Takeover regimes in Europe have been under persistent scrutiny by the public, politicians, and market participants. Sometimes, that is just the nature of the game: Takeovers create winners and losers, and the latter (with the help of their champions and constituencies) often complain. But other times the discontent derives from the inadequacy of regimes in handling certain deals. The task of the law is not easy: Deals are complex and unique, while the law is general. In particular, target companies have a particular ownership structure that must fit the paradigm contemplated by the law, which in the EU consists almost entirely of bright-line rules. In a recent paper to be published in the Columbia Journal of European Law, I show that (a) the discontent is mostly attributable to the fact that the law often does not get the ownership structure and the deal right, and (b) legislatures typically try to fix past mistakes with new one-size-fits-all regimes that are overreactive, stymie the market, and create new opportunities for regulatory arbitrage.
Upsetting Deals Lead to Reforms
There is consensus that corporate and securities laws are reactive in nature. The most prominent reforms have been prompted by either scandals or systemic failures. In the U.S., the Enron debacle and similar scandals and the financial crisis were crucial for passing SOX and Dodd-Frank, respectively. European M&A law is no stranger to this dynamic, but its reform cycles are much faster. That is because M&A reforms in Europe are not necessarily scandal driven—they are deal driven. Consider the following incidents, which I present in my paper as evidence of a recurring pattern.
- Rumors of a potential acquisition of French dairy products giant Danone by PepsiCo prompted the French legislature to amend its takeover laws with a harsh provision for acquirers: At its discretion, the securities regulator may require a person who is believed to be launching a takeover bid to state if in fact s/he intends to proceed—any such statement must then be honored for six months. Also, in the aftermath of the highly contested takeover of Arcelor (a Luxembourg company with headquarters and the bulk of operations in France), the French Parliament passed a law that introduced tenure voting, abandoned the board neutrality approach (which required a shareholder vote to authorize frustrating actions against a pending bid), and added further hurdles for hostile bidders, such as a minimum tender condition of a majority of the target’s issued shares. Finally, shortly after the politically charged acquisition of Alstom’s energy operations by GE, France extended the reach of its own veto powers over takeovers affecting national strategic interests.
- In Italy, the migration of Italian automaker Fiat (reincorporated in the Netherlands and listed in London), as well as the creeping acquisition of Parmalat by its French competitor Lactalis (i) contributed to the lifting of a long-standing prohibition against multiple voting shares, (ii) lowered the mandatory bid threshold from 30 percent to 25 percent for large cap companies (anyone crossing such a threshold must make an offer for all shares at a price not lower than the highest paid in the 12-month period prior to crossing it), and (iii) resulted in what is already Italy’s third attempt at implementing the board neutrality rule—first adopted as mandatory, the rule was turned into an optional regime in 2009, and is now a default companies can opt out of. More recently, Vivendi’s creeping acquisitions of Telecom Italia and Mediaset resulted in revisions to the regulation of disclosure of significant holdings, which now requires the acquirers of 3 percent of the voting stock to reveal their goals with respect to the target for the six months after the purchase. In such occasion, the government considered, but subsequently abandoned, introducing veto powers similar to those passed in France.
- The Endesa saga in Spain showed how little a Spanish target could do to preserve its independence facing an unsolicited takeover. To rebut the hostile attempt by Gas Natural in September 2005, Endesa could only resort to seeking out a white knight, German utility E.On, but because of governmental intervention, it was ultimately acquired by a consortium comprising Italy’s energy giant Enel and Spanish infrastructure conglomerate Acciona. In 2007, when implementing the Takeover Directive, Spain loosened its board neutrality rule, introduced a reciprocity principle with respect to such a rule (but only applicable to foreign companies), and banned partial tender offers, which in the past had facilitated creeping acquisitions. Also, the controversial creeping acquisition of Iberdrola by Florentino Perez’s ACS, resulted in two Spanish governments passing in sequence two opposite measures: first, to lift the 10 percent voting cap in the target’s articles of associations and thus allow ACS to vote all its shares at the shareholder meeting (the measure was ironically dubbed the “Florentino law”); then, to abolish the Florentino law and reinstate the voting caps, amidst fears that such law, together with the board neutrality rule, was facilitating hostile takeovers, especially foreign ones, too much.
- As political retribution for the Vodafone takeover of Mannesmann (to this date, the largest M&A deal ever), Germany orchestrated the demise of a proposal of a takeover directive endorsed by the UK at the European Parliament, and passed two takeover acts, one in 2002 and the other in 2006, neither of which required shareholder authorization for takeover defenses. Also, the creeping acquisition of Hochtief by ACS raised concerns over the effectiveness of the German takeover act against lowballing practices (launching an offer at a low price from a starting point that is right below the 30 percent mandatory bid threshold). The ACS example showed that, if purchases of stakes from blockholders are timed carefully to occur outside the relevant time window for setting the tender offer price, the German regime does not ensure an equal distribution of the control premium. In the aftermath of such a deal, the Social Democratic Party made a proposal in parliament to extend, for particular cases like Hochtief, the time window that sets the offer price, but no law was ultimately enacted.
- In the UK, in early 2010, Kraft managed to grab control of Cadbury after a 19-week standoff. There was a push to review takeover rules when disappointed investors and public opinion realized that UK takeover law did almost nothing to protect a revered and iconic company like Cadbury from being taken over by a foreign buyer that was incapable of making good on certain commitments regarding the workforce. The Takeover Panel (i) introduced disclosure and monitoring rules, as well as enforcement powers, on employment-related commitments made by the bidder to non-shareholder constituencies (so-called ‘post-offer undertakings’), (ii) severely limited break-up fees, and (iii) crystalized in a bright-line rule its ‘put up or shut’ approach by fixing to a 28-day deadline the time a potential offeror has to announce either a firm intention to make an offer or that it does not intend to do so (in which case it will be prohibited for a six-month period to launch an offer on the same target). The long wave of the Cadbury deal can still be felt today. Recently, to make good on a promise by U.K. Prime Minister Theresa May to protect local workers and communities from deals like Cadbury and the attempted (but ultimately failed) acquisition of AstraZeneca by Pfizer, the U.K. government has proposed sweeping changes to its merger regulations that can result in extensive review and possible veto of inbound deals on the basis of, among other things, national security. According to commentators, the move is largely driven by protectionist intent, not national security concerns, and can lead to reviewing as many as 200 deals per year (while in the last 15 years only 10 deals were reviewed on national security grounds).
The “Reform Loop”
In my paper, I label the pattern described above as a ‘reform loop.’ Over time, M&A markets experience controversial acquisitions that upset investors, local politicians, and the public. Vodafone/Mannesmann, Olivetti/Telecom Italia, Endesa, Mittal/Arcelor, Kraft/Cadbury, and Vivendi/TIM are only the most reverberating deals in a much larger group of transactions that took place in Europe in the last 20 years or so. The EU Takeover Directive itself is the product of such a pattern. According to some accounts, talks of a harmonized takeover regime were a partial consequence of the attempted cross-border hostile takeover of Société Générale de Belgique by Italian entrepreneur Carlo De Benedetti in the late 1980s.
Generally, inadequate price, concern for the fate of employees, and the foreign identity of the acquirer are recurring features that raise criticism. As a result, public outcry ensues, often demanding changes to the existing rules to address the very issues that made the acquisition so controversial. New rules get promulgated, but they are either overkill (eg, introducing tenure voting or giving the government open-ended veto power over foreign investment) or insufficient because soon enough a new deal emerges to reveal a different, ‘new’ issue overlooked by the reform itself (Italy’s reform to lower the MBR threshold and chill creeping acquisitions did absolutely nothing to block Vivendi from getting de facto control of TIM, even if just temporarily, and negative control of Mediaset). Because of the inadequacy of the legal framework, in some instances national governments intervene to block a deal or to favor one contender over the other, thus adding a layer of uncertainty for any future deals. The Endesa saga, in which the Spanish government opposed E.On’s intervention as white knight, is a case in point.
The Case for Adaptability
In my paper, I advance a thesis and a proposal. First, with few exceptions, policymakers have failed to grasp that M&A dealmaking is a product of the underlying ownership structure of the company. The reason why so often the legal and regulatory framework is incapable of addressing the issues of the particular deal is because the deal is unique, because the given target and its very ownership structures are unique. This feature is not news to M&A practitioners; after all, they pride themselves on working on transactions that are always different. But it is one thing to tweak an acquisition agreement among private parties to fine-tune it to their interests and needs, and another to have a legal and regulatory framework that fits all potential deals. Hence, the proposal is that policymakers throughout Europe should consider an approach that has thus far been either overlooked or not fully explored: adaptability. The regime itself should be able to adapt to the specific features of the target (its ownership structure in particular) and of the deal itself, via a mix of private ordering and ex-post adjudication standards.
Without adaptability, there is no easy way out of the reform loop. In fact, the upsets in European M&A have continued to occur because, under the current M&A regime, the law that a company is subject to is seldom adaptable to its ever-changing ownership structure (structure-adaptation) or to the specifics of the deal (deal-adaptation). For instance, the rigid nature of the mandatory bid rule (MBR) and its triggering thresholds might not be able to capture situations in which a company is controlled below the specified thresholds—in such a scenario, the MBR does not fit, and the company cannot adapt the rules of the game to its peculiar ownership structure. On the other hand, deals that seek to exploit investors with low-ball offers might find directors unable (because of various restrictions to defenses) or unwilling (because of collusion with the offeror) to bargain effectively on behalf of their shareholders. Here, the rules of the game, for one reason (lack of defenses) or another (unfettered discretion for directors to agree to friendly deals with little or no judicial review), cannot be adapted to counter a low-value deal. Put another way, investors keep getting new bright-line rules whose rigid nature is structurally incapable of fulfilling what investors need, which is responses tailored to the very deal—something that an adaptable environment would instead allow.
How do we achieve adaptability? Here comes the difficult part. The two main avenues to reach such a goal, private ordering and judicial standards, contemplate some discretion for a decision-maker in order to take context into account. Private ordering strategies empower companies to tailor the framework that is most suitable to them in light of the underlying circumstances (present and foreseeable). Alternatively, or in addition, another approach is to adopt standards that grant discretion to an adjudicator, who can craft the adequate framework in light of the facts and circumstances of the specific case, including the underlying ownership structure of the company and the economics of the deal on the table.
To some extent, the EU takeover system has tolerated timid steps toward freedom of contract in setting the rules of the game. When member states opt out of the board neutrality rule, local companies have the ability to opt back into it with their bylaws (though none do). In a way, the UK system also relies on the latter approach, given the open-ended nature of its takeover regime, as well as the ample discretion awarded to the Takeover Panel in administering and enforcing the Code.
Note that outside the EU, the Delaware system relies on a combination of both of these policy options. On the one hand, thanks to the availability of the poison pill, companies can rely on an adaptive device to fend off acquisitions they believe are not in the best interests of their shareholders (but shareholders can overrule them via a proxy fight, in the absence of which the pill pretty much represents an absolute obstacle to a subpar deal). On the other hand, the most important aspects of Delaware M&A law are shaped by different standards of review, which are triggered by events and circumstances where the actual ownership structure of the target plays a crucial role.
My paper sits within the growing body of literature emphasizing the importance of ownership structures in corporate governance and, especially, M&A. My specific contribution is to draw attention to how legal or regulatory obstacles to structure-adaptability and to deal-adaptability can leave many problems currently faced by European companies and its shareholders unresolved, and lead to a potentially never-ending series of misguided catch-up reforms that present new problems without satisfactorily taking care of the old ones.
Matteo Gatti is Professor of Law at Rutgers Law School. This post is based on his recent paper, “Upsetting Deals and Reform Loop: Can Companies and M&A Law in Europe Adapt to the Market for Corporate Control?,” forthcoming Columbia Journal of European Law (2018) and available here. This post first appeared here.