15 November 2019
The recent Australian Takeovers Panel decision in Pacific Energy Limited is a clear win for target shareholders in the short term, but may ultimately end up harming the Australian market for corporate control by increasing the level of uncertainty faced by initial bidders when looking to put forward change of control proposals.
Consistent with previous decisions where lock-up devices did not stop an auction from unfolding, the Panel found that paying a break fee to a rival proponent (even where it may breach the contractual terms of an existing agreed deal) was not anti-competitive or coercive, but rather necessary to facilitate target shareholders receiving a better offer.
But rubbing salt into the wound, it left the successful bidder in a situation where it ended up paying more, for less.
Not only did the successful bidder have to agree to pay more to acquire the target company to exercise its matching rights, the assets of the target company were reduced by the amount of break fee paid to receive the rival proposal – the very proposal that ultimately resulted in the successful bidder having to pay more for the target!
The case raises interesting public policy issues concerning who should bear the costs of facilitating an auction for corporate control.
Pacific Energy entered into a scheme implementation deed (QIC SID) with Queensland Investment Corporation (QIC) whereby QIC agreed to acquire Pacific Energy for $0.975 cash per share via a court approved scheme of arrangement (Original QIC Proposal). The Board of Pacific Energy unanimously recommended the Original QIC Proposal to its shareholders and Pacific Energy undertook to proceed to seek to implement that transaction.
Consistent with market practice, the full terms of the QIC SID were released to the ASX. The QIC SID contained customary exclusivity provisions for an agreed transaction, provided for certain notification and matching rights in favour of QIC, and required a break fee to be paid by Pacific Energy in certain circumstances.
Subsequent to the Original QIC Proposal being announced, Pacific Energy was approached by a consortium comprised of OP Trust and Infrastructure Capital Group (APC) regarding a potential competing transaction to the Original QIC Proposal.
Those communications culminated in Pacific Energy receiving a competing proposal from APC to acquire Pacific Energy for $1.085 cash per share (an 11% premium to the Original QIC Proposal) by way of a scheme of arrangement (APC Proposal).
The APC proposal contained a proposal deed (APC Proposal Deed) and a suite of scheme documents including a scheme implementation deed (APC SID), which had been executed by APC and were to be held in escrow pending execution by Pacific Energy of the APC Proposal Deed by 8.00am the next day. Upon its execution, the APC Proposal Deed required Pacific Energy to pay a break fee to APC of $2.5 million if Pacific Energy did not ultimately execute the APC SID within seven days (APC Break Fee).
Pacific Energy subsequently announced it had received a competing proposal from APC and commenced the matching right process under the QIC SID. Pacific Energy also disclosed it had entered into the APC Proposal Deed requiring it to pay the APC Break Fee in the event that it did not ultimately execute the APC SID within the required timeframe. Whilst its announcement summarised the key terms of the APC Proposal, the draft APC SID and APC Proposal Deed were not released to the ASX.
QIC subsequently exercised its matching rights and revised its proposal (Revised QIC Proposal) to effectively match the APC Proposal by increasing the amount payable per share to $1.085. The Pacific Energy Board subsequently recommended that revised proposal to shareholders.
As a result of the exercise of those matching rights, Pacific Energy did not execute the APC SID within the required timeframe and the APC Break Fee was triggered in accordance with its terms.
QIC brought an application in the Takeovers Panel seeking to prevent the payment of the APC Break Fee, alleging that:
QIC argued that APC was fully aware of the QIC SID yet knowingly structured its proposal so as to require the APC Proposal Deed to be entered into, in breach of the QIC SID.
QIC focused on the effect of the breaches of the QIC SID on the auction for control of Pacific Energy and asserted that there would be a significant adverse effect on the market for corporate control if a potential bidder could not rely on matching rights and other fundamental protections that had been agreed with the target company, as a precursor to proceeding with the Original QIC Proposal.
QIC argued that the Panel should prevent conduct that has a dampening effect on a bidder’s willingness to put forward scheme proposals.
APC countered this argument by submitting that the concern around the dampening effect applies equally to a counter bidder’s willingness to put forward superior competing proposals. APC further submitted that the principles in section 602 of the Corporations Act were weighed towards contestability.
The Takeovers Panel weighed up the ability of lock-up devices to secure and deter superior proposals.
In each case, this will require the potential benefits to target shareholders of the proposed arrangements to be considered, including why the target board were satisfied of the commercial and competitive benefits of entering into the proposed arrangements.
In this instance, the Panel found that the APC Break Fee was not anti-competitive or coercive; without agreeing to it, Pacific Energy would not have been provided with a binding proposal that exceeded QIC’s initial offer price.
The Panel found that the way the QIC SID was drafted forced Pacific Energy to have to accept the APC Break Fee in order to secure a better deal for its shareholders. The actions of Pacific Energy in entering into the APC Proposal Deed were found not to have inhibited the acquisition of control from taking place in an efficient, competitive and informed market and did not have the effect of denying shareholders an opportunity to participate in the benefits of a superior proposal.
The Panel noted that Pacific Energy had taken advice from its legal advisers, Senior Counsel and financial advisers and was not prepared to second-guess the decision of the Pacific Energy Board on these matters.
In relation to matching rights, the Panel was unequivocal in finding that nothing gives a bidder’s matching right any special place in the market for control beyond its contractual terms. A bidder can decide not to match a competing proposal or seek to terminate its agreement if there is a breach of the agreement by the target and claim its break fee. The Panel was clearly unwilling to step in to assist a party with a claim for breach of contract.
The Panel was also not persuaded by the argument that the APC Proposal was designed to frustrate QIC’s matching right because, if QIC exercised its matching right, it would acquire Pacific Energy with reduced assets (given the APC Break Fee).
The Panel found that the APC Break Fee was not borne by Pacific Energy shareholders and that the target shareholders were not otherwise harmed by the APC Proposal. Rather, the APC Proposal increased the value those shareholders would receive. The manner in which Pacific Energy engaged with APC allowed it to preserve the substance of QIC’s matching right, without losing the superior proposal.
As a result, the Takeovers Panel declined to interfere with the proposed payment of the APC Break Fee.
It is hard to not have some sympathy for the situation QIC found itself in.
This was quite different to where an unsolicited proposal is announced and a target company enters into lock-up arrangements with a rival proponent in order to solicit a superior proposal for its shareholders. In those circumstances, the initial bidder has lost nothing as they were prepared to go ‘naked’ with their initial proposal.
It also raises the question as to whether the Panel has swung too far in supporting outcomes that only serve to encourage the ’free-rider‘ problem whereby second bidders can free-ride on the efforts of an initial bidder.
An environment which supports the ability of a target company to breach contractual undertakings (without consequence) in circumstances where it facilitates a better offer will inevitably have some impact on the willingness of potential acquirers to put forward initial proposals in the first place, as it will increase the level of uncertainty that an “agreed” proposal will ultimately be successful. This in turn may negatively impact the market for corporate control and ultimately reduce the potential for economically desirable changes in ownership to occur.
So where does this leave the successful bidder?
There is generally no point pursuing the target company for breach of any agreed implementation agreement as the successful bidder will ultimately own the target company and would, in effect, be suing itself.
The successful bidder is also unlikely to find much joy in pursuing the target company’s directors for any alleged breach of directors’ duties as they will no doubt argue that they acted in a manner that was in the best interests of target shareholders – a course of conduct that secured a materially higher offer for those shareholders, and a business judgment that would be hard to second guess.
So what about going after the rival bidder?
Liability under tortious interference (intentional interference with contractual relations) can arise where one person intentionally interferes with someone else’s contractual relationship with a third party, causing economic harm. Liability could arise even when dealing with a willing contract breaker.
The elements required to establish intentional interference with contractual relations are:
Establishing liability requires demonstrating actual intent which turns on the facts in each case and looks at the state of mind of the defendant. Knowledge of the contract is one aspect of intent. A genuine belief, actually held, that the conduct would not be a breach of contract (even if wrong or, as described in one case, “muddleheaded”) would likely absolve a defendant from liability.
The terms of an agreement and how it should be construed could be complicated and that would affect a Court’s preparedness to find that the defendant intended to induce or procure the breach of contract. There is also the practical risk around preventing the defendant from dispersing the proceeds of the break fee before any action is commenced, leaving an empty shell behind.
In Pacific Energy’s case, it is clear that APC knew that a contract existed between Pacific Energy and QIC. The full terms of the scheme implementation deed were publicly disclosed to the ASX in connection with the announcement of the Original QIC Proposal. The structure of the APC Proposal also appears to have been designed to accommodate the QIC matching right process.
However, to establish a cause of action, it must be proved that APC knew that Pacific Energy’s execution of the APC Process Deed would be a breach of the QIC SID and that they intended to induce Pacific Energy to breach its obligations to QIC under those arrangements. Importantly however, such a cause of action does not require the Court to consider public policy issues associated with who should bear the costs of facilitating an auction for corporate control.
The Takeovers Panel is a body focussed on ensuring that acquisitions of control in Australia take place in an efficient, competitive and informed market and that the policy ideals enshrined in section 602 of the Corporations Act are upheld.
It is always easier with the benefit of hindsight, but one wonders whether an action through the Courts for tortious interference with contractual relations may have provided a better pathway to prevent and potentially recoup the leakage that ultimately resulted from amounts paid out to the rival bidder by way of the break fee.
 The Pacific Energy directors’ unanimous recommendation was made subject to no superior proposal emerging and an independent expert concluding that the Original QIC Proposal is in the best interests of Pacific Energy shareholders.
 Market practice is varied on whether a process deed is released in full or is summarised. The failure to disclose the entire arrangements may in certain circumstances have an anti-competitive effect by reducing the likelihood that a competing bidder will want to make an approach due to the uncertainty surrounding the arrangements already committed to by the target company. See GBST Holdings Ltd  ATP 15 for a further discussion on this issue.
 Again made subject to no superior proposal emerging and the independent expert concluding that the Revised QIC Proposal is in the best interests of Pacific Energy shareholders.
 The QIC SID contained obligations that prevented Pacific Energy from entering into a competing proposal until QIC exhausted its matching rights under the QIC SID, as well as obligating Pacific Energy to “ensure that all assets are maintained in the normal course of business consistent with past practice”.
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