Deal protection in the spotlight

Summary

• Recent scheme decisions have questioned formulaic deal protection provisions.
• In particular, restrictions on the ability of target boards to exercise fiduciary outs have been subject to scrutiny.
• These decisions provide a reminder to deal participants to apply care and thought when crafting and negotiating exclusivity and notification provisions in schemes and takeovers.

Two decisions of Justice Farrell of the Federal Court towards the end of last year have provided an interesting insight into judicial attitudes towards standard deal protection provisions.

The SKM scheme

By interconditional schemes and related transactions, Jacobs Engineering Group Inc acquired the Sinclair Knight Merz group. At the first court hearing, Justice Farrell examined the relevant provisions of the Implementation Deed. Her Honour found that the no shop, no talk, notification and matching right provisions did not have an anti-competitive effect of any material concern because of a number of factors, including that:

• the deal was agreed after the target had conducted a lengthy process of actively seeking out competing bidders, having had more than one company undertake due diligence,
• the bidder did not have a say as to the target’s legal counsel and the target did not have any obligations to share the relevant advice with the bidder,
• the target was not required to name a competing bidder as part of the notification right regime if that bidder did not agree, and
• the matching right period of 3 days was short.

The Cape Alumina scheme

By way of contrast, the deal provisions in the now defunct Cape Alumina scheme caused Justice Farrell more concern. In particular:

• target directors in that scheme could only change their recommendation if they obtained a written opinion from a Queen’s Counsel or Senior Counsel acceptable to the bidder after providing a copy of the advice to the bidder,
• the fiduciary carve out to the no talk obligation required a Queen’s Counsel or Senior Counsel’s opinion which had to be provided to the bidder before the fiduciary out would be enlivened (noting that this was a reciprocal provision),
• the notification provisions required details of the person making the approach and the details of any proposal to be provided, and
• the evidence of the target non-executive director in relation to the exclusivity arrangements was ‘highly formulaic’. That evidence noted among other things that the exclusivity arrangements were agreed after arm’s length negotiations, that legal advisers were involved, that the arrangements were a requirement of the parties and that the arrangements did not operate to the detriment of the target.

Justice Farrell commented:

‘It is concerning that exclusivity provisions appear to have become a standard feature of transactions: they add weight and complexity to documentation and cost to transactions which it is sometimes difficult to see the justification for unless it is the anti-competitive effect, which the Takeovers Panel guidance suggests is not a virtue. I do not doubt [the target non-executive director’s] sincerity. However, it is difficult to find persuasive those statements in affidavits which are in almost the same form in transactions whose circumstances vary widely.’

Her Honour went on to note that ‘directors should carefully consider whether it is consistent with their fiduciary duty to accept arrangements which so fetter their ability to exercise their fiduciary duties.’

What does this mean?

Exclusivity provisions appear to be on the judicial agenda. What is clear from both of these decisions is that each deal will depend on its own circumstances.

In terms of specifics, the decisions suggest that placing too many hurdles in the way of fiduciary outs is likely to become more difficult for the Courts. Those hurdles in the SKM scheme took the form of requirements around legal opinions. It seems fair comment that these hurdles are inconsistent with the principle of a simple fiduciary out, noting that they do not provide a bidder with any particular advantage anyway.

Beyond that point, the spate of highly contested M&A situations over the past year suggests that the balance between encouraging bidders to make the first move by providing some deal protection, while also encouraging auctions, is about right.