Hostile takeovers: Defenses cos can adopt to play safe

Indian Hotels has made numerous attempts at striking an alliance with global hospitality company Orient Express. But Orient Express has spurned every offer made by the Tata Group company. Ratan Tata says he would never do a hostile takeover. But even if he tried in this case, Orient Express, it seems is virtually impenetrable thanks to the many poison pills that it has put in place.

There are many defenses that a company can adopt to ward off a hostile takeover, both internationally as well as in India. These are called poison pills, and as CNBC-TV18 found out in its special show - THE FIRM, Corporate Law in India, it is ultimately all about size. A bigger promoter holding makes for a more effective defense. So, for now, India Inc. can just bulk up on ownership and can forget all about poison pills.

Martial arts maybe a great way of self-defence. But preparing to ward off enemies may not mean always that you can get away without a scratch. That is especially true of the corporate world. In fact, preparing yourself from corporate sharks may sometimes make it necessary to pop a poison pill.

Rewind to 1982, when Martin Lipton today considered to be one of America’s 100 most influential lawyers invented the warrant dividend plan or the shareholder rights plan. It was used by the El Paso Corporation as a successful defence against a hostile bid made by former railroad company Burlington Northern. A year later, a banker coined the term poison-pill.

One poison pill every year keeps your company healthy and safe. Call your nearest corporate lawyer for a prescription.

In its most basic version, the pill finds a hostile takeover by allowing the target company to issue a much large shareholding to the existing shareholders so that it makes it more difficult for the acquirer to gain control or it makes it more expensive, according to Timmy Kandhari, Executive Director, PwC.

That is the Flip-in plan. Currently ring-fencing Yahoo! in 2000, the Internet major adopted a plan permitting shareholders to buy new shares at half price - the trigger, when 15% or more of Yahoo!’s stock is acquired by any party.

The Flip-over gives the company’s shareholders the right to buy discounted shares in the merged company in the even of a successful hostile bid.

In the Macaroni Defence, the target company issues a large number of bonds to be redeemed at a high price. Why Macaroni? Because the price is expandable in the case of a takeover.

Differential voting rights give the holders of a certain class of shares, higher voting power. A staggered board defence permits only a certain percent of the company’s directorial board’s to be replaced every year making it difficult for an acquirer to seize control.

And then there are one-off unique measures, born of desperate circumstances and yet to be jargonised. Such as the one set in place by steel company Arcelor to protect itself from hostile acquirer Mittal Steel.

Abizer Diwanji, Executive Director, KPMG says, “They had bought a Canadian company called Dofasco. They put that Dofasco shareholding in a trust, which had a huge breakage fee, which basically made the transaction null and void or rather very difficult to implement. Whoever acquired Arcelor had to effectively acquire Dofasco too. So, they had to honour the Dofasco transaction, otherwise there was a very high breakage fee, which was a penalty.”

Both the United States and Europe allow corporations located there a whole host of defensive measures against hostile takeovers. In fact, in the United States, companies don’t even need shareholder approval before adopting a poison pill structure.

But that is not true in India. While nothing stops Indian companies from issuing preferential shares or warrants, but they cannot be at a deep discount. The pricing is fixed, at either the 26-week weekly stock price average or the two-week daily average, whichever is higher and the new share issue must be approved by shareholders.

Somasekhar Sundaresan, Partner, J Sagar says, “There is also a requirement to complete allotment within 15 days of shareholder resolution. So, you cannot have a resolution in your pocket, which has not been acted upon for a very long time.”

As for differential voting rights, Indian law does allow for the issue of such shares, but only on paper.

Diwanji says, “As is normally the case in our country is that we do not have the rules to actually enable that to happen.”

And there is no staggered board defence available. The Company’s Act gives Indian shareholders the power to remove all company Directors in a single shareholders meeting.

In fact, Indian law leaves companies exposed to hostile takeovers. For instance, if there is an open offer on the table, preferential allotment guidelines restrict the actions that a target company can take.

Somasekhar Sundaresan adds,”Those include, signing of material contracts, further dilution of capital. There are carve outs for things like ESOP which will not be affected by that prohibition. You cannot appoint directors on the board.”

Yet, fortune favours the brave. Just last year, DCM Shriram defended itself from a hostile acquirer by allowing its promoters to increase stake via a fresh issue of preferential shares. Challenged at the Company Law Board, the offer passed muster, and the hostile bid was defeated.

But experts maintain that embedded defenses such as the Brand Pill make for better protection.

Akhil Hirani, Managing Partner, Majumdar & Co, says, “Different Tata companies have in place an arrangement with the Tata Sons entity, whereby anybody who acquires any of those entities may not be allowed to use the Tata name or the brand. So, if that is what you are chasing, then clearly that is a contractual issue and even if you manage to takeover the company, you won’t have the right to a brand, which is probably a significant portion of your valuation.”

So, ultimately in India, it is all about size. A bigger promoter holding makes for a more effective defense. So, for now India Inc. can just bulk up on ownership and forget all about poison pills.

That was the world of poison pills, shock repellants and porcupine provision. Sooner rather than later, India Inc.’s acquisitive foray is going to run into defensive measures like this.

In fact it is evident already in Indian Hotels’ move to strike an alliance with Orient Express, a company that has built several such defensive measures around it and is protected from any US court judgement on US security laws because it is based out of Bermuda.

So, what can Indian acquiring companies or already acquiring companies for that matter do to overcome such defensive measures?

Cyril Shroff, Managing Partner, Amarchand Mangaldas & Suresh A. Shroff & Company and Diwanji discuss the possibilities.

Excerpts from CNBC-TV18’s exclusive interview with Cyril Shroff and Abizer Diwanji:

Q: What can an acquiring company do when faced with several such defensive measures? Is there any way to get around them?

Shroff: It can vary from market to market. There are some markets, which are pro-acquire and there are some markets which are pro-target. Some of the examples that you were giving are in jurisdictions where there is a very pro-target jurisprudence. So, there are defenses that are available like the poison pill defence that you mentioned, and that can vary. So, that is the first thing that one needs to do.

There is a lot of legality involved, which one could challenge in a court of law in those markets. There would be securities regulators with whom you could complain and get around those. But ultimately it comes down to getting the principles of good governance to prevail in terms of the defence, because these sorts of defences are usually meant to perpetuate, managements, not necessarily in the interest of the shareholders. So, you have to come in as an acquirer with a powerful governance theme.

Q: Some of the most commonly used defensive measures, for example differential voting rights or the fact that you can do a huge do a preferential issue of shares at a huge discount thereby reduce the acquiring companies stake to a minimal or make it more expensive for them to buy more. These are not challengeable in court in a friendly jurisprudence like the US?

Shroff: We lawyers stay in business because we can challenge almost anything in a court of law. But the important thing is to make sure that it is done correctly and there is a lot of process that is involved in these courts as well, whether this differential voting rights was properly done or not, whether you followed your own terms which are set out in your own constitutive documents or in terms of the local process that is involved.

So, it is too general to say that one cannot challenge it. But there are jurisdictions that are pro-acquire and pro-target and that really varies from market to market.

Q: Would you agree with the fact that lawyers can pretty much challenge just about anything that they want to and so therefore such defensive measures can also be challenged, because I am trying to think back to all the research we have done and I haven’t come across too many successful cases of this being challenged except for governance grounds as Mr. Shroff brought up?

Diwanji: Fundamentally, if you look at it, lawyers can contest anything. But fundamentally the issue is that these poison pills are devised to protect the general shareholder, in general. That is the philosophy behind these regulations primarily in the US or anywhere else. That is why these regulations do not even require sometimes, shareholder approvals.

Now the basic premise, if it is violated - for example if one is doing a particular deal or introducing a poison pill just to protect management who tend to become “control freaks”, that is when these things can be challenged in a court of law.

Q: How easy or difficult is this to challenge it on the grounds of governance in different jurisdictions. Which are the jurisdictions that are a little more protective of the entire defensive measure and poison pill structures, which are the jurisdictions that are more likely to be swayed by the whole governance argument?

Diwanji: Effectively there are enough cases in the US too, which is one country that enables a lot of these provisions to happen in the first place. There are enough cases in the US itself where poison pills have effectively been dislodged. If you know Maxmillon was up for acquisition by the Maxwell Corporation owned by Robert Maxwell, Robert Maxwell actually fought a successful poison pill dislodge, because he proved that his acquisition was effectively better for the shareholders of Maxmillon. And it happened.

So, really it is not that there are jurisdictions that are legally friendly or unfriendly to do. If you look at Europe for example, it like Indian law requires shareholder approval for most things. So, that is obviously an easier jurisdiction. But it is not that jurisdictions that actually allow these things to exist are not defensible. They are.

Q: There are other jurisdictions such as Bermuda, which I am quoting in the case of Orient Express, but I am not only referring to that case, which in fact gives companies even more flexibility. Am I correct?

Shroff: That is correct. You would find that typically in financial centres like Bermuda, Cayman Islands, Mauritius, which are essentially devised to protect and to give a lot of flexibility to shareholders and to companies to write the way they want their articles and shareholder rights, which is why you can have these sorts of provisions in the first place.

Jurisdictions that are more rigid in terms of what rights can be provided and where there is a more developed securities market jurisdiction where principles of governance are more dominant. You would find less of these.

Q: A question specific to the Orient Express case - Orient Express has made very clear in its communication to its shareholders that US Securities law and therefore a judgement in a US court is not enforceable on us because we are based and registered out of Bermuda. If you were to raise the whole corporate governance argument in the case of a company like Orient Express, which has traded in the US but registered in Bermuda, how much luck would you have?

Shroff: In my view a fair amount of luck, because whilst the underlying company law to this Bermuda company would be Bermuda law, the fact is that once they have registered their securities in the US, they have effectively imbibed those principles including the laws that will apply to the securities that are listed - their depository receipts. So, I don’t think they are going to get very far on that. But again, the jury is out on that. Let us see how that evolves. In my perception, you cannot make that argument once your securities are listed in those markets.

Q: When I spoke with Mr. Krishna Kumar of Indian Hotels, who is actually trying to do this alliance bid with Orient Express and not a hostile takeover, I asked him there are so many defensive structures, even if you did want to make a hostile bid, how would you do it, and he said eventually in this world of corporate governance economic ownership will prevail. Would you agree with that?

Diwanji: Absolutely. In fact that has happened, and there is a very recent case when Larry Ellison of Oracle tried to acquire PeopleSoft. Ultimately, PeopleSoft created a defense and actually said that license fees sold in the last three years will be reimbursed at five times over to everybody who has bought a PeopleSoft software. That liability would have had to be met by Oracle. That is the kind of defense that they had. But really what happened ultimately is that the larger shareholders saw value in the merger between Oracle and PeopleSoft, and it happened.

So, economic ownership, shareholder opinion and all of that ultimately will prevail no matter what you build around yourself.