Company Law 6

8/2/2019 Company Law 6

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Introduction to Company LawNote 6 of 7 Notes

Merger & Takeover

Universiti Kebangsaan Malaysia

Faculty of LawPursuing PHD Program in Law

Musbri Mohamed

DIL; ADIL ( ITM )

MBL ( UKM )

1



A takeover occurs when existing shareholders of a target

company transfer sufficient shares to an offeror so as to

confer on the offeror control of the voting power

attaching to the target company's share capital. Takeover

therefore involves a transfer of corporate control.

Takeover offer which is opposed by the target's

incumbent directors and management is known as

hostile takeover . There are various factors that may

drive hostile takeovers. Hostile takeovers may involve

underperforming companies , under priced companies

or cash rich companies. Companies with dispersed

shareholding, with no party holding deciding block mayalso attract hostile takeover.

2



In Malaysia, there is cultural adversity to hostile takeovers. Moreover,

the rate of institutional participation is still low as compared to theUnited Kingdom ('UK') (66%), the United States (over 50%) or Australia

(25%). It is worth noting, however, that the current exercise of mergers,

increase in size and increased institutional participation may dilute

concentration of ownership and make the companies vulnerable to

hostile takeovers. Thus, there is a need for putting in place some

measures to protect target companies and its shareholders.

3



The

US however has not clearly addressed the legality of most takeover defences.

Some suggested that it was not until the Delaware Supreme's Court opinion in

1995 in Unitrin v American General Corporation 651A 2d 1361 Delaware

Supreme Court (1995) that it became reasonably clear that corporate

management has the right to maintain a takeover defence against an unwanted

takeover bid without the need to obtain shareholders approval. Despite the fact

that hostile takeovers were being commonly used by bidders in 1980s in the US,corporate law in US only addressed this issue long after hostile takeovers had

first appeared on the scene. In the US, the use of poison pill defence in

conjunction with a staggered board is claimed to be the most potent defence. It

is worth noting that in the US, takeover defences are largely a matter of state

corporate law. In Delaware, for example, defensive action must meet an

enhanced scrutiny standard i.e the target board must show that it had reasonable

grounds for believing that a danger to corporate policy and effectiveness existed

as a result of the bidder's offer and that the defensive action taken was a

reasonable response in relation to the threat posed.

4



The Malaysian takeover regime on the other hand has chose to state

clearly the position of takeover defences. The Malaysian Code on

Takeovers and Mergers 1998 forbids the target company from taking anyaction that may amount to frustration of the bid when a bid is made or is

imminent. The provisions are similar to those found in the City Code.

In Australia, defensive tactics are limited by Listing Requirements of the

Australian Stock Exchange. Generally speaking, a transaction or conduct by

the board of the target that has the effect of triggering a bid condition which

is likely to lead to the defeat of a bid, must be submitted promptly to thetarget's shareholders for approval. The law in Australia relating to

frustration action was influenced by the rules in UK. However, unlike the

UK rules, the Australian Panel did not specify any precise limits to the

operation of the rule.

5



Section 33A(5)(d) of the Malaysian Code on Takeovers and Mergers

1998 imposed a duty on Securities Commission to ensure that the

directors of both the acquiring and target companies act in good faith

when responding to, or making recommendations with respect to a

takeover offer. It is clearly important that the directors of the target

should ensure that, consistent with their fiduciary duties, the

shareholders have an adequate opportunity to appraise the offer made for

their shares and to consider any alternative or better one. Similarly,

General Principle 3 of the City Code (UK) states that:

Shareholders shall have in their possession sufficient evidence, facts

and opinions, upon which an adequate judgement and decision can bereached and shall have sufficient time to make an assessment and

decision. No relevant information shall be withheld from them.

6



Another issue that has always been raised in the context of takeover

is the degree to which directors may have regard to the interests of

shareholders as distinct from the interest of the company as a

commercial entity. The most important issue in a takeover context

which is likely to be considered by the shareholders of the target is

the value placed on the company by the bidder. Directors are well

aware of this fact and the practice has been that defensive tactics

engaged in by many companies are specifically designed to

maximise the share price for the benefit of shareholders.

7



In the US, it is worth noting how the business judgment

rule has influenced the involvement of directors in

defending the company against takeovers. Since the

nineteenth century, the American courts have recognised

the Business Judgment Doctrine/Rule. The rationale of the

doctrine is explained by Professor John H Farrar in the

following manner:

First, it is a recognition of human fallibility. Secondly, it

recognises the role of risk-taking in business decisions.

Thirdly, it keeps the court from becoming bogged down in

complex corporate decision making and second-guessing

management decisions which they are ill-equiped to do.

8



Defensive tactics

White knight When a company is the target of unwanted bid or threat of a bid from a

potential acquirer, it may seek the aid of a white knight. Ie the company can issue

a significant number of shares to a person who or a company which was

perceived as friendly. White knight may best suit a company which has a share

register without any major shareholding blocks. n28 The effect is to provide a

blocking state before another person could acquire sufficient shares to acquire

control of the company. The issue of shares also has the effect of diluting existing

shareholdings, including those of any potential bidders.

White knight is a tactic frequently adopted in the United States. It has also

been applied in Australia, the UK, and Malaysia. It is worth noting that any

company considering the use of such a tactic should be extremely careful in

proceeding with such step. Rodd Levy stated that there have been many instances

in Australian corporate history where a white knight subsequently became hostileand either sold the shares to bidder or made a takeover bid itself. n29 This

defence however has its own disadvantage. One disadvantage to this tactic is that

White knight shareholders may suffer deterioration in shareholder value.

9



Another similar tactic is White Squire defence. In the white

squire defence, however, the target company seeks to implement astrategy that will preserve the target company's independence. A

white squire is a firm that consents to purchase a large block of the

target company's stock. The stock selected often is convertible

preferred stock. The white squire is typically not interested in

acquiring control of the target. A deal may be structured so that the

shares given to the white squire may not be tendered to the hostile

bidder.

It is worth noting that in Malaysia, unless the shareholders give

consent, tactical share allotment will constitute frustration of the

offer under section 35 of the Code on Take-overs and Mergers 1998.

10



Differential voting rights

A company may adopt a voting

structure which could enable the directors

and other insiders to own a small number

of shares but have a disproportionately alarge number of votes. This will have the

effect of making it more difficult for an

outsider to acquire sufficient shares to

achieve control. The steps necessary to

implement a differential voting structure

will depend on the constitution of the

company.

11



Interlocking or circular shareholdings

It is possible for two or more companies to acquire and to

hold blocks of shares in one another. Interlocking

shareholdings may be established to rationalise a market

or to facilitate a greater degree of integration between the

companies concerned.

Shark repellants

"Shark repellant" is the expression used to describe a wide range

of devices designed to deter opposed takeovers. It is common in the

United States but less common in Australia. It is a provision in a

company's constitution designed to make it more difficult for theacquirer of a significant number of shares to take control of the

company. Shark repellants generally involve amendments to the

articles of association of company.

12



Defensive strategies

Companies may adopt defensive strategies in an attempt to avoid takeover

or at least to make takeover difficult. Here the company may adopt certainmeasures in advance of a bid so as to make the target less vulnerable. One of

the first steps in developing defensive strategies is to analyse the distribution

of share ownership of the company. A number of the more common strategies

include:

Golden parachutes

One long term defence to be considered by a company to buffer itself

against takeover attempts is to enter into service or employment agreements

with officers of the company. This contract between a company and an

executive which provides for a significant termination payment on the event

of losing their position to a successful offeror is usually referred to as golden

parachute. The word golden is used because of the lucrative compensation

that executives covered by these agreements receive. A typical golden

parachute agreement provides for lump sum payments to certain seniormanagement upon termination of their employment. The amount of

compensation is usually determined by the employee's annual compensation

and years of service.

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14



Employee stock ownership plans ('ESOPs')

Another defence where potential target may consider to thwart a takeover isthrough employee stock ownership plans which is commonly referred to as

ESOPs (in Malaysia this is commonly known as ESOS). This tactics normally

involves placing large blocks of shares in the hands of employees through an

employees' trust fund. The use of ESOPs affords a target company a strong

defence in avoiding the loss of control of the company. A target company may

try to use the ESOPs as a white squire by placing stock in the plan. It then

hopes that ESOPs shares will vote with management on major decisions suchas approving takeovers.

15



Share buy-backs

Another way to prevent a takeover is for the target to buy back its

own shares. Such share repurchases have several advantages for a

target corporations. Share repurchases can divert shares away from a

hostile bidder. Once the target has acquired certain shares, these shares

are no longer available for the bidder to purchase. The acquisition of

the target's own shares can allow the company to use up its own

resources. Further, periodic purchases by a company of its own sharesmay be desirable as a long term defensive measure. This may reduce

the existence of loose shares which could otherwise be sold into a bid,

return surplus cash to shareholders and add depth to the market for the

company's shares. If the share price is depressed, a buy back program

shall also improve the company's earnings per share and asset backing

per share figures.. Buy-back activity will also assist to ensure the

company's shares are properly valued in the market and diminish the

attractiveness of the company as a takeover target.

16



Crown jewel

A crown jewel defence is essentially an

arrangement concerning the most attractive

assets or the key assets of the company, which

in the event of a takeover bid, may lead to the

assets being sold. One way of doing it is

where the company's asset would become

subject to an arrangement which would

require the consent of a third party before the

asset could be dealt with.

The same technique may be applied in

Malaysia as long as there is shareholdersapproval. Otherwise this would amount to

frustration of takeover bid.

17



Poison pill

Poison pill which is a preventive anti-takeover measures has only been adopted

in the US. Poison pills were invented by Martin Lipton who used them in 1982 todefend El Paso Electric against General American Oil. This type of poison pill is

referred to as preferred stock plan. However, due to certain disadvantages, second-

generation poison pill was developed. The new pills did not involve the issuance

of preferred stock. The pill came in the form of rights offerings that allowed the

holders to buy stock in the firm at a low price. It is commonly known as the flip-

over poison pill. This type of pill, however, has its own drawback. They are only

effective if the bidder acquires 100% interest in the target. The third generation

poison pill is called flip-in poison pills which were an innovation designed to deal

with the problem of a bidder who was not trying to purchase 100% of the target.

The flip-in provisions allow holders of rights to acquire stocks in the target. The

flip-in rights were designed to dilute the target company regardless of whether the

bidder merge the target into his company. They can be effective in dealing with

bidders who seek to acquire a controlling influence in a target while not evenacquiring majority control. It is worth noting that in the UK poison pills have not

been prevalent, in part due to the fact that the investment community has generally

not looked favourably upon such practices.

18



Staggered Board

Another preventive measure that applies only to US is "staggered board". Itrefers to a technique where companies adopt provisions in the article providing

for a staggered board of directors. A staggered board provision comes in the form

of an amendment of the corporate charter. The ability to amend the corporate

charter is dictated by the prevailing state laws. A typical staggered board

provision provides for one-third of the board to be elected each year for a three

year term. Here, the terms of the board of directors is varied so that only a few

directors can be elected in any given year. This technique slows down the offeror

company in placing its own appointees on the board even though it may have

acquired legal control pursuant to the takeover bid. n44 When the bidder has

already bought majority control, the staggered board may prevent him from

electing managers who will pursue the bidder's goals for the corporation.

However, the effectiveness of this right is dependent upon there being no

weighted voting rights in connection with the appointment and removal of directors. This technique may not be applicable in Malaysia as entire boards can

be replaced through shareholder action.

19



Companies have the ability to implement a wide variety of

defensive tactics if they becomes the target of a takeover bid,

especially a hostile one. The tactics and strategies discussed

above are just a few examples of defences adopted by

companies in defending against takeovers. Other defensive

measures include criticism of the bidding company, appeals to

the shareholders to reject the offer on the basis of loyalty and

also lobbying or appealing to the regulators in the responsible jurisdiction.

Companies may also resort to other long term defensive

tactics. For instance, the company may bring out the valuation

of share price through improving profits. The company may

also build and improve communications and relations with

shareholders, investors and analyst. Another way of buffering

takeover offer is through response to the offer and by showing

independent adviser true worth of the company.

20



It is worth noting, however, that takeover activities in the United States

outperform the exercise of takeover elsewhere. In the UK, Australia and

Malaysia the legal position on takeover defences are clearly stated. Thelaw requires that once a bona fide offer has been made or is imminent, the

board of the target is barred from taking action which would frustrate the

bid without first receiving shareholders approval. This to some extent has

limit the ability of the target management to block unwelcomed bids.

However, it is important to note that the law is not designed to prevent

takeover exercise, whether friendly or hostile, as long as the takeover

activity creates significant wealth.

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22

Much of what is called investment is actually nothing more than mergers and

acquisitions, and of course mergers and acquisitions are generally

accompanied by downsizing.

Thanks you.

Musbri Mohamed

May 2012

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Company Law 6