Staging foreign takeovers in Germany

Author: | Published: 10 Oct 2001
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This article has been compiled mainly for the benefit of foreign investors contemplating to stage a public takeover bid in Germany. The article is less legalistic than other publications on the same subject may have been. The article attempts to give interested foreign parties a first insight as to what to expect when staging a public bid in or into Germany. When focussing on the issues described we have tried to summarize those which have been brought to our attention or have been typically addressed by either foreign investors or by investment banks acting as financial advisers for those.

Economic overview

Hostile takeovers have been virtually unknown to the German business world for a long time. Most takeovers have been friendly and, if not so in the beginning, a consensus was reached in the course of the then-friendly bid. A first major attempt at an all domestic hostile takeover took place in 1997 when Krupp tried to take over Thyssen. In the end, the deal went through as a consensual (recommended) merger. The most spectacular recent case was Vodafone's hostile bid for Mannesmann, which was eventually concluded on friendly terms. This peaceful picture of only friendly takeovers will rapidly change because of the increased liquidity and transparency of the capital markets, and because institutional and private investors have motivated stock corporations to focus more heavily on the shareholder value.

Should we expect an increased number of takeovers in the future under the new German Takeover Act? The main targets of takeovers are obviously those enterprises with high earnings, a high earnings potential or particularly attractive assets, including licences, patents or attractive subsidiaries. While many enterprises of the old economy (if one were to accept such distinction for the purposes of this article) will aim at staying independent and may also have the financial means to defend against a hostile takeover bid, the same is doubtful for start-up companies of the new economy. These companies - now often on the edge of insolvency – are likely to be targets of takeover bids if they hold assets that promise high revenues in the future, such as advanced computer programmes or high-tech developments that can be commercially used for the benefit of the bidder. But most of these bids will not be hostile. After all, to many of the new economy enterprises the takeover by a financially potent bidder may be the only chance of survival.

This trend has been far reaching, prompting US and UK private equity houses to increase their activities in Germany. Despite general market conditions at present, the German markets are becoming more attractive to foreign investment. Notable public transactions include: Deutsche Telekom/Telecom Italia, Hoechst/Rhone-Poulenc, Degussa/Hüls, VEBA/VIAG, Vodafone/Mannesmann, KPN/E-Plus Mobilfunk. And yet, there are relatively few of these transactions and consequently there is little precedent. In the year 2000 to 2001 in the UK there were 198 published takeover or merger proposals of which 193 reached the stage where formal documents were sent to shareholders. 15 of these remained unrecommenced at the end of the offer period, of which nine lapsed (source: the Takeover Panel, annual report 2001).

Historic development

German domestic and cross-border mergers and acquisitions have become increasingly significant, not only for bidder and target companies, but also for investment banks and law firms. However, until now neither the EU nor Germany had enacted any binding legal instrument that deals with the specific problems arising out of public takeover offers. The main sources of binding rules for public takeovers in Germany are varied. This is even more surprising as the problems of takeover bids, particularly with regard to a fair procedure of the public offer and to the rights of a target company's shareholders, are obvious and uncontested. The fact that there have been attempts within the EU since the 1970s to find a commonly acceptable solution for a European directive shows how problematic it has been to reach a compromise on this issue.

Under Germany's presidency of the EU council, there has been a particularly strong movement in the EU to launch a takeover directive. Surprisingly, on July 4 2001, the EU Parliament failed to form a simple majority necessary to pass the draft. Different reasons for the failure of the draft are being discussed. The German government has confirmed that it deemed the defence measures available to target companies against hostile takeovers to be insufficient. Also under consideration is whether the Italian government finally opposed the draft due to hostile takeover attempts taking place in Italy. However, it was recently announced by EU officials that a new initiative will be brought about soon to finally come up with a European Directive. However, Germany has enacted its new law. It replaces the voluntary code of conduct, which contained – other than the former rules of good conduct – a mandatory minimum offer to minority shareholders. Since April 2001, 755 of the 1,016 stock corporations listed on stock exchanges have acknowledged this code of conduct, which means that a significant proportion of German stock corporations – with a high capitalization – still reject the code while other countries have either enacted binding rules or have a set of rules on a self-regulatory basis, such as the City Code on Takeovers and Mergers in the UK.

This may explain Germany's eagerness to enact a law on public offers, which was finally passed by the German parliament on July 11 2001 and will take effect January 1 2002. The law will be of major significance. Mergers and acquisitions will play an ever greater role in the future, a process that is caused not only by the globalization of the markets but also – as far as Germany is concerned – by the reform of the corporate taxation that will take effect in 2002 and will exempt corporations' capital gains from taxation.

The new German Securities Acquisition and Takeover Act

The enactment of the German Takeover Act is driven by the idea of laying down a set of binding rules that will ensure a fair and systematic procedure of bids and takeovers including certain obligations on behalf of the bidder as well as the target company. It will apply to public limited companies (Aktiengesellschaft) and partnerships limited by shares (Kommanditgesellschaft auf Aktien). The enactment of the German takeover legislation will simultaneously trigger changes to the German Securities Trade Act as well as the Stock Corporation Act.

Applicability to German targets

The Takeover Act does not look to the offeror but rather to the target company. The Act is applicable to the acquisition of stock of target companies that are admitted to trading at an organized market. The term target company is defined in §2(3) as a public limited company or partnership limited by shares that is incorporated in Germany. The term organized market is defined as official trading or the unofficial market at a stock exchange in Germany or the unofficial trading of securities in another member state of the European Economic Area. The requirement to be met in order to apply the new German law is therefore twofold: the target company has to be incorporated in Germany and must be admitted to trading at an organized market.

Fair and equal treatment

The Takeover Act sets out a few general principles. These principles, which are to be considered in interpreting specific provisions, are: all holders of the same kind of shares must be treated equally. This aims to avoid a race among the shareholders in accepting the offer because the bidder has graded the consideration depending on the time of the acceptance. First come - first served offers are not permissible. All shareholders of the target company must be given sufficient time and information in order to make an informed judgment on the offer. The board of directors and the management board have to act in the interest of the target company. With this provision the legislator underlines that the management may under no circumstances accept or refuse an offer because it provides a personal advantage or disadvantage – financially or otherwise – to members of the management.

Disclosure and stakebuilding

The German rules on disclosure and stakebuilding in preparation of a public bid are not very complex: under the German Securities Trade Act, anyone who acquires a certain percentage of stock in a public limited company (5%, 10%, 25%, 50%, 75%, the so-called threshold values) has to notify the target company and the Federal Securities Supervisory Office (FSSO) of such acquisition. Under the new law, the bidder immediately has to publish the management board's decision about a public bid, independent from any given or anticipated threshold stake, even if the decision depends on the outstanding approval of its shareholders. The new law furthermore sets forth more detailed rules about the procedure that the bidder has to comply with in the course of the public announcement.

General requirements for public offers

With regard to the offer itself, the German Takeover Act stipulates certain requirements of the content and differentiates between all public offers and those where the offeror intends to acquire control over the target company. Any public offer requires the public announcement of "all facts that are necessary to make an informed judgment with regard to the offer". The bidder has to provide information about the terms and conditions of the offer, for instance as to the amount and kind of consideration offered for the target company's stock, or about the beginning and end of the period of acceptance. Supplementary information is required and must state how the bidder will ensure the availability of the necessary financial means for the fulfilment of the bid, in addition to the implications that a successful bid will have on the bidder's capital, financial and earnings situation. It must also state the bidder's intentions concerning the future commercial activities of the target company. All of this information has to be provided in the German language (a consequence of the fact that this had not always been the case in the Vodafone/Mannesmann battle). It should be noted that the German Ministry of Finance can, by way of inquiry or administrative ruling (Rechtsverordnung), modify and amend the catalogue of requirements later in order to cope with legislative deficiencies and the lack of detail of the German Takeover Act itself.

Public offers to acquire control

In the case of an offer to acquire control over the target company – control being defined as holding 30% or more of the voting stock – the offeror has to comply with additional requirements. The consideration for the stock of the target company has to be "equitable". In computing the price the average stock exchange price, as well as acquisitions of the target company's stock by the bidder, must be considered. The consideration must be cash or liquid stock listed at an organized market. If such stock is offered in exchange for voting stock, the offered stock has to be voting stock as well. Cash is only permitted if the bidder has acquired either: (i) any stock in the target company against cash after the announcement of the offer and prior to the end of the period of acceptance; or (ii) 5% of the stock or voting rights within three months prior to the public announcement. If the bidder acquires stock of the target company after the public announcement, and pays or agrees to pay an amount above the one fixed in the public offer, that latter's price is automatically increased by the difference of the two prices. Any takeover bid has to be made to all shareholders of the target company.

Consideration in kind

For foreign bidders it will be of special interest to pay in shares rather than making a cash offer. The provisions about consideration in the new Takeover Act differentiate between all public offers and those with the intent to acquire control. All offer documents must contain details of the type and amount of consideration offered in exchange for the shares in the target company. This provision implicitly confirms that there are no restrictions on the kind of consideration in a public offer. Things are different, though, if a public offer is launched with the intent to acquire control over the target company. As mentioned before, in this case the consideration must be cash or liquid stock that is admitted to trading at an organized market. It seems noteworthy that the exchange of stock in this context does not aim at giving the transaction the quality of a merger. Therefore there is no requirement that the stock must be shares in either the offeror or any related company; it can be an interest in any other enterprise. In this context, the stock given away by the bidder as consideration is simply a substitute for cash.

Prospectus liability of financing banks

Two provisions of the Takeover Act, §12 and §13, are delicate and deserve special attention. If any information in the offer documents (§11) is incorrect or incomplete any shareholder who accepts the offer and suffers damage from the acceptance has a claim against: (i) the one who has taken responsibility for the offer documents; and (ii) anyone who has caused the issue of the offer documents. The scope of this provision with regard to liable persons and institutions is, according to the express legislative intent, identical to the one in §45 of the German Stock Exchange Act, which deals with liability due to an incorrect prospectus in the course of the issuance of stock. It is unanimously understood that the provision covers a bank that assists in such issue. Banks will therefore, in the same way, be responsible and liable under §12 of the new German Takeover Act. There is no way for banks to escape this liability as long as the consideration offered to shareholders for their shares is cash: In this case, it is mandatory for the offeror in the course of the public bid to provide an independent bank's confirmation that it has taken the necessary steps to ensure that the funds needed to completely fulfil the offer are available to the bidder. By this confirmation, the bank may have taken responsibility for the offer documents and may be just as liable to the shareholder as the offeror if any damage occurs.

This results in serious extension of a bank's liability in the context of public bids. One way to mitigate this sharp provision from a bank's standpoint is to have an agreement of recourse with the offeror. If the offeror is a subsidiary of a foreign company, which would typically be the case for US inbound bids into Germany it may be possible to obtain an advance exoneration from any liability from the offeror's parent company, in case the offeror itself becomes insolvent. However, none of this relieves the bank from its joint and several liability with the offeror to the target company's shareholders.

Mandatory offers

The fact of a bidder having acquired control over a target company has to be announced publicly as well as the share of the voting stock then held. Disclosure must be made within seven calendar days. The bidder has to submit the publication to the FSSO and to the management of the target company. Within a further four weeks the bidder must make a public offer to acquire the remaining stock of the target company. Exceptions to this far-reaching rule apply in several circumstances, most importantly if the offeror has acquired control over the target company in the course of a takeover bid – in this case the bidder has qualitatively already fulfilled the requirements of a mandatory offer. The rules about mandatory offers do also not apply to the target company's treasury stock or to its stock held by a target company's subsidiary. The FSSO may, at its discretion, dispense the offeror from the mandatory offer if this seems to be justified.

Defence measures

The German Takeover Act does not distinguish between recommended (friendly) and offensive (hostile) takeovers. This is surprising, since the issue that has mainly led to Germany's rejection of the EU takeover directive was a fear of excessive restrictions on the defence measures a target company may take in order to ward off takeovers. It was commonly understood that, under the proposed EU directive, poison pill defences, in particular, were not permissible. Such poison pills could, for instance, be the vesting of an option for the benefit of a third party to acquire shares or assets of the target, the cancellation or redemption of shares or the issue of new shares to a third party. Such measures would have to be set out in the target company's articles of incorporation and will be triggered automatically if a certain event occurs, especially if a bidder acquires a certain percentage of the voting stock of the target company. The effectiveness of poison pills in scaring off hostile bidders is uncontested and has a long history in the US. In Europe, it has rather been used to protect state-owned or controlled enterprises in infrastractural industries.

The German government, apparently in line with the management of most of Germany's blue chip companies, deems such defence measures acceptable against hostile bids and has included a section in its Takeover Act that implies the permissibility of such measures. However, any measure by the management or board of directors of a target company after the publication of an offer, which might prevent the success of the offer, needs the approval of a shareholder meeting, with the particular exception of the search for a competing offer (white knight). Any shareholder approval given prior to a public offer (store resolution) must specifically name the anticipated measures.

Another significant way for the target company to avoid or at least impede the bidder's chances of success are capital measures. Under German stock corporation law, the shareholders can issue fresh capital, either as authorized capital (genehmigtes Kapital) or conditional capital (bedingtes Kapital). The creation of additional capital needs the prior approval of a shareholders' meeting including precise guidelines about the intended purpose of the use of such capital. This newly created capital can be used in several ways against takeover bids. The target company may issue additional shares and therefore jeopardize the bidder's financing. A public takeover bid has to extend to all shares of the target company; that includes also the newly issued shares.

The target company may also use capital to acquire its own shares, which will most often lead to a higher price at the stock exchange and may again make the bid more expensive and possibly even unworkable for the bidder. The target company can also acquire a competitor of the bidder, which may lead to problems of competition law, in case the bidder succeeds.

Squeeze out strategies

A major topic in structuring takeovers is the bidder's aim to get rid of any other shareholders that may interfere with the new owner. This desire is understandable given the protection German corporate law awards to minority shareholders. For instance, any minority shareholder has the irrevocable right to bring avoidance actions against resolutions adopted in shareholder meetings. Even if such action turns out to be unjustified and is later dismissed by the court it may hamper the implementation of economically important decisions while the court decides the issue.

Prior to the effect of the new law, German corporate law provided only very limited possibilities to oust shareholders, and even those only for exceptional circumstances. The German Takeover Act effects changes in the Stock Corporation Act. Now, as of January 1 2001, a shareholder meeting may vote, upon proposal by a majority shareholder holding 95% of a company's stock, that the minority shareholders must surrender their shares to the majority shareholder in exchange for a reasonable cash compensation. The description of the provision illustrates its narrow scope: one majority shareholder has to hold 95% of the shares, which minority shareholders with shares of more than 5% can easily avoid by holding on to their shares. Therefore, in order to effect a squeeze out, bidder companies will continue to resort to measures that will make the shares of the minority shareholders economically unattractive.

One way to make minority shares unattractive is to transform the public limited company (Aktiengesellschaft) into a private limited company (GmbH), which automatically delists (cold delisting). This could be done with a three-quarter majority of the votes cast at a shareholders' meeting. This transformation may make the share in the corporation unattractive only for the reason that shares in private limited companies in Germany always have been much less fungible than shares in public limited companies. Any shareholder opposing the transformation must be offered adequate cash compensation; if the shareholder accepts the compensation the company acquires its share. It should be noted that this shareholder may not bring an action against the validity of the transformation resolution on the grounds that the cash compensation was unfair, but the court may, upon motion by the shareholder, assess a higher compensation.

The same reason – lack of fungibility of shares – may cause minority shareholders to sell their shares in the case of a valid delisting without transformation where the target company withdraws from the stock exchange listing. Such "structural measure of outstanding significance" (quoting the current view of the German Federal High Court of Justice) also requires a three-quarters majority in the shareholders meeting.

Another way of ousting shareholders could be to merge the target company into a parent company. The shareholder approval of the merger requires a three-quarters majority of both companies. In the course of the merger the shareholders of the target company receive shares in the parent company as consideration for their shares in the target company. This exchange of shares has to take place on adequate terms. Shareholders opposing the transaction – for whatever reason – have to be offered cash compensation, which again is subject to judicial review.

Of the before-mentioned economic measures, none allows the mandatory withdrawal of shareholders from target and parent company – what would be of strategic importance in this context. The shareholders may keep their shares or receive shares in the parent company. A significant way of getting rid of minority shareholders is therefore the so-called cold squeeze-out, in which the target company sells all assets to a fully-owned new subsidiary of the bidder and is subsequently dissolved. This can be done with a three-quarters majority of the target company's shareholders approving.

Due diligence and insider trading

In the case of a public offer the bidder is limited to information publicly accessible in Germany. Public sources include the commercial register, stock market releases and intellectual property registers and, within limits, the German land registers. Despite the scope of these sources, they may still fail to present the bidder with a full picture. Insider trading rules restrict the management from disclosing vast amounts of information.

Typical structure

A typical structure of an acquisition by a foreign company of a German target company that is publicly listed could be as demonstrated in the chart below for a US bidder.

Step 1. Setting up of German subsidiary
  • German NewCo (AG or GmbH) incorporated by US company as wholly owned (unlisted) subsidiary
Step 2. German NewCo offers for Target Co
  • Capital increase of US company for German NewCo
  • German NewCo offers shares (and cash) to Target Co shareholders
Step 3. Interim Structure
  • US company share will be held by US company shareholders and Target Co shareholders accepting the offer
  • German Co shares will be held by German NewCo and Target Co shareholders not accepting the offer
  • If 95% acceptances, possible squeeze out of remaining Target Co shareholders (under new German law from January 2002 onwards), or
  • Merger of Target Co into NewCo, or
  • Asset deal between Target Co and NewCo Transaction Structures
Step 4. Merger ("Verschmelzung") of German NewCo and Target Co
  • Merger of Target Co into German NewCo by qualified majority ("Verschmelzung")
  • Shareholders of Target Co not accepting offer become shareholders of German NewCo by law (automatic delisting of Target Co)

Summary

The new German Takeover Act provides a set of rules that in particular impair the bidder's freedom to act in the course of the bid. Mandatory measures like the equal treatment of shareholders, the public announcement of the bid, proof of sufficient funds for its financing or the obligation to grant substantial information to the shareholders are evidence for this. All of these requirements effect a better protection not only for the shareholders, but certainly for the target company itself. The legislator has put the latter in an even better position by authorizing the above-discussed defence measures in the spelled-out limits. After all, the new Takeover Act provides very strong measures of protection to target companies and its shareholders, especially against hostile takeovers. However, the German Takeover Act also improves the ability of a new majority shareholder to genuinely squeeze-out the minority shareholders. The economic development of the markets will certainly not be blocked by this new German law.


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