Lectures - notes - Professor Edmund Schuster Introduction and Basic Toolkit PDF

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LL4F3: Law of Mergers, Acquisitions and Restructurings in EuropeLectures (Week 1)Course OverviewAims for this courseWhat this course is  M&A and the “Law of the Horse” (Easterbrook 1996)? o This quote: we should be careful not to lamp together different areas of law because they are used to or ...

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LL4F3: Law of Mergers, Acquisitions and Restructurings in Europe Lectures (Week 1) Course Overview Aims for this course What this course is 

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M&A and the “Law of the Horse” (Easterbrook 1996)? o This quote: we should be careful not to lamp together different areas of law because they are used to or relevant to a particular business activity. Everything that has to do with horses and putting it one basket. There are things which might arise and are not specific to horses. So, we should split the law into different areas. o Acquisitions of business, the restructurings of large corporations. Such transactions are usually complex and will touch on different areas such as contract law problems, data protection law problems and competition law problems. So, given the complexity of these transactions, they often relate to a wide variety of legal problems and it would not be useful or possible to cover all these things in one course. A corporate law course focussing on the legal techniques used to acquire businesses in Europe and restructure their operations Emphasis on the underlying commercial problems and policy implications underlying business transactions. o We will map them to the commercial solutions available to these operations. Focus on transactions in an EU and UK context Particular focus on corporate takeovers o Public M&A transactions.

What this course is not  

A “deals course” A course on drafting deal documentation or on how to negotiate a deal

COURSE OUTLINE Course contents - Outline Week 1: Introduction & Basic Toolkit   

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Rationales and Motives for M&A deals Understanding the “Market for Corporate Control” o Chapter 1 Reading Understanding Synergies o Video 2 o Synergies is one of the core drivers for M&A activity – we will look at this from an economic and legal perspective. o Just have a read at the hypothetical handout and think about it. don’t spend too much time on it. Control Transactions and Intra-group Restructurings

Week 2: Basic Toolkit    

Types of corporate transactions o Differences between asset sale, and share sale, mergers transactions. Anatomy of M&A transactions – from an LOI to closing The Role of Lawyers in Corporate Transactions Relevance of capital markets for (public) M&A transactions

Week 3: EU law aspects, company migration, and choice of law   

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Freedom of Establishment / Free Movement of Capital Choice of corporate law, migration in and out Impact of Treaty on M&A transactions and restructurings o What if a company decides that a particular foreign company law is more suited to its activities? How easy it is to relocate your business? What are the EU law constraints from protecting EU companies from foreign takeovers? Foreign investment control & M&A o This area is gaining significance all across the world.

Week 4: Allocating Risk Through Contract   

Incentive and Information-related Problems in Private M&A deals o Techniques to solve these problems by: Allocation of risks and rewards through contract (contractual arrangements) e.g. earn-outs, W&I (“R&W”) insurance, locked box, etc

Week 5: Takeovers I - Introduction to Takeovers Regulation in Europe    

Introduction to public M&A o EU takeover regulation Takeovers and corporate governance European Takeover Directive – History, Relevance, Content, and Implementation Takeovers and shareholder structure

Week 6: Reading week Week 7: Takeovers II    

Friendly and Hostile Takeovers Takeover Defence Regulation in the EU and the UK A view across the pond Collective action problem in public M&A transactions

Week 8: Takeovers III 

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Mandatory bids o In public M&A transactions, there is an obligation for an acquirer to buy out all shareholders in the case of a takeover, whenever they acquire control. We will look at this from an economic and legal perspective. Squeeze-out and sell-out

Week 9: Mergers, Divisions, and Schemes of Arrangement 

Domestic Mergers & Divisions under EU law

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o When two companies are incorporated in the same state – how they merge. o Mergers in the UK are rarely used. Schemes of arrangement o Are a functional equivalent to mergers. Shareholders & creditors in mergers & divisions: interests, risks, and legal protection

Week 10: Cross-border Mergers 

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Cross-Border Merger Directive and its application o Regulates the way in which companies from different members states can combine their operations through merger and the complications that may arise from such transaction. Protection of national employee participation Shareholder and creditor protection in cross-border transactions

Week 11: Conclusion 

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Regulatory aspects: o MAR and corporate transactions  How deal makers can lead to different type of transactions that can lead to similar commercial outcomes, and how they choose between them – what is the driving force. o Extraterritorial effect of US law Regulatory arbitrage

Administrative Issues Prerequisites -

No formal prerequisites but useful to have taken previously some corporate modules.

Course delivery    

Weekly recorded lecture: about one hour in total Weekly classes – 1 hr, online via Zoom Hard cap of 75 (5 groups - switching groups only with prior permission) Additional live Zoom sessions (TBC)

Readings 

All core readings are available on Moodle

Assessment  

Formative coursework: posted in Week 5, due at the end of Week 7 (1,200 word limit) o Will be relevant to the final exam. Final exam in ST (100%) – format TBC

THE MARKET FOR CORPORATE CONTROL  Kershaw’s Chapter 1.

Basic Toolkit: Market for Corporate Control Main motivations for control transactions: By control transactions we mean transactions which are not merely intra-group restructurings where large group of companies decide they want to restructure the way they organize their business. But it means, a transaction where the ultimate authority, the control over business changes from one person to another where you have different decision makers as a consequence of the transaction. For example, if someone acquires a majority of the shares in the company. o In some way, there are two main motives for M&A transactions: Disciplining motives and the corporate governance role of M&A o The first one is that you want to discipline or that the lack of discipline triggers the transaction itself. This is related to the corporate governance role of an M&A transaction. Synergy-driven control transactions o

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1. Disciplining transactions 

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Agency costs o When talking about disciplining M&A transactions, we are referring to cases where the current management of the business doesn’t do its job well. Management controls the business decision and if management doesn’t do a good job from the viewpoint of the shareholders of the company, then there can be a motivation for an M&A transaction. What are agency costs? o Examples: empire building, self-dealing, laziness  Agency costs is where an agent (a manager) as economic agents takes decision and in taking those decisions, they prioritise their own interests in a way which is somewhat optimal.  Managers may be lazy and hence they destroy value – sleep until 11 am and don’t go to work etc.  Agency costs could also be empire building – mangers decide to acquire other businesses not because it is in the interests of the business, but because they are interested in a specific business area they always wanted. Or perhaps, they may just want to acquire another business because it improves their own position by making them more relevant, more important.  Another example would be self-dealing -> managers engage in transactions between themselves and the company itself and they do so in a way which is beneficial to themselves.  This means that the sub-optimal performance of those managers devalues the shares that are held by the shareholders of the company in that business. In other words, the shares would be worth more if not for the sub-optimal behaviour of the agents (managers). Relevance of ownership structure  These sorts of agency costs are most relevant where you have this personal ownership. Where you don’t have shareholders who are particularly influential;

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you don’t have controlling shareholders. We are concerned with the agency costs in disperse shareholder transactions – meaning that managers can make decision without fearing about interference by any controlling shareholder.  If you have a disperse shareholder structure, then managers will have incentive to impose agency costs on shareholders because it is unlikely that shareholders will coordinate to discipline. If you are a CEO of a company with 100000 shareholders and each shareholder holds tiny percentage of the company’s shares, then if the manager does something which is not necessarily ideal, the risk of shareholders doing anything about it is small because there are significant collective action problems. It is not likely that you will be disciplined by your shareholders. If this is true, then you don’t bear the cost of engaging in suboptimal behavior. For example, if you engage in empire building and you acquire another company which doesn’t increase the value of the shares then you don’t have to worry about shareholders starting a revote because starting a revote is costly, and difficult and is unlikely to be achieved by such dispersed group of shareholders. One way to solve this problem is through the idea of a market for corporate control. If you are a manager who is underperforming, then the value of the shares is lower than it could otherwise be because of your underperformance. Even though the shareholders are subject to a bunch of collective action problems which makes it hard for them to intervene, if the value of the business is lower than it could be then the value of the shares will be lower than the value it could be. This undervaluation of the shares compared to what it could otherwise be with more efficient management, this creates an incentive for acquisition. So, if you are an acquirer, you can buy those shares at a price which is lower the potential value of the company. Corporate law prerequisites? o Whether or not this incentive exists, and whether an acquirer will acquire those shares because the manager is incompetent, then the acquirer will put himself in that position of managing if the shares go up in value – so the acquirer only needs to buy enough shares in the company to get rid of the existing manager (Edmund) and which will hence increase the value of the business because the acquirer will be better manager. Whether or not he can do this will depend on the company law rules which apply – in our example, it will depend on whether or not it is possible to acquire a company against the will of its current management. More precisely, it is always somehow possible how difficult it is, how costly it is and how long will it take to acquire a business. If the acquirer wants to buy the majority of shares in the company which Edmund runs, the question will be how difficult it is to achieve it if Edmund opposes it and it is likely that Edmund will oppose it because how low your value proposition is to get rid of Edmund and replace him with more competent manager. o We will also look at the takeover defences available to Edmund to fend off the acquisition of the business which Edmund is a manager of. Structural & regulatory obstacles o Obstacles to acquiring a busines for disciplining reasons. Weaknesses of the theory o This theory of market for corporate control is not perfect – it is not clear how important this idea is. It is hard to come up with empirical evidence. Empirical evidence

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In a corporate law environment, it is possible to have agency costs which are big enough to drive a significant number of M&A transactions.

 On the vertical axis, we see the share price and on the horizontal we have time. If we have a company and we were to manage this company efficiently, so there are no agency costs, we have a competent manager, the value would be on the distorted red line.  If Edmund is the CEO and he is not good at his job and he imposes some type of agency costs on the shareholders, then shareholders would realize that he is underperforming, the shareholders would update their expectations as to the company’s cashflow. We will then see a reduction in the cash price (the share reaches a value of 10 pounds) as he underperforms. The shareholders may start selling their shares, they leave the company rather than change the management. The share price will hence fall – so we will reach such a low share price that a bidder will want to step in because he thinks it could be worth more than its current price (that the share price could reach a value of 15 pounds), so he offers a price below the potential value of the company and above the value at which the share price is currently at. So, the shareholders will be happy to sell at that price because it is more than the current price, but the bidder will be able to make some profit if the acquirer replaces the existing management and the value of the company does go up.  If the manager is lazy and is shown this diagram, he may understand that it is not a good idea to underperform because he will not want to lose his job in a hostile takeover, so the mere presence of this model, the CEO being aware of this risk could discipline him without any transaction ever taking place. This is one of the empirical difficulties here. The reason why the CEO is a good manager is because he is trying hard and worries about this picture, he does better job and prevents the fall in the share price to avoid a bidder taking over.

 If you receive a bid at the red line, which is triggered by an underperforming management then the argument will be that they undervalue the company in this offer. So, they tell their shareholders not to accept the offer because it undervalues their company and in a way, it is true because if the bidder doesn’t undervalue the company, then there is no point in the acquirer making such an offer.  The difference between the 10 pounds that the shares trade for on the stock exchange at the moment and the 15 pounds theoretical value, the question is how much of that 5 pound per share potential value gain is allocated to the acquirer as opposed to the target shareholders.  Kershaw summarizes nicely the literature on this and the empirical evidence which suggests that what we see is that the target shareholders get the largest chunk of this potential gain and in fact, often, they get more than 100% of the gains. So, the acquirer ends up offering a price abode the red line and might end up making a loss.  The second big class of transactions:

2. Synergy-driven control transactions 

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Allocative efficiency and control transactions o The idea here is that the combination of two businesses creates value because the joint control over productive assets in itself allows you to act to produce more efficiently than just having those two companies separately. So, the idea here is not that the manager doesn’t do his job properly, is just that the very combination of the acquirer’s and target’s assets allows you to do something which isn’t possible. It is not due to underperformance of management, it is just more efficient if you have these two business managed jointly. o It is not easy to tease out the extent to which this expectation of creating value by combining businesses actually plays out in practice. We have examples where managers and shareholders expected value gains to be realized through these transactions because of synergies and often they don’t play out in this way. It is not easy to assess empirically how big the value creation is in practice with reasons to do how complex the business is. For example, what would have happened to Google had they not acquired YouTube. Value creating and value destroying takeovers/mergers

Sources of value gains? 

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Increased efficiency, synergies o The value gains in this synergy value transactions are the synergies – so increased efficiency operationally. Regulatory/tax advantages o Stem from combining two business create regulatory advantages and tax advantages. Wealth transfers o From/to whom?  It is possible that there is some transfer of wealth from employees – so, you shift some of the cost to the employees so the shareholders can make profit.  Competition law aspect: It is possible for two companies to merge and to increase the profitability of the business but not because of shared innovation or increased efficiency but because the combination of two businesses creates a dominant position in the market which means the company can increase its profits – this is really a wealth transfer from consumers of the company or from suppliers. An important aspect of competition law is to avoid situations which creates value for the transacting parties not by way of increasing operational efficiency but by way of transferring value from consumers. Empirical evidence (see the detailed discussion in Kershaw)

 These are two companies which announced that would get merged, and which would create value. They made convincing argument of how they would increase value. They also announced that they didn’t know which legal technique they would use – they would decide later whether they would do this through a merger or a scheme of arrangement.  They announced this transaction on the 24th of August and the share price of both companies rose -> so, the idea here is that if we see both companies go up in value then we know that for this transaction, the market expectation is that value will be created form the shareholders perspective.

 Another big transaction here. ARM was taken over by Southbank – the share price of ARM goes up by 40% on the announcement and the share price of Southbank goes down by 10%.

 There are also transactions which sound like a good synergy-driven idea. Afria Group and Philip Morris announced a potential merger. The announcement signified by the red line – the announcement was negative for both companies. So, the shareholders looked at this transaction and said ‘you promised a lot of synergies, and we don’t believe it. we believe that if you combine these two companies, the value of the combined entity will be lower than the value of the separate entities’. We can see this on the X axis that the value went down and hence the transaction was cancelled.

WHAT ARE SYNERGIES? Synergies What are “synergies”? 

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All additional value created as a consequence of combined control -> “1+1 = 3” o It is the additional value that can be created if you have different assets and you end up combining those assets under a single company’s control. Cost savings, better management, economies of scope/scale, etc o These synergies could be cost-saving -> if you have two companies and each has its own operations and there is some element of those operations, that if you in somehow combined their operation, you could produce the same stuff at a lower cost. o Better management is also a synergy -> this slightly blurs the line between disciplining and synergy-driven transactions, but it is possible that you have an efficient management team which has the capacity to manage efficiently additional areas of a business without reducing the quality of that management. This could hence create a value and it is a synergy. o It could also produce economies of scale/scope – it is possible that there are certain fixed costs in producing items and if you increase...