current tender offer rules allow a third-party bidder in a tender offer for all of the subject class of securities to include a subsequent offering period during which securities may be tendered and purchased on a rolling or “as tendered” basis if certain conditions are met. The U.S. time limit of 20 business days on the length of a subsequent offering period has often been a source of conflict with non-U.S. regulations because many jurisdictions have subsequent offering periods that extend beyond that timeframe. As a result, the SEC has eliminated the 20 business day time limit. Although not initially proposed, the SEC extended this relief to domestic tender offers as well.
- Changes to Prompt Payment Rules. The revised rules also allow a bidder in a cross-border tender offer conducted under the Tier II exemptions to “bundle” and pay for securities tendered in the subsequent offering period within 20 business days of the date of tender. However, where local law and practice require a period shorter than 20 business days, payment must be made more quickly than 20 business from the date of tender in order to satisfy U.S. prompt payment requirements.
- Payment of Interest on Tendered Securities. In some non-U.S. jurisdictions, bidders are legally obligated to pay interest on securities tendered during a subsequent offering period. As the rules currently stand, paying interest on securities tendered during a subsequent offering period would violate U.S. rules. The SEC’s revised rules allow for the payment of interest on securities tendered during a subsequent offering period where such payment is mandated by the law of the relevant foreign jurisdiction.
- Changes to Rules Relating to “Mix and Match” Offers. The cross-border tender offer rules have also been revised to facilitate “mix and match” cross-border tender offers, where bidders offer a fixed mix of cash and securities in exchange for each target security but permit tendering holders to request a different portion of cash or securities. The revised rules permit the use of separate offset “pools” for securities tendered during initial and subsequent offering periods for cross-border tender offers conducted under Tier II. The amended rules also eliminate the prohibition on a ceiling for the form of consideration offered in a subsequent offering period in a mix and match Tier II offer structure where target security holders are able to elect to receive alternate forms of consideration in the offer.
Terminating Withdrawal Rights
Under U.S. tender offer rules, bidders must ensure that a tender offer remains open and includes withdrawal rights for a prescribed period after a material change in the terms of the offer. Waiving or reducing the minimum acceptance condition is usually considered a material change in the terms of the offer that triggers this requirement. This requirement has come into conflict with laws or practices in certain foreign jurisdictions. The adopting release affirms the SEC’s interpretive position, albeit in modified form, of permitting flexibility for bidders in Tier II cross-border tender offers to waive or reduce a minimum tender condition without providing withdrawal rights if certain conditions are met. The SEC states in the adopting release that the interpretive guidance, as modified in the adopting release, may not be relied upon unless the bidder undertakes not to waive below a simple majority or the percentage threshold required to control the target company under applicable foreign law, if it is greater.
Early Termination or Voluntary Extension of an Initial Offering Period
Changing the expiration date of a tender offer which has previously been set by the bidder requires notice to target security holders before the initial offering period closes and withdrawal rights terminate. This extension requirement conflicts with the law or practice of some foreign jurisdictions. The SEC has amended the cross-border tender offer rules to codify guidelines set forth in existing staff guidance to permit early termination, subject to specific conditions specified in the rules.
Expanded Availability of Early Commencement
Under existing rules, the ability of a bidder to “early commence” an exchange offer is available only when an exchange offer is subject to Rule 13e-4 or Regulation 14D. The revised rules extend the early commencement option to domestic and foreign exchange offers not subject to Rule 13e-4 or Regulation 14D. These exchange offers may now commence upon the filing of the registration statement registering the offer, subject to certain conditions. Early commencement will be available for Regulation 14E-only offers so long as no securities are purchased until the registration statement is declared effective. The amended rules require offerors to provide withdrawal rights in early commencement offers not subject to Rule 13e-4 or Regulation 14D to the same extent as would otherwise be required.
Beneficial Ownership Reporting by Foreign Institutions
Sections 13(d) and 13(g) of the Exchange Act provide investors and the issuer with beneficial ownership reporting information about accumulations of securities that may have the potential to change or influence the control of the issuer. Forms filed pursuant to these sections are part of the reporting system in place for gathering and disseminating information about the ownership of equity securities. Under the rule revisions adopted by the SEC, certain foreign institutions will be allowed to comply with beneficial ownership reporting requirements by filing on the short-form Schedule 13G, as opposed to Schedule 13D. As would be required of a domestic institution, a foreign institution seeking to file the short-form Schedule 13G at the time it exceeds the beneficial ownership threshold will need to determine its eligibility. The initial eligibility assessment will require a foreign institution to determine whether it is subject to a foreign regulatory scheme that is substantially comparable to the regulatory scheme applicable to the corresponding category of U.S. institutional investor.
This article was originally published as a McDermott On the Subject.