Takeover Panel consults on Rule 21
The Code Committee of the Panel on Takeovers and Mergers (the "Takeover Panel") has published a consultation paper (PCP 2023/1) (the "Consultation Paper") setting out proposals to amend Rule 21 (Restrictions on frustrating action) of the City Code on Takeovers and Mergers (the "Takeover Code"), with the aim of easing certain of the restrictions on actions which offeree companies can take during the course of an offer.
The proposed amendments mean that, in general, offeree companies would be able to take actions without shareholder approval, provided that such action is either not material or is in the ordinary course of the company's activities. Amendments to the Notes on Rule 21.1 will seek to provide additional guidance and clarity on the actions that will and will not be restricted and the circumstances in which the Executive will normally consider that a proposed action either is not material or is in the ordinary course.
This is the first time that the Code Committee has undertaken a specific review of this Rule, which has otherwise been largely unchanged since the Takeover Code was established. If adopted, the proposed changes will be incorporated into Rule 21.1, the related Notes on Rule 21.1 and a new Practice Statement 34 that will set out the Takeover Panel's updated guidance on how the Executive will interpret and apply Rule 21.1.
The Code Committee has also proposed amendments to Rules 21.3 (Equality of information to competing offerors) and 21.4 (Information to independent directors in management buy-outs). No amendments are proposed to Rule 21.2 (Offer-related arrangements), which the Code Committee considers is operating satisfactorily.
Greater flexibility for offeree companies
General Principle 3 of the Takeover Code states that the board of directors of an offeree company must not deny shareholders the opportunity to decide on the merits of a takeover bid. Rule 21.1 codifies this, stating that during the course of an offer (including during any period where the board believes an offer may be imminent), the offeree board must not take any action which could result in an offer, or bona fide possible offer, being frustrated, or which could result in shareholders being denied the opportunity to decide on its merits. Rule 21.1 lists specific actions that should not be taken without shareholder approval, including issuing shares, granting options and disposing of/acquiring material assets.
In the Consultation Paper, the Code Committee acknowledges that in some cases the application of the specific restrictions set out in Rules 21(a)(i) to (v) can result in preventing an offeree company from taking actions that are in the ordinary course of being a company but which may not be considered to be in the ordinary course of its day-to-day business, for example a debt refinancing or entering into a new office lease. This can be particularly problematic for offeree companies in the business of buying and selling assets, for example infrastructure investment companies, which are restricted from undertaking disposals and acquisitions of a material amount under existing Rule 21.1(a)(iv).
In determining whether a proposed action is restricted by Rule 21.1 or to grant the offeree company a dispensation from Rule 21.1, the Executive usually asks the offeree company to inform each offeror or potential offeror of its intention to take the proposed action at least 24 hours beforehand. However, the Executive has recognised that this approach can affect the commercial relationship between the parties to an offer, requiring the offeree board to provide commercially sensitive information to the offeror it may not have otherwise chosen to disclose, and perhaps creating perceived leverage for one party over another.
The Consultation Paper is clear that the Takeover Code should not interfere in the commercial dynamics between the parties to an offer unless there is a strong reason to do so and the Code Committee recognises that greater clarity on the actions that offeree companies are permitted to take during an offer would be very valuable. Although offeree companies would still be required to consult the Executive to determine whether a proposed action is restricted, the effect of the proposed clarifications and guidance set out in the Consultation Paper should make it less likely that an offeror or potential offer would need to be consulted before the Executive can make its determination.
Amendments to Rule 21.1
The proposals introduce a clearly defined time period during which Rule 21.1 restrictions would apply, starting with the earlier of (a) the offeree board receiving an approach, and (b) the beginning of the offer period, and running until (x) the end of the offer period, or (y) 5.00 p.m. on the seventh day following the date on which the last approach was rejected by the offeree board.
This "relevant period" would apply in respect of each potential offeror, meaning that an offeree company with more than one potential offeror would be subject to different relevant periods in respect of each of them. In the context of a target-run sale process, Rule 21.1 would not apply until the offeree company received at least one indicative proposal.
During a relevant period amended Rule 21.1 would restrict an offeree board from taking or agreeing to take any "restricted action", being:
- issuing, transferring out of treasury, redeeming or buying back shares or convertible securities, or granting options or awards over shares, other than in the ordinary course of business;
- disposing or acquiring assets of a material amount, other than in the ordinary course of business; and
- entering into, amending or terminating material contracts, other than in the ordinary course of business.
In most cases, the proposed amendments to Rule 21.1 should not restrict an action that is not material and actions that are material should not be restricted where they are undertaken in the ordinary course of business.
Actions affecting share capital
The Code Committee considers it unlikely that issuing new shares would be in the ordinary course of any offeree company's business and, in light of the consequences associated with actions affecting the share capital of an offeree company, for example the impact on an offeror's financing arrangements and possible tactical issues of shares to achieve a particular outcome, a stricter approach is proposed in relation to such action.
No materiality threshold will apply in relation to the issue of new shares; an issue of any number of shares will be restricted under Rule 21.1 unless it is in the ordinary course of the offeree company's business.
During an offer it is not unusual for an offeree company operating a share incentive scheme to seek to grant options over, or awards in respect of, shares to its employees in accordance with such a scheme. The Notes on Rule 21.1 will be amended to reflect that the Executive will normally consider the proposed grant of options over, or awards in respect of, shares to be in the ordinary course of the offeree company's business if the timing and level are in accordance with (i) the offeree company's normal practice under an established share incentive scheme; or (ii) the offeree company's proposed practice under a new share incentive scheme, provided that the proposed practice was publicly disclosed before the relevant period (for example in an IPO prospectus, shareholder circular or annual report). The amended Notes will also clarify that the Executive will consider the issue of new shares or the transfer of shares from treasury to satisfy the exercise of options or the vesting of awards under a share incentive scheme to be in the ordinary course of the offeree company's business.
In relation to share buyback programmes, a new Note 2 on Rule 21.1 will provide that a redemption or purchase of an offeree company's own shares in line with defined limits announced or established before the relevant period will normally be in the ordinary course of the offeree company’s business.
Disposals and acquisitions
The Code Committee recognises that the restrictions in existing Rule 21.1 can operate to hinder the ability of an offeree company to carry on its normal activities during an offer, which is contrary to the intended purpose of avoiding any frustration of an offer. Particularly for offeree companies such as infrastructure investment companies and real estate investment trusts (REITs).
The proposed amendment to Rule 21.1 means that disposing of or acquiring (in one or more transactions) assets of a material amount, other than in the ordinary course of the offeree company's business, would be a restricted action.
A new Note on Rule 21.1 will provide that the Executive may have regard to other indicators of materiality that it considers appropriate when determining whether a disposal or acquisition is material, for example in the context of the relevant industry or in order to take into account the particular circumstances of the offeree company. These other indicators could be considered either as well as or as an alternative to the financial tests set out in the current Note 2(a) on Rule 21.1.
Existing Note 2(d) on Rule 21.1 provides that if several transactions relevant to Rule 21.1, but not individually material, occur or are intended, the Executive will aggregate such transactions to determine whether Rule 21.1 should apply to any of them. If the proposed amendments in the Consultation Paper are adopted, only disposals and/or acquisitions that are outside the ordinary course of an offeree company's business will be required to be aggregated when determining whether such disposals and acquisitions are, in aggregate, of assets of a material amount.
According to draft new Practice Statement No 34 the Executive will assess whether a contract is a material contract mainly by reference to its financial size in comparison to other contracts entered into by the offeree company.
However, the Executive will apply a low threshold for determining materiality and so does not expect the amendments to Rule 21.1 in relation to entering into, amending or terminating a material contract to make a significant difference to the proposed contracts in respect of which offeree boards currently consult the Executive.
The Executive will assess whether a material contract is in the ordinary course of an offeree company’s business by reference to all the relevant circumstances, including:
- the frequency with which the offeree company has entered into similar contracts;
- the size of the contract in comparison to similar contracts entered into by the offeree company;
- whether the contract is of particular importance to the offeree company’s business;
- the terms of the contract and whether any non-market terms are onerous on the offeree company; and
- if relevant, the costs associated with terminating or amending the contract.
Additional factors, which are set out in draft new Practice Statement 34, will be taken into consideration by the Executive when they are considering certain types of contracts, including contracts in relation to capital expenditure, refinancing or raising new debt, property leases and settlement agreements.
Application to reverse takeovers
A new note to the amended Rule 21.1 will apply the restrictions in Rule 21.1 to the actions of the offeror in the case of a reverse takeover, as if the offeror were the target. This would provide the (larger) target with some comfort that there would be no diminution of value of the smaller (bidder) during the offer period, without the need for further contractual protections which would otherwise be prohibited.
The Committee's proposals also include amendments to Rule 21.3 and 21.4, which are intended to reduce the administrative burden associated with requests for information under these Rules.
Rule 21.3 - Equality of information to competing offerors
Competing bidders will no longer be required to make specific information requests in order to obtain all information that has been shared by the offeree company with other potential offerors or offerors. The proposed amendments remove the prohibition on requesting information in general terms and mean that all information provided to one party would, on request, be required to be provided in full to a competing bidder, with such request being deemed to remain open for a period of seven days.
Rule 21.4 - Information to independent directors in management buy-outs
Similarly, in a management buy-out or similar transaction, the independent directors of the offeree company or its advisers must be provided promptly on request with all information which the offeror or potential offeror has been, or is subsequently, provided to external providers or potential providers of finance.
Additional guidance welcome
In the course of acting for offeree companies, we have first-hand experience of the operation of Rule 21.1(a) to some degree hindering the ability of the company to carry on its ordinary course activities, for example raising questions over whether a real estate investment trust (REIT) can sell a property, which is an inherent part of its day-to-day business – and the Consultation Paper also touches on this.
The operation of Rule 21.1 in this way is contrary to its overarching intention and we expect that offeree companies and advisers alike will welcome the additional flexibility and guidance the proposed amendments provide.
The consultation closes on 21 July 2023 and a Response Statement is expected to be published in Autumn 2023, with the amendments to the Takeover Code coming into effect approximately one month thereafter.
In the meantime, if you have any questions about the proposals set out in the Consultation Paper, please feel free to get in touch with a member of our team: SHCapitalMarkets@shlegal.com.