Shareholder Activism: Takeover Code Consequences

By Simon Allport and Leon Ferera

For most publicly quoted companies, the day-to-day management is very often divorced from the ownership of the company in terms of its shareholders. A company's board of directors may collectively own some shares, but rarely more than a few percent, with voting control usually vested in the hands of large institutional shareholders. As long as the directors perform to expectations, such shareholders are generally happy to remain as passive investors. However, when the directors are no longer performing to the expectation of its shareholders, it is possible that those shareholders will wish to take action to protect themselves.

Although out and out shareholder activism is still relatively rare in the UK, particularly among institutional shareholders, there are a number of legislative provisions in UK company law which allow shareholders to provoke change in the day-to-day management of a company, should they so wish. In particular, shareholders owning 10% or more of the voting shares in a company have an ability to requisition a meeting of shareholders to vote on such resolutions as they may wish to propose. When this right is exercised, the proposals put forward may include the removal and appointment of directors such that the effect of such action could be for the requisitioning shareholders to obtain actual control of a company through the composition of its board.

In some cases, requisitioning shareholder meetings for these purposes is seen as a takeover of the Company through the backdoor. In the UK, the City Code on Takeovers and Mergers ("the Code") seeks to regulate public takeovers, but its focus is primarily on takeovers through the acquisition of shares rather than through changes to a company's board. The Code does not generally seek to prevent shareholders from exercising their rights, as shareholders, in voting in a particular way.

Notwithstanding this, shareholders who seek to participate in the requisitioning of a shareholders meeting need to have regard to the potential Code consequences of such action. Following a consultation process, the Code Committee of the Panel on Takeovers and Mergers ("the Code Committee") (the body responsible for considering and approving amendments to the Code) has published changes to the Code to introduce a new note which sets out the manner in which the Panel on Takeovers and Mergers ("the Panel") will approach these situations. The purpose of this Jones Day Gouldens Commentaries is to summarise the main principles that will apply in such circumstances.

Fundamental to the manner in which the Panel approaches shareholder activism is the definition of acting in concert. Persons are considered to be acting in concert where there is an agreement or understanding (whether formal or informal) actively to co-operate through the acquisition by any of them of shares in the company so as to obtain or consolidate control of that company. For these purposes, control is defined as an aggregate shareholding of 30% of more.

It is important to bear in mind that notwithstanding the definition of acting in concert, it is not necessary to acquire shares in order to be acting in concert and so in circumstances where a shareholder or shareholders requisition a meeting to consider a particular proposal, the question of whether there will be deemed concertedness between the requisitioning shareholder and others who support the requisition will be dictated by two issues. These are:

a) whether there is an agreement or understanding between the requisitioning shareholders and their supporters at the time that the requisition is made or threatened; and

b) whether the proposal that is the subject of the requisition is considered by the Panel to be a board control seeking proposal.

Where these circumstances exist or are deemed to exist, the mere fact of concertedness will not have any Code implications provided there are no acquisitions of shares. However, where the aggregate holdings of parties is near to or in excess of 30%, a subsequent acquisition of shares by the requisitionists or persons deemed to be acting in concert with them could give rise to an obligation to make a mandatory Rule 9 general offer to all shareholders of the company. In such circumstances, the offer price would generally have to be at the highest price paid for shares in the company by any member of the concert party at any time during the previous 12 months. In view of these potentially draconian consequences, there needs to be some certainty as to whether a mere supporter of a particular proposal is or is not in concert. This is particularly important because it will usually be the case that, once a requisition is proposed, there will be a battle between the requisitionists and the incumbent board for the support of other shareholders. However, the Panel recognises that merely persuading other shareholders to support a requisition should not of itself result in those shareholders being deemed to be acting in concert with the requisitionists.

So what are the tests in establishing whether or not concertedness exists? In its guidance note, the Code Committee has laid down certain parameters (which are not exhaustive) which it will consider in deciding whether or not there is concertedness between requisitionists and their supporters.

The first issue to establish is whether or not the proposal is board control seeking. The Panel normally will take into account a number of issues in assessing this as follows.

First, the Panel will look at the relationship between any proposed directors and any of the shareholders proposing or supporting the proposal at the time of the requisition. Proposals may be deemed to be board control seeking, depending on the further factors set out below, if there is or has been any prior relationship between any of the activist shareholders and proposed directors, or there are any agreements, arrangements, or understandings regarding the proposed directors' appointments (unless the Panel considers such relationships or arrangements to be insignificant) and, in particular, if any of the proposed directors will be remunerated in any way by any of the activist shareholders following their appointment.

The next issue the Panel will look at is the number of directors being proposed in the context of the existing board. Generally, a proposal to appoint or replace only one director will not be considered to be board control seeking, whereas a proposal to replace the entire board or to make board changes such that the proposed directors would represent a majority of directors on the newly constituted board would be considered to be board control seeking. If the proposal would not result in the proposed director representing the majority of directors, then the Panel would not normally consider the proposal to be board control seeking unless the further factors below suggest otherwise.

The Panel will also take into account the board positions held by the directors being replaced and proposed to be held by the proposed directors. For example, if the proposal was to change the key executive directors only, but these changes would not result in the proposed director representing a majority of the Board, this could still result in the Panel concluding that the proposal was board control seeking. In this regard, the Panel will take into account the nature of the role being proposed for the proposed directors, whether any of the activist shareholders are likely themselves directly or indirectly to benefit as a result of the proposal (other than merely through the holding of shares in the company) and whether there is an existing relationship between the proposed directors and the activist shareholders.

If it is established that a proposal that is the subject of a requisition is a board control seeking proposal, then the Panel will generally view those parties who sign the requisition, together with the proposed directors, as being in concert with each other. In addition, any other shareholder who supports the requisition at the time it is made or threatened will also be deemed to be acting in concert with each other and with the proposed directors.

It should be noted from this that, once a requisition is made or the threat of a requisition is publicly announced, the Panel will not normally treat shareholders who subsequently agree to support the requisitionists as having come into concert with them merely by virtue of their decision to support the proposals, unless there is some other reason for them to be viewed as being in concert.

There are no consequences to parties being deemed to be acting in concert under the Code provided there are no acquisitions of shares. The difficulty is that, in circumstances where there is shareholder activism, opportunities may well present themselves to either the requisitionists or persons who support a particular requisition for the purchase of shares. It is therefore essential to know whether concertedness exists so that particular shareholders knows whether or not they can acquire shares without unforeseen consequences arising.

On a practical level, any shareholders who are considering requisitioning shareholder meetings would need to assess at the outset whether a particular proposal is board control seeking. Bearing in mind that the tests now set out in the Code are very subjective and depend on the Panel's interpretation of particular circumstances, even where the proposal would appear not to be board control seeking, it would always be sensible to seek confirmation of this from the Panel, particularly if between them the requisitionists, proposed directors and supporters have anything near an aggregate 30% shareholding.

If a proposal is board control seeking, then it would be prudent for the requisitionists to ensure that all parties who sign the requisition, all of the directors who are being proposed, all supporters of the requisition who are contacted prior to the requisition being served or threatened (and, in some cases, all companies in the same groups as the requisitionists) commit in writing not to acquire shares in the company concerned without the consent of all of the other parties involved. This is particularly important because, if a Rule 9 mandatory bid obligation were to arise, the Panel could impose this obligation on all or any of the members of the deemed concert party.

If a board control seeking requisition is served and the requisitionists and/or supporters of the requisition are constrained from acquiring shares by virtue of that concertedness, it will naturally be important to those parties as to when the Panel will view the concertedness as coming to an end. In such circumstances, it will always be necessary to consult with the Panel in determining this, but the Panel has laid down a number of factors which it will take into account in making this decision. Those factors include:

a) whether the parties have been successful in achieving their objectives through the requisition;

b) whether there are any other facts or circumstances which would suggest that the parties should continue to be viewed as acting in concert;

c) whether, notwithstanding the success of the requisition, there is evidence of an ongoing struggle between any of the activist shareholders and the board.

In assessing these issues, the Panel will take into account the nature of the activist shareholders, the relationship between them and the relationship with any of the new directors.

The Panel's approach to shareholder activism has largely been something which the Panel has ruled on, from time to time, on an ad hoc basis. On occasions, this has led to parties inadvertently falling foul of the definition of acting in concert with consequences that mandatory bid obligations have arisen.

By setting out specifically in the Code the Panel's approach to shareholder activism, this can only serve to create a more certain regulatory environment for those participating in this area. Bearing in mind the UK Government's desire to promote greater shareholder activism amongst institutional shareholders, these developments have broadly been welcomed.

Of course, as the Panel has now set out explicitly the parameters for determining whether a shareholder activist will be viewed as acting in concert in the Code, this reduces the scope for practitioners deciding to proceed with a proposal without seeking guidance from the Panel Executive in advance and then seeking to justify the position subsequently.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.