Anti Takeover Deenses

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1818 The Ukrainian Journal of Business Law | September 2006

Terms such as poison pill,shark repellent andscorched earth defencemight conjure up images ofold action movies. Yet they

are more than real in this era of economicwarfare. In this connection designing

strategies for mergers and acquisitionsand planning defences against hostiletakeovers now preoccupy many corpo-rate managers.

This article examines some of thesteps that a company should take to plan

and implement defence strategy againstunfriendly takeover. It will focus on open joint stock companies since such com-panies are usually the battlefield in thecorporate war.

I. The warning signals

There are some signs that tell you thatthe hunt for your company has begunand a predator is coming:

1. Suddenly minority shareholdersstart to get interested in the business af-

fairs of the company and start asking forcopies of certain documents.

2. The company becomes the object ofvarious inspections carried out by bodiesof the state controll that are particularlyinterested in reviewing the companys

register of shareholders, the list of majorclients and creditors, information on as-sets of the company, etc.

3. The company and its executives be-come the target of negative publicity.

4. The number of small transactionsin shares of the company has consider-ably increased.

5. Other companies in your industryhave been attacked by raiders.

6. Unsolicited offers to sell the sharesin the company have been received dur-ing the last few months.

Katerina S. Kokot is a senior attorneywith PricewaterhouseCoopers

in re

by Katerina S. KOKOT

TheTheArtArtofTakeoverDefenceDefence

S.

Riabokon


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takeover defence |in re

7. The company is ambushed withlaw suits, often with absurd claims forprotection of the rights of minority share-holders.

II. Defence techniques

Preventive measuresPreventive measures against hostile

takeovers are much more effective thanreactive measures implemented oncetakeover attempts have already beenlaunched. The first step in a companysdefence, therefore, is for managementand controlling shareholders to begintheir preparations for a possible fightlong before the battle is joined. There areseveral principal weapons in the hands oftarget management to prevent takeovers,

some of which are described below.

Control over the registerThe raider needs to know who the

shareholders of the target are in orderto approach them with the offer to selltheir shares. With joint stock companiesthis information is contained in the shareregister. In particular, the share registerprovides for the possibility to identify theowners of the shares, quantity, nominalvalue and type of shares held by share-holders. So it is very important to ensure

that non-authorized persons do not haveaccess to the share register of the com-pany by taking the following steps:

Careful consideration is neededwhen choosing the registrar; the pref-

erence should be given to a reputableregistrar;

Check the track record of the shareregistrar in regards to its involvement inhostile takeovers in the past;

Check who controls the registrarcompany.

In case of transfer ofshares to a nominee holder(custodian or depository)information on the ben-eficiary owners of sharesis not stated in the shareregister. Instead, the shareregister contains informa-tion on the nominee hold-ers1. This makes it muchmore difficult for the raiderto identify who is the realowner of the shares.

Control over debtsCreditor indebtedness of the company

may be used by a raider as the principalor auxiliary tool in the process of hostiletakeover. In particular, the raider mayemploy so-called contract bankruptcyin order to acquire the assets of the target.In connection with this the following cau-tionary measures should be taken:

Monitor the creditors of companycarefully;

Prevent overdue debts;

If there is indirect evidence thata bankruptcy procedure is about to belaunched, the company should do its bestto pay all outstanding debts;

Accumulate all the debts and risksrelating to commercial activity of thecompany on a special purpose vehiclethat does not hold any substantial assets.

Cross shareholdingSeveral subsidiaries of a company

(at least three) have to be established,where the parent company owns 100%

of share capital in each subsidiary. Theparent transfers to subsidiaries the mostvaluable assets as a contribution to theshare capital. Then the subsidiaries issuemore shares. The amount of these shouldbe more than four times the initial sharecapital. Subsidiaries then distribute theshares among themselves. The result ofsuch an operation is that the parent ownsless that 25% of the share capital of eachsubsidiary. In other words the parentcompany does not even have a blockingshareholding. When implementing this

scheme it is important to ensure that themanagement of the subsidiaries is loyalto the parent company. In this way theraider who proceeds with a takeover mayfind himself deprived of the very objec-tive of his ambitions.

Golden parachuteThis measure discourages an un-wanted takeover by offering lucrativebenefits to the current top executives,who may lose their job if their company istaken over by another firm. The trigger-ing events that enable the golden para-chute clause are change of control overthe company and subsequent dismissalof the executive by a raider providedthat this dismissal is outside the execu-tives control (for instance, reduction inworkforce2 or dismissal of the head of

the board of directors due to the decisionof the general meeting of shareholdersprovided such additional ground fordismissal is stated in the labour contractwith the head of the board3).

Benefits written into the executivescontracts may include items such asstock options, bonuses, hefty severancepay and so on. Golden parachutes can beprohibitively expensive for the acquiringfirm and, therefore, may make undesir-able suitors think twice before acquiringa company if they do not want to retain

the targets management nor dismissthem at a high price.The golden parachute defence is

widely used by American companies. Thepresence of golden parachute plans atFortune 1000 companies increased from35% in 1987 to 81% in 2001, according toa survey by Executive Compensation Ad-visory Services. Notable examples includeex- Mattel CEO Jill Barads USD 50 milliondeparture payment, and Citigroup Inc.John Reeds USD 30 million in severanceand USD 5 million per year for life.

1 The nominee holder discloses the beneficialshareholders to the registrar only in specificcases set forth in Ukrainian legislation.

2 Under para 3 art. 36 of the Labor Code ofUkraine (CLL) the change of ownership overthe company does not result in termination ofan employees labor relations with a company.However, labor contract may be terminatedby employer in case of reduction in workforce(clause 1 para 1 art. 40 of CLL). Under Ukrain-ian legislation and according to court practice,a company has the right to determine howmany employees it needs and which jobs or

job functions it will keep, so it may not becalled upon to justify its decision in court.

3 Under art. 65 of the Commercial Code ofUkraine conclusion of a labour contract withthe head of the board of directors is manda-tory. Under art. 21 of CCL the parties to thelabour contract may agree on, inter alia, termof the contract, rights, obligations and respon-sibilities of the parties, grounds for terminationof the labour contract, including early termi-nation.

Preventive measuresagainst hostile takeoversare more effective

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Change of control clauses (SharkRepellents)The company may include in loan

agreements or some other agreementsconditional covenants that in the event ofthe company passing under the control ofa third party, the other party to the agree-

ment has the right to accelerate the debt orterminate the contract. The result of suchagreements is that a potential raider maynot be sure whether it will be able to ben-efit from important advantages enjoyed

by the target. Although one of the effectsof change of control clauses is to discour-age raiders, their purpose is legitimate: toprotect creditors from being placed in aworse position than they visualised.

Post takeover defence

It is essential that the company startsto react immediately after the takeoverattempt is launched. Otherwise the com-pany may find itself at a strategic and tac-tical disadvantage that may prove fatal.

LitigationBringing administrative claims or

court proceedings against the raider isregarded as one of the most common anti-

takeover measures. A target of a hostileoffer should search for any regulatory, se-curities law or other skeletons in the closetof the attacker. Court action can consider-ably lengthen the period of time neededto complete the takeover and reduce itschances of success by increasing the costand by allowing time for the target to so-licit competing bids or put up defences.

Self-tenderUnder the Business Associations Act

of Ukraine, a joint stock company has the

right to acquire the paid up shares fromthe other shareholders only by sums thatexceed the share capital. A corporatebuy-back of its own shares increases therelative voting power of those sharehold-ers friendly to management who do nottender their shares.

However, if the charter of the compa-ny provides that the decision on buy-backof own shares falls within the competenceof a general shareholders meeting, self-tender may prove to be a rather time-

consuming exercise. In sucha case the law requires that ofshareholders should be noti-fied about the general share-holders meeting at least 45days in advance. The periodof time necessary for properconvening the shareholders

meeting may be enough forthe raider to accumulate asufficient quantity of sharesto block the decision on buy-back of shares.

It should also be kept inmind that such shares mustbe disposed of or cancelled

within a period of one year. During thisperiod voting and determination of aquorum on the general shareholdersmeeting will be made without takinginto account own shares bought by the

company.

Pacman defenceThis defence, named after the video-

game, consists of a counter-purchaseby the target of the shares against itsattacker. In some cases it will suffice tobuy even a small fraction of shares of theattacker to be able to initiate legal claimsagainst the attacking company in the ca-pacity of minority shareholder.

Sometimes the company will be un-able to buy the shares of a raider due to the

lack of readily available funds or for someother reasons, e.g. the shares of the attack-er are consolidated in the hands of share-holders friendly to the attacker. In this casethe company or the persons affiliated withthe company may start to acquire othertools of influence on the attacker or thebusiness group it belongs to, e.g. rights ofclaim, debts, bills of exchange.

PropagandaThe company is well advised to make

use of media to let the public know its

arguments against a takeover. The com-pany may strengthen its positive imageand emphasize its importance for theregion/country and, at the same time,to put stress on the means of takeovertactics used by the raider that fall withinthe grey area of law or contradict the

law altogether. A skilfully organized PRcampaign may significantly influence theposition of state bodies, shareholders andgeneral public in favour of the company.

White KnightA White Knight is a company (the

good guy) that gallops to rescue thecompany that is facing a hostile takeoverfrom another company (a Black Knight)by making a friendly offer to purchase theshares of the target company. The targetmay seek out a white knight by itself or

with the help of investment bankers.

People PillHere, management threatens that in

the event of a hostile takeover, the man-agement team and the core specialists willresign at the same time en masse. This isespecially useful if they are highly quali-fied employees who are crucial in identi-fying and developing business opportuni-ties of the company. Losing them couldseriously harm the company, especially ifthe company operates in hi-tech business

where talented human resources are themain asset of the company. On the otherhand, hostile takeovers often result in themanagement being fired anyway, so theeffectiveness of a people pill defence de-pends on the specific situation.

III. Concluding remarks

Hostile takeover defence is an art, nota science. Careful advance preparation isnecessary to ward off the unfriendly bids,as being prepared can well make the dif-

ference between success and failure.It is also important to remain flexiblein responding to changing dynamics oftakeover techniques. A company musthave an efficient defence strategy in placeto provide maximum flexibility in deal-ing with whatever the attacking companymight throw its way.

There is no one size fits all strategyto make the company takeover-proof.Therefore, a regular review of the takeo-ver environment is essential as is keepingthe available defences up to date.

in re |takeover defence

It is important to remainflexible in responding to

changing dynamics oftakeover techniques.

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Anti Takeover Deenses