The law of corporate finance general principles and EU law volume III

The Law of Corporate Finance: General Principles and EU Law Petri Măantysaari The Law of Corporate Finance: General Principles and EU Law Volume III: Funding, Exit, Takeovers 123 Professor Petri Măantysaari Hanken School of Economics Handelsesplanaden 65100 Vaasa Finland petri.mantysaari@hanken.fi This title is part of a three volume set with ISBN 978-3-642-03105-2 ISBN 978-3-642-03057-4 e-ISBN 978-3-642-03058-1 DOI 10.1007/978-3-642-03058-1 Springer Heidelberg Dordrecht London New York Library of Congress Control Number: 2009938577 c Springer-Verlag Berlin Heidelberg 2010 This work is subject to copyright All rights are reserved, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilm or in any other way, and storage in data banks Duplication of this publication or parts thereof is permitted only under the provisions of the German Copyright Law of September 9, 1965, in its current version, and permission for use must always be obtained from Springer Violations are liable to prosecution under the German Copyright Law The use of general descriptive names, registered names, trademarks, etc in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use Cover design: WMXDesign GmbH, Heidelberg Printed on acid-free paper Springer is part of Springer Science+Business Media (www.springer.com) Table of Contents Introduction 1.1 Cash Flow, Risk, Agency, Information, Investments 1.2 Funding, Exit, Acquisitions .1 1.3 Financial Crisis 2 Funding: Introduction 2.1 General Remarks .3 2.2 Separation of Investment and Funding Decisions? 2.3 Forms of Funding, Funding Mix, Ancillary Services 2.4 Legal Risks Inherent in Funding Transactions 13 2.5 Particular Remarks on the Subprime Mortgage Crisis 17 2.6 Funding Transactions and Community Law 19 Reduction of External Funding Needs 21 3.1 Introduction 21 3.2 Retained Earnings 22 3.3 Management of Capital Invested in Assets 22 3.3.1 Introduction 22 3.3.2 Excursion: IFRS and Derecognition 23 3.3.3 Leasing .25 3.3.4 Sale and Lease-back 35 3.3.5 Repos and Securities Lending 39 3.4 Management of Working Capital 39 3.4.1 General Remarks 39 3.4.2 Management of Accounts Payable .40 3.4.3 Management of Accounts Receivable 44 3.4.4 Particular Aspects of Securitisation 57 3.4.5 Cash Management 70 3.5 Excursion: Basel II 81 Debt 83 4.1 Introduction 83 4.2 Management of Risk: General Remarks 87 4.3 Particular Clauses in Loan Facility Agreements 98 4.4 Prospectus 111 4.5 Particular Remarks on Corporate Bonds 112 VI Table of Contents 4.6 4.7 Particular Remarks on Securities in the Money Market 119 Particular Remarks on Syndicated Loans 125 Equity and Shareholders Capital 131 5.1 The Equity Technique, Different Perspectives 131 5.2 Share-based Equity and Equity That Is Not Share-based 138 5.3 The Legal Capital Regime 140 5.4 The Legal Capital Regime Under EU Company Law 145 5.5 Strategic Choices 158 5.6 Legal Aspects of Equity Provided by Shareholders 163 5.6.1 General Remarks 163 5.6.2 General Legal Aspects of Shares in Legal Entities 163 5.6.3 Shares in Partnerships 171 5.6.4 Shares in Limited Partnerships 172 5.6.5 Shares in Private Limited-liability Companies 173 5.7 Private Placements 180 5.8 Shares Admitted to Trading on a Regulated Market 183 5.9 Listing and the Information Management Regime 185 5.9.1 Introduction 185 5.9.2 Listing Conditions 193 5.9.3 Prospectus 199 5.9.4 Periodic and Ongoing Disclosure Obligations 205 5.9.5 Disclosure of Risk 207 5.9.6 Disclosure of Corporate Governance Matters 208 5.9.7 Prohibition of Market Abuse 209 5.9.8 Enforcement 215 5.9.9 Delisting 218 5.10 Shares as a Source of Cash 222 5.10.1 General Remarks 222 5.10.2 Management of Risk 224 5.10.3 Internal Corporate Action 234 5.11 Shares as a Means of Payment 236 5.11.1 Introduction 236 5.11.2 Community Law: General Remarks 237 5.11.3 Mergers and Share Exchanges 239 5.11.4 Mergers and Company Law 244 5.11.5 Share Exchanges and Company Law 256 5.11.6 Share Exchanges and Securities Markets Law 260 5.11.7 Fairness, Price, Existence of a Market 268 5.12 Shares as a Means to Purchase Other Goods 278 5.13 Share-based Executive Incentive Programmes 281 Mezzanine 283 6.1 Introduction 283 6.2 Example: Venture Capital Transactions 289 6.3 Loan-based Mezzanine Instruments 292 Table of Contents 6.4 6.5 VII 6.3.1 General Remarks 292 6.3.2 Structural Subordination of Debts 293 6.3.3 Repayment Schedules as a Form of Subordination 293 6.3.4 Statutory Subordination 294 6.3.5 Contractual Subordination of Debts 294 6.3.6 Contractual Subordination of Collateral 298 6.3.7 Structural Subordination of Collateral 300 6.3.8 Participation in Profits 300 Share-based Mezzanine Instruments 302 Profit-sharing Arrangements 306 Chain Structures and Control 309 7.1 General Remarks 309 7.2 Examples of Cases .309 7.3 Legal Risks 311 7.3.1 Parent 311 7.3.2 Companies Lower Down in the Chain .312 Exit: Introduction 315 8.1 General Remarks 315 8.2 Exit from the Perspective of the Investor 316 8.3 General Remarks on the Management of Risk 318 8.3.1 Introduction 318 8.3.2 Replacement Risk and Refinancing Risk 318 8.3.3 Risks Relating to Ownership Structure and Control .320 8.3.4 Counterparty Risks (Agency) in General 321 8.3.5 Information and Reputational Risk 321 Exit of Different Classes of Investors 325 9.1 General Remarks 325 9.2 Exit of Asset Investors .325 9.3 Exit of Debt Investors 327 9.4 Exit of Shareholders 328 10 Exit of Shareholders 329 10.1 Introduction 329 10.2 Cash Payments by the Company 329 10.2.1 General Remarks 329 10.2.2 Dividends and Other Distributions 331 10.2.3 Redemption of the Subscribed Capital .334 10.2.4 Share Buy-backs .335 10.2.5 Redeemable Shares 340 10.2.6 Withdrawal of Shares Otherwise 342 10.3 Third Party as a Source of Remuneration 342 10.3.1 Introduction 342 10.3.2 Clean Exit, Private Sale, Auction, IPO, Bids 343 VIII Table of Contents 10.4 10.5 10.6 10.7 10.3.3 Termination of a Joint-Venture 362 10.3.4 Privatisation 365 Mergers and Divisions 370 10.4.1 General Remarks 370 10.4.2 Mergers 370 10.4.3 Formation of a Holding SE 377 10.4.4 Divisions 378 Private Equity and Refinancing 383 Walking Away 388 Liquidation 389 11 Takeovers: Introduction 391 11.1 General Remarks, Parties 391 11.2 Structures 392 11.3 Consideration and Funding 398 11.4 Process 399 11.5 Contents of the Sales Contract 401 11.6 Summary 403 12 Acquisition of Shares in a Privately-owned Company for Cash 405 12.1 Introduction 405 12.2 Confidentiality 407 12.3 Preliminary Understanding 408 12.4 Ensuring Exclusivity, Deal Protection Devices 410 12.4.1 General Remarks 410 12.4.2 Exclusivity Clauses 411 12.4.3 Ensuring Exclusivity v Company Law 414 12.5 Signing, Conditions Precedent to Closing 417 12.6 Employee Issues 421 13 Due Diligence and Disclosures 427 13.1 General Remarks 427 13.2 Due Diligence in Practice 428 13.3 Legal Requirements and Legal Constraints 432 13.3.1 General Remarks 432 13.3.2 Vendor Due Diligence, Vendors Perspective 433 13.3.3 Buyer Due Diligence, Vendors Perspective 433 13.3.4 Buyer Due Diligence, Targets Board 436 13.3.5 Buyer Due Diligence, Buyers Perspective 440 13.3.6 Buyer Due Diligence, Buyers Board 442 13.4 Particular Remarks on External Fairness Opinions 443 14 Excursion: Merger Control 447 14.1 General Remarks 447 14.2 Jurisdiction 449 14.3 Complying with Community Law 452 14.4 National Merger Control 458 Table of Contents IX 15 Excursion: Sovereign Wealth Funds 459 15.1 General Remarks 459 15.2 Community Law 460 16 Key Provisions of the Acquisition Agreement 463 16.1 General Remarks 463 16.2 The Specifications of the Object 463 16.3 Excursion: Non-Competition Clauses 470 16.4 Remedies (Indemnities) .472 16.5 Purchase Price and the Payment Method 478 16.5.1 General Remarks 478 16.5.2 Choice of the Payment Method 479 16.5.3 Adjustment of Consideration 481 16.6 Buyer Due Diligence After Closing, Claims .486 16.7 Excursion: Auction Sale 487 17 Duties of the Board in the Context of Takeovers 491 17.1 General Remarks 491 17.2 In Whose Interests Shall Board Members Act? 491 17.3 Duty to Obtain Advice or to Give Advice 496 17.4 Takeover Defences and the Interests of the Firm 498 18 Takeover Defences .503 18.1 General Remarks 503 18.2 Pre-Bid Defences Well in Advance .506 18.3 Structural Takeover Defences, Control 506 18.4 Price-increasing Defences 507 18.5 Keeping Assets Away from the Acquirer 508 18.6 Securities Lending .509 18.7 The White Knight Defence 510 18.8 Poison Pills, Shareholder Rights Plans 511 18.9 Greenmail and Other Targeted Repurchase Actions 512 18.10 Tactical Litigation, Administrative Constraints 513 18.11 Example: Arcelor and Mittal .514 19 A Listed Company as the Target 519 19.1 General Remarks 519 19.2 Information Management: Secrecy v Disclosure .521 19.3 Toehold, Creeping Takeover, Major Holdings 524 19.4 Selective Disclosure Internally 531 19.5 Selective Disclosure to Lenders 533 19.6 Selective Disclosure to Outsiders by the Acquirer 533 19.7 Selective Disclosure to Outsiders by the Target 535 19.8 Disclosure to the Public .539 19.9 Acting in Concert, Acting in a Certain Capacity 541 19.10 Public Takeover Offers 543 X Table of Contents 20 Acquisition Finance 549 20.1 Introduction 549 20.2 Funding Mix 552 20.3 Particular Remarks on Securities Lending 555 20.4 Financial Assistance 556 20.5 Debt 564 20.5.1 General Remarks 564 20.5.2 Commitment of Banks 567 20.5.3 Many Legal Entities on the Side of the Borrower 570 20.5.4 Internal Coherence of Contracts 576 20.6 Shareholders Capital 579 20.7 Mezzanine 580 References 583 580 20 Acquisition Finance The issuing of shares may take the form of an IPO, a private placement, or a joint venture 20.7 Mezzanine Mezzanine capital can close the gap between traditional shareholders capital and debt financing As explained in Chapter 6, mezzanine financing can consist of debt mezzanine or equity mezzanine instruments In other words, the equity technique means that debt instruments are made to behave more like shares and shares more like debt instruments (section 5.1) Mezzanine financing can complement traditional sources of financing where the acquirers capital requirements are substantial or the acquirer needs flexibility when structuring its financing mix Mezzanine capital is popular even in the expansion phase of the firm Mezzanine loans The buy-out transaction may only justify a limited amount of senior debt on typical senior debt margins, fees, and gearing If further debt is required to fund the acquisition, mezzanine debt may be available at a higher price.115 In large transactions, mezzanine debt can form an important part of the funding package For lenders, mezzanine loans are a source of additional arranging and other fees They are also a source of higher margins.116 In addition, mezzanine loans can bring other benefits There is typically a component that enables mezzanine lenders to benefit from the increase of the value of the targets shares The firm should take the cost of those benefits into account and should also investigate whether the benefits can reduce the margin The margins are higher because of the use of subordination techniques Typically, mezzanine loans are subordinated in the event of insolvency (but not to the extent that their ranking falls as low as that of the claims of shareholders).117 In addition, mezzanine loans will have a longer maturity compared with senior loans and may have a to 10 year term There is generally a one-time payment at the expiry of the loan term (bullet repayment) often combined with early prepayment premiums Like mezzanine debt itself, collateral will typically be subordinated Mezzanine loans can benefit from security from the target company or security and guarantees from target group companies, ranking behind the senior loans.118 Where investors expect the value of the acquirer to increase, investors may prefer to get their share of it This can be achieved through an equity kicker The equity kicker can be real or synthetic 115 Gayle C, Acquisition Finance Syndication Best Practice, Int Comp Comm L R 13(8) (2002) p 300 116 Ibid, p 301 117 For example, in Switzerland, contracts are drafted so as to avoid subordination as defined in Art 725(2) OR (Obligationenrecht, the Code of Obligations) See Barthold BM, Mezzanine-Finanzierung von Unternehmensỹbernahmen, SZW/RSDA 5/2000 p 232 118 Gayle C, op cit, p 301; Diem A, op cit, Đ 38 number 20 20.7 Mezzanine 581 Real equity kickers such as share option rights, conversion rights, or transferable warrants can give the mezzanine lenders a share in an equity upside Where the equity kicker does entitle its holder to subscribe for shares, the firm must comply with particular company law rules rules on the issuing of share option rights or similar rights; rules on the increase of the number of shares; rules on the preemptive rights of existing shareholders; and, in most cases, rules on the increase of the legal capital of the company (section 5.4).119 For example, when a German AG issues warrants, it must create conditional capital (bedingtes Kapital) in anticipation of the exercise of those rights.120 The creation of conditional capital must be authorised by a qualified majority of three-fourths at the general meeting.121 In contrast, a German GmbH cannot create conditional capital Instead, a GmbH could in principle decide on an increase in capital and the waiving of pre-emptive rights.122 When a mezzanine investor exercises his share option rights, conversion rights, or warrants, the ownership structure of the company will change In order to avoid it, the firm and its owners often ensure that the equity kicker may be exercised immediately before an IPO or a trade sale and may not be exercised earlier.123 Alternatively, the controlling shareholders of the firm and the mezzanine investors can choose a synthetic equity kicker such as a tag-along right (see below) or a back-ended fee (see below) Synthetic equity kickers neither entitle their holders to subscribe for shares nor dilute the existing ownership of the firm A tag-along right is triggered in the event of the sale of the controlling block in the firm A tag-along right can consist of an obligation of the controlling shareholders to ensure that mezzanine investors will have an option to sell their mezzanine instruments to the buyer of the controlling block at the same price per instrument as the price paid for each share.124 A back-ended fee is an additional payment on top of the purchase price It will be made after the expiry of a certain period of time on the basis of the performance of the firm.125 The amount of share option rights or conversion rights is set to provide the lenders with a target rate of return on their investment based on the loan yield plus the value of the equity kicker.126 Equity mezzanine In acquisition finance, mezzanine loans (that is, subordinated debt instruments with an equity component) are more common than mezzanine 119 For Swiss law, see Barthold BM, op cit, pp 228230 Đ 192(1) AktG For the contents of the decision to create conditional capital, see Đ 193 AktG 121 Đ 193 AktG This fulfils the requirements of the Second Company Law Directive See Articles 25 and 29 of Directive 77/91/EEC (Second Company Law Directive) 122 ĐĐ 53(2) and 54(1) GmbHG 123 Diem A, op cit, Đ 38 number 16 124 Ibid, Đ 38 number 17 125 See, for example, Barthold BM, op cit, pp 226227 126 Diem A, op cit, Đ 38 number 15; Gayle C, op cit, p 301 120 582 20 Acquisition Finance shares (that is, shares that are made to behave more like bonds) or other forms of equity mezzanine Popular forms of equity mezzanine include preference shares,127 German-type participatory rights (Genussscheine), and US-type preferred stock, 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CBC-RPS No 0039 (October 2008) 594 References Zimmermann C, An approach to writing loan agreement covenants, Journal of Commercial Bank Lending (1975) pp 213228 Zumbansen P, Archer SB, The BCE Decision: Reflections on the Firm as a Contractual Organization (July 14, 2008) CLPE Research Paper No 17/2008 [...]... depend on the form of funding (reduction of capital needs, debt, equity, mezzanine), the enterprise form of the firm, the category of investors, the particular aspects of the transaction, and other circumstances such as the governing law The legal framework that governs the funding transaction and the related agency relationships between the firm and its various investors depends on the form of the funding... Management of Capital Invested in Assets 27 Leasing is always based on a contract between the lessor and the lessee The lessee may use the asset, but the ownership of the asset will remain with the lessor This enables the parties to agree on the allocation of risks associated with the residual value of the asset On the other hand, the parties will have to address the question of to whom the asset will... and so forth The management of capital invested in tangible and intangible assets may typically have the largest impact on the firm’s funding needs and will therefore be discussed first Such questions will be followed by the management of working capital, cash management, and the special case of financial institutions P Mäntysaari, The Law of Corporate Finance: General Principles and EU Law, DOI 10.1007/... manage the availability and cost of funding Key funding-related cash flow questions include: access to funding; the mechanism of raising funds; the management of costs and the mechanism of payment of costs; and the repayment of funds The modalities of the transaction are, to a large extent, determined by its structure The cost of funding is influenced not only by agreements, but also by tax aspects and the. .. gearing and dividends However, the Modigliani-Miller theorem does not hold in a world with agency costs, asymmetric information, and other market imperfections The choice of the financial structure of the firm can affect its value The irrelevance theory is true only in circumstances so rare that they are the exception rather than the rule.11 There is no universal theory of the debt-equity choice There... deeply out of the money (an option so far out of the money it is highly unlikely to go into the money before expiry) On the other hand, the entity must continue to recognise the asset if it retains substantially all the risks and rewards of ownership of the asset Derecognition requires the transferor’s exposure to the risks and rewards of ownership to change substantially.12 There are many examples of when... structuring of the acquisition can therefore be influenced by the interests of the lenders and other investors and depend on the structuring of the funding transaction The connection between investment and funding decisions can be illustrated by the takeovers of Chrysler, an American car manufacturer, and ABN Amro, a Dutch bank Chrysler In 2007, the suddenly tightening market for corporate debt and the high... Investments The first volume dealt with the management of: cash flow (and the exchange of goods and services); risk; agency relationships; and information The firm manages these aspects by legal tools and practices in the context of all commercial transactions The second volume discussed investments As voluntary contracts belong to the most important legal tools available to the firm, the second volume. .. “owners” in the first place and that they do not share the same interests Corporate finance law In corporate finance law, questions of funding and investment are, for four reasons, very often connected First, the providers of funding also provide ancillary services (section 2.3 below) Who holds the claim in general matters.3 Some investments are not possible without the ancillary services of certain finance. .. also means the choice of a mix of agents providing a mix of ancillary services like monitoring the firm’s management and ensuring the long-term survival of the firm Second, one of the core duties of the firm’s top management, as its agents, is to decide on the allocation of value and risk between different stakeholders Many of them (shareholders, creditors, and asset investors) are providers of funding