The Takeovers Panel has effectively closed the gate on hard exclusivity in pre-bid agreements given to non-distressed enterprises. In applying re Ausnet to the fact situation in re Virtus, The Panel reasoned that without fiduciary carve-outs enabling Boards to engage with unsolicited bidders presenting potentially superior bids, coupled with the length of the exclusivity period and the lack of a genuine auction process, such lock-ups were likely to be anti-competitive and hence to constitute unacceptable circumstances.
The hard exclusivity in re Virtus
In re Virtus the Target granted CapVest Partners LLP one month hard exclusivity under a publicly announced Process Deed during the non-binding offer stage. This is not an uncommon approach during the pre-bid phase (although often kept confidential). It provides the preferred bidder comfort of exclusivity in order to spend the time and resources on exhaustive due diligence. Given the importance of due diligence these days, particularly ESG due diligence, one would be hard pressed to find a bidder who would proceed in detail without some form of exclusivity ahead of execution of transaction documents.
The Panel remedied the situation in re Virtus by requiring fiduciary outs to be included within "no-talk" and "no-due diligence" provisions of the exclusivity agreement between the Target and the existing bidder ("stalking horse"). The Panel refused to require the Target to engage with actual or potential bidders. The remedy was consistent with Panel Guidance on lock-up arrangements, consistent also with the approach taken in re GBST Holdings Ltd. Put another way, the Panel sees it as being for the Target Board to form views around market testing, whether to offer disparate treatment between bidders (for example, exclusivity), to determine what constitutes a superior or inferior bid and to decide whether and the extent of engagement with unsolicited bids. Directors make those decisions having regard to fiduciary and good-faith dealing and no-conflict rules.
Australia does not have an auction rule
This differs from the Revlon mode approach of the USA – there, once directors form a view that a company is in play, they assume positive obligations to facilitate best price offers from the market. Not always, but most times, this requires some form of auction process, generally with some form of approved due diligence/data room accommodated process.
On occasion when the Board decides to enable limited bidding with structured exclusivity instruments, directors must establish that the nature and extent of exclusivity benefits to those parties was proportional to the benefit likely to flow to the company and its shareholders (Unocal). In other words, that exclusivity would drive the highest possible valuation for the company. This is usually measurable in a post-bid phase, less easily so when the parties are in a pre-bid non-guaranteed transaction phase.
The distressed enterprise, debt, and the white knight on his stalking horse
All of this exacerbates when the enterprise is distressed, particularly when the distress is so acute that value breaks inside senior debt. Once a company is known to be distressed, value can easily crash – contractors walk off sites, suppliers withhold goods, contracting parties try to negotiate new arrangements, labour seek out other opportunities, competitors pounce on customers etc. Ipso facto reform cannot protect the company during this pre-restructuring stage. Confidentiality of a proposal (even without exclusivity) becomes more even more important for targets and bidders.
Acceleration of debt is relatively common when principal payable under long-term financing instruments accelerates on occurrence of covenant breach. In uncertain earnings markets (debt service coverage ratios), deflating asset cycles (net tangible ratios), revenue constrained conditions (litigation or regulatory covenants) and other conditions, covenant breach becomes more real. To take as an example, the 2020 COVID-led collapse in demand for oil and gas led to negative Brent-crude values. Strictly, a number of otherwise strong producers faced unexpected covenant defaults. If these had all been called, as they might have been by senior lenders, a number of these producers would have been at risk of having to repay five years' worth of principal almost immediately.
In those circumstances, a white knight or, as a better descriptor, a stalking horse bidder may be reluctant to invest time, energy and cost into a potential financing repair of the balance sheet without some form of exclusivity (or at the very least – strict confidentiality). What's more, the Target would have little interest in putting the company in play when the adverse publicity event would potentially see value run in the manner outlined above. Doing so delivers the stalking horse too much leverage, too many opportunities to "time-out" negotiations and too many strategies to gain de-facto control or to influence board, shareholder and management decisions while the Target moves further into zones of insolvency or distress. Further, given the "target" generally initiates rather than receives unsolicited bids during a distressed process, and boards will generally be assessing a number of alternate options in distressed conditions, there may not be any market information capable of disclosure until the stalking horse signals an intention to commit to a bid or financing structure. So, it is less likely a distressed Target would publicly announce a strategic process than might a non-distressed entity.
The restrictions available for pre-bid exclusivity
Conceptually, it seems non-contentious that no shop, matching right and limited form of information/competing-bidder rights can be considered by a Board without fiduciary carve-outs. That is, that the Target cannot actively seek out other bidders and, on receipt of competing proposals, will disclose at least the broad nature of the competing bid sufficient for the stalking horse, or original white knight bidder, to match. Takeovers Panel, and Court, guidance suggests that limited break fees within the exclusivity instruments may also be supportable, even though these effectively cause pricing inflations to the competing bidder based on the value of the break fee.
The more interesting aspect of the exclusivity suite lies in whether no-talk and no due diligence restrictions, especially when temporally longer termed than market expectations, should also be included in a pre-bid exclusivity instrument when dealing with distressed companies.
The answer is to some extent given in re Virtus #2 – according to the Panel's announcement on 2 March 2022, it had declined an application to force the Target Board to provide due diligence and/or to engage with the competing bidder on the basis of a Target announcement to the effect that the Board had considered a revised offer from the stalking horse bidder and saw no need to engage further with other bidders. In other words, the Board, without having to enter into a Revlon mode auction process had exercised business judgments to proceed with its existing bidder negotiations (an approach which Unocal does leave open in the USA). Of course, when dealing with a single bid when the company is very much in play, the Board would need to have available a compelling body of evidence to establish the horse it backs is likely to result in the best possible deal for the company and its shareholders.
This is where time and certainty considerations play on a distressed situation – looming default, acceleration and controllership risks will be balanced by the Board against the nearing certainty of value, commitment and terms that are being developed during the pre-bid stage with the stalking horse. It is for the Board, on the whole, to determine how best to discharge fiduciary duties. Only the properly informed Board can really determine how the balancing of situations is likely to play out. No-talk provisions remain troubling, especially pre-bid, because they restrict the Board make an informed choice as to other options in the market. However a no-talk, of itself, may be the lesser of two evils when a Board faces equity extinction on the one part and Panel risk on the other.
The risk is that the Panel will made an order for structural changes to be made to the exclusivity arrangements, by incorporation of fiduciary outs. If the Target has tried its best without success to negotiate in such a term and the distress event looms large such that other market testing is less likely to yield stalking horse bidders willing to consider bidding for the company without hard exclusivity, then the Target board will need to make a call between default and wipe out of shareholder value or engaging with a bidder on the basis of a potentially flawed exclusivity during the pre-bid stage. If the Panel then changes the exclusivity arrangements, so be it. At least the Target board will have considered company interests first.
If the Bidder then walks because the Panel seeks to force a change of exclusivity conditions through a declaration of unacceptable circumstances, secured creditors can then appoint controllers to take control of the Target. Those controllers must, of course, test the market for value. Which forces on the Revlon style auction that Australian law does not require.
These are matters a future Panel may need to consider when deciding if distressed conditions merit a different approach or outcome than suggested in re Virtus.