This article was written by Lee Horan, Anthony Boogert, Alex Morris and Armen Varvachtian.
A common question circling amongst targets and the wider business community is exactly what are the short, medium- and long-term impacts of COVID-19? The reality is that, at this point in time, these are matters difficult to predict. So where does this leave bidders in public control transactions?
The short answer is that bidders may be particularly exposed, as the implications of government enforced shutdowns, a rapidly changing regulatory environment, an unprecedented level of fiscal stimulus and extreme volatility in global credit and financial markets are challenging to assess and will not have been factored into the proposed pricing and terms.
Whilst for many targets, there are likely to be very material adverse short-term impacts (arising from an inhospitable trading environment, demand and supply chain pressures, and a workforce and potential customers confined to their homes), bidders are rightly questioning whether medium and long-term value is being destroyed and, in turn, whether they can pull out of existing deals. This article outlines key statutory and contractual rights that bidders need to be aware of, in the event they may need to walk away.
Statutory rights to withdraw
Firstly, if a takeover bid has been announced but offers have not yet been despatched, a bidder may be able to rely on section 670F of the Corporations Act to refrain from making offers in light of a 'change in circumstances.
A bidder is not required to continue with making a takeover offer within 2 months of first proposing it where the bidder could not reasonably be expected to comply with that requirement. Section 670F provides this will occur if there is a change in circumstances either unknown to the bidder at the time, they proposed their bid (or which the bidder could not reasonably have been expected to know) or occurring after that time (provided it was not directly or indirectly caused by the bidder).
If parties are contemplating relying on section 670F, they should consider with precision how to define the 'change in circumstances' they propose as the factual basis for doing so. For example, an action or occurrence outside the control of the bidder that has resulted in a condition not being met would likely constitute such a change that would enliven the defence, whereas a change in commercial circumstances or a downturn in general economic conditions is unlikely in itself to constitute a change in circumstance unless the target is directly affected (such as a government enforced shutdown).
Contractual right to terminate
For takeover offers that have been despatched, a bidder may be entitled to terminate those offers due to the failure of a condition to their bid. Common conditions that are likely to be relevant in the current context are:
- Foreign investment review board (FIRB) approval – the Treasurer has announced monetary screening thresholds have been reduced to $0, and screening times have been increased from 30 days to up to 6 months. For some bidders, the delay in processing applications may give rise to a potential walkaway right, provided they continue to comply with any best endeavours obligation to obtain FIRB approval (which is typical);
- No debt refinancing – some targets are seeking to negotiate with their banks to strengthen their financial position in the face of short-term disruptions. In Starwood Capital's bid for Australian Unity Office Fund (ASX:AOF), AOF announced it had breached such a condition which Starwood sought to then rely on to withdraw its bid;
- No equity issues – some businesses are implementing emergency capital raisings to shore up their balance sheet and ensure short- and medium-term liquidity, which will typically breach the prescribed occurrences condition for issuing share capital;
- No breach or material default – breaches of material leases, contracts or financing may also give rise to termination triggers to the extent the breach is material; and
- No material adverse change (MAC) – depending on how the MAC condition is drafted, bidders may be able to rely on a material reduction in assets, profitability or prospects of the target to withdraw – see below. For example, on 30 March 2020, Abano Healthcare Group (NZX:ABA) announced that its scheme implementation agreement with BGH had been terminated due to a MAC resulting from the closure of its dental practices in Australia and New Zealand.
MAC Conditions
In public control transactions, general MAC conditions have historically been difficult to enforce when broadly drafted, such as in the following terms:
"a material adverse effect on the assets and liabilities, financial position and performance, profits and losses or prospects of Target".
Courts have been reluctant to make findings that a deterioration of a target's business between signing and completion of a transaction justifies the bidder costlessly cancelling the transaction in reliance on a general MAC condition.
In Australia, it is becoming more common for MAC conditions to include objective triggers to assist the party seeking to rely on them. An example of these objective triggers is as follows:
"a specified event occurs that, whether individually or when aggregated with all such specified events, will or is reasonably likely to have a diminution in value of the consolidated net tangible assets of the target group by [a fixed amount] or EBITDA of the target group by [a fixed amount] against what they would reasonably have been expected to be but for the specified event".
Whilst an objective trigger may assist a bidder's own internal determination that a MAC condition has been triggered, ultimately this is a question of fact and not a subjective inquiry. The onus of proof is on the party seeking to rely upon the triggering of the MAC condition. Accordingly, much will depend on how the MAC condition is drafted and whether bidder has the necessary evidence to prove it has been triggered.
Terminating for failure of the MAC condition may leave a bidder with potential exposure for damages if the MAC is successfully challenged through the Takeovers Panel or the Courts by the target or shareholders.
What is the specified event?
As a preliminary step, bidders must determine the relevant COVID-19 'event'. Typically, events occurring, or disclosed to the relevant stock exchange, before announcement of the transaction, cannot be relied upon. Depending on relevant exclusions, post-announcement events that might permit reliance on a MAC condition include the World Health Organisation's announcement characterising COVID-19 as a pandemic, or a Federal or State Government enforcing shutdown or country specific travel restrictions. In all cases, the question should be considered carefully and with close reference to the contractual framework.
Care should be taken when considering MAC triggers, to ensure that the event isn't expressly excluded, which is often the case for changes in general economic or political conditions (including changes in foreign exchange rates, interest rates or commodity prices). Indeed, sometimes, pandemics are specifically excluded from the operation of MAC triggers.
What is the result or likely result of the specified event on the Target?
As mentioned, a bidder seeking to rely on the MAC condition must be able to establish the fact of a specified event having occurred, which has resulted in the relevant MAC trigger being met. In practice this could prove difficult as the bidder may not have access to all relevant information (such as internal information of a target) to be able to demonstrate conclusively the impact of the specified event on the target. The target will generally be in a better position to make this determination. In friendly deals, bidders should seek to exercise all relevant contractual information rights to reduce any information asymmetry.
Hostile bidders are particularly exposed as they are largely restricted to relying on public information. Whilst circumstantial evidence such as a dramatic fall in the target's share price or equity markets might indicate the market's perception that a target's prospects have diminished, this is unlikely to be sufficiently probative evidence for a Court to draw an inference that, as a result, a reduction in a particular target's net asset value or EBITDA has necessarily occurred or that there has been a material adverse change to the prospects of that particular business. It is particularly difficult for hostile bidders to draw this conclusion when targets can rightly point to their continuous disclosure obligations and say that if a MAC had occurred, they would have been obliged to update ASX accordingly.
What objective evidence can be gathered to prove a MAC has occurred?
Bidders seeking to terminate for failure of the MAC condition, should only do so if they are in a position to demonstrate the facts underlying that failure by admissible evidence. Otherwise, they potentially face significant exposure to damages claims from the target or its shareholders, who may have a commercial incentive in the current economic environment to seek to challenge the bidder's decision.
Whilst targets are required to update the market if a condition to a bid (or scheme proposal) is not capable of being met, there is no requirement to provide a bidder all relevant information if the target has formed the view that a MAC has not been triggered. Accordingly, hostile bidders have no general right to compel the target to provide relevant information for that assessment by the bidder to occur.
In the absence of any rights to obtain information from a target (for example, under existing contractual frameworks such as an implementation agreement), a bidder should consider engaging one or more independent experts to opine on whether a MAC has occurred.
An expert's brief should be drawn carefully in a way that is closely linked to the terms of the MAC condition. For example, if that condition is triggered by changes in the net tangible assets or EBITDA of the target, then the expert should be briefed to opine on those particular aspects of the target's position rather than being asked to prepare a report on general matters concerning the target that, strictly, fall outside the scope of the contractual framework. To the extent possible within the constraints imposed by information asymmetry, a bidder should brief an expert with objective facts relating to those aspects of the target's position.
Another approach is for the expert to undertake his or her own fact-finding, which could extend from sourcing market data on available platforms to the expert briefing, say, a property valuer to value particular real estate assets of the target, with that valuation then being used by the expert to form holistic views about the questions in their brief. In most cases, a combination of these approaches is likely to be adopted.
A bidder must be careful when appointing experts for potential court proceedings, to ensure that they have the necessary specialised knowledge, based on their training, study or experience, to render the opinions they express admissible as a matter of evidence law. It is also important that an expert's independence be maintained and that they comply with relevant expert codes of conduct.
Analysis prepared by a bidder's own financial advisers is unlikely to admissible or probative in proceedings due to the inherent conflicts of interest involved. That said, it should be borne in mind that the facts on which an expert relies in order to express an opinion will themselves need to be proved by admissible lay evidence (whether by way of documentary tender or witness testimony) if reliance on a MAC condition is ultimately challenged – and, in that scenario, a bidder's own advisers or management could be afforded the chance to have their (limited) day in court.
With this in mind, the decision to terminate a transaction for failure of the MAC condition should not be taken lightly and only after sufficient admissable evidence has been gathered to support the decision.
