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of

Takeover Defence
strategies for mergers and acquisitions and planning defences against hostile takeovers now preoccupy many corporate managers. This article examines some of the steps that a company should take to plan and implement defence strategy against unfriendly takeover. It will focus on open joint stock companies since such companies are usually the battleeld in the corporate war.

The

Art

by Katerina S. KOKOT

erms such as poison pill, shark repellent and scorched earth defence might conjure up images of old action movies. Yet they are more than real in this era of economic warfare. In this connection designing Katerina S. Kokot is a senior attorney with PricewaterhouseCoopers
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I. The warning signals

There are some signs that tell you that the hunt for your company has begun and a predator is coming: 1. Suddenly minority shareholders start to get interested in the business af-

fairs of the company and start asking for copies of certain documents. 2. The company becomes the object of various inspections carried out by bodies of the state controll that are particularly interested in reviewing the companys register of shareholders, the list of major clients and creditors, information on assets of the company, etc. 3. The company and its executives become the target of negative publicity. 4. The number of small transactions in shares of the company has considerably increased. 5. Other companies in your industry have been attacked by raiders. 6. Unsolicited offers to sell the shares in the company have been received during the last few months.

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7. The company is ambushed with law suits, often with absurd claims for protection of the rights of minority shareholders.

II. Defence techniques Preventive measures

Preventive measures against hostile takeovers are much more effective than reactive measures implemented once takeover attempts have already been launched. The rst step in a companys defence, therefore, is for management and controlling shareholders to begin their preparations for a possible ght long before the battle is joined. There are several principal weapons in the hands of target management to prevent takeovers, some of which are described below. Control over the register The raider needs to know who the shareholders of the target are in order to approach them with the offer to sell their shares. With joint stock companies this information is contained in the share register. In particular, the share register provides for the possibility to identify the owners of the shares, quantity, nominal value and type of shares held by shareholders. So it is very important to ensure that non-authorized persons do not have access to the share register of the company by taking the following steps: Careful consideration is needed when choosing the registrar; the pref1

erence should be given to a reputable registrar; Check the track record of the share registrar in regards to its involvement in hostile takeovers in the past; Check who controls the registrar company. In case of transfer of shares to a nominee holder (custodian or depository) information on the beneciary owners of shares is not stated in the share register. Instead, the share register contains information on the nominee holders1. This makes it much more difcult for the raider to identify who is the real owner of the shares.

scheme it is important to ensure that the management of the subsidiaries is loyal to the parent company. In this way the raider who proceeds with a takeover may nd himself deprived of the very objective of his ambitions.

Preventive measures
against hostile takeovers are more effective than reactive
Golden parachute This measure discourages an unwanted takeover by offering lucrative benets to the current top executives, who may lose their job if their company is taken over by another rm. The triggering events that enable the golden parachute clause are change of control over the company and subsequent dismissal of the executive by a raider provided that this dismissal is outside the executives control (for instance, reduction in workforce2 or dismissal of the head of the board of directors due to the decision of the general meeting of shareholders provided such additional ground for dismissal is stated in the labour contract with the head of the board3). Benets written into the executives contracts may include items such as stock options, bonuses, hefty severance pay and so on. Golden parachutes can be prohibitively expensive for the acquiring rm and, therefore, may make undesirable suitors think twice before acquiring a company if they do not want to retain the targets management nor dismiss them at a high price. The golden parachute defence is widely used by American companies. The presence of golden parachute plans at Fortune 1000 companies increased from 35% in 1987 to 81% in 2001, according to a survey by Executive Compensation Advisory Services. Notable examples include ex- Mattel CEO Jill Barads USD 50 million departure payment, and Citigroup Inc. John Reeds USD 30 million in severance and USD 5 million per year for life.
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The nominee holder discloses the benecial shareholders to the registrar only in specic cases set forth in Ukrainian legislation. Under para 3 art. 36 of the Labor Code of Ukraine (CLL) the change of ownership over the company does not result in termination of an employees labor relations with a company. However, labor contract may be terminated by employer in case of reduction in workforce (clause 1 para 1 art. 40 of CLL). Under Ukrainian legislation and according to court practice, a company has the right to determine how many employees it needs and which jobs or job functions it will keep, so it may not be called upon to justify its decision in court. Under art. 65 of the Commercial Code of Ukraine conclusion of a labour contract with the head of the board of directors is mandatory. Under art. 21 of CCL the parties to the labour contract may agree on, inter alia, term of the contract, rights, obligations and responsibilities of the parties, grounds for termination of the labour contract, including early termination.

Control over debts Creditor indebtedness of the company may be used by a raider as the principal or auxiliary tool in the process of hostile takeover. In particular, the raider may employ so-called contract bankruptcy in order to acquire the assets of the target. In connection with this the following cautionary measures should be taken: Monitor the creditors of company carefully; Prevent overdue debts; If there is indirect evidence that a bankruptcy procedure is about to be launched, the company should do its best to pay all outstanding debts; Accumulate all the debts and risks relating to commercial activity of the company on a special purpose vehicle that does not hold any substantial assets. Cross shareholding Several subsidiaries of a company (at least three) have to be established, where the parent company owns 100% of share capital in each subsidiary. The parent transfers to subsidiaries the most valuable assets as a contribution to the share capital. Then the subsidiaries issue more shares. The amount of these should be more than four times the initial share capital. Subsidiaries then distribute the shares among themselves. The result of such an operation is that the parent owns less that 25% of the share capital of each subsidiary. In other words the parent company does not even have a blocking shareholding. When implementing this

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Change of control clauses (Shark Repellents) The company may include in loan agreements or some other agreements conditional covenants that in the event of the company passing under the control of a third party, the other party to the agreement has the right to accelerate the debt or terminate the contract. The result of such agreements is that a potential raider may not be sure whether it will be able to benet from important advantages enjoyed

It is important to remain exible in responding to changing dynamics of takeover techniques.

by the target. Although one of the effects of change of control clauses is to discourage raiders, their purpose is legitimate: to protect creditors from being placed in a worse position than they visualised.

right to acquire the paid up shares from the other shareholders only by sums that exceed the share capital. A corporate buy-back of its own shares increases the relative voting power of those shareholders friendly to management who do not tender their shares. However, if the charter of the company provides that the decision on buy-back of own shares falls within the competence of a general shareholders meeting, selftender may prove to be a rather timeconsuming exercise. In such a case the law requires that of shareholders should be notied about the general shareholders meeting at least 45 days in advance. The period of time necessary for proper convening the shareholders meeting may be enough for the raider to accumulate a sufcient quantity of shares to block the decision on buyback of shares. It should also be kept in mind that such shares must be disposed of or cancelled within a period of one year. During this period voting and determination of a quorum on the general shareholders meeting will be made without taking into account own shares bought by the company. Pacman defence This defence, named after the videogame, consists of a counter-purchase by the target of the shares against its attacker. In some cases it will sufce to buy even a small fraction of shares of the attacker to be able to initiate legal claims against the attacking company in the capacity of minority shareholder. Sometimes the company will be unable to buy the shares of a raider due to the lack of readily available funds or for some other reasons, e.g. the shares of the attacker are consolidated in the hands of shareholders friendly to the attacker. In this case the company or the persons afliated with the company may start to acquire other tools of inuence on the attacker or the business group it belongs to, e.g. rights of claim, debts, bills of exchange. Propaganda The company is well advised to make use of media to let the public know its

arguments against a takeover. The company may strengthen its positive image and emphasize its importance for the region/country and, at the same time, to put stress on the means of takeover tactics used by the raider that fall within the grey area of law or contradict the law altogether. A skilfully organized PR campaign may signicantly inuence the position of state bodies, shareholders and general public in favour of the company. White Knight A White Knight is a company (the good guy) that gallops to rescue the company that is facing a hostile takeover from another company (a Black Knight) by making a friendly offer to purchase the shares of the target company. The target may seek out a white knight by itself or with the help of investment bankers. People Pill Here, management threatens that in the event of a hostile takeover, the management team and the core specialists will resign at the same time en masse. This is especially useful if they are highly qualied employees who are crucial in identifying and developing business opportunities of the company. Losing them could seriously harm the company, especially if the company operates in hi-tech business where talented human resources are the main asset of the company. On the other hand, hostile takeovers often result in the management being red anyway, so the effectiveness of a people pill defence depends on the specic situation.

Post takeover defence

It is essential that the company starts to react immediately after the takeover attempt is launched. Otherwise the company may nd itself at a strategic and tactical disadvantage that may prove fatal. Litigation Bringing administrative claims or court proceedings against the raider is regarded as one of the most common antitakeover measures. A target of a hostile offer should search for any regulatory, securities law or other skeletons in the closet of the attacker. Court action can considerably lengthen the period of time needed to complete the takeover and reduce its chances of success by increasing the cost and by allowing time for the target to solicit competing bids or put up defences. Self-tender Under the Business Associations Act of Ukraine, a joint stock company has the
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III. Concluding remarks

Hostile takeover defence is an art, not a science. Careful advance preparation is necessary to ward off the unfriendly bids, as being prepared can well make the difference between success and failure. It is also important to remain exible in responding to changing dynamics of takeover techniques. A company must have an efcient defence strategy in place to provide maximum exibility in dealing with whatever the attacking company might throw its way. There is no one size ts all strategy to make the company takeover-proof. Therefore, a regular review of the takeover environment is essential as is keeping the available defences up to date.

The Ukrainian Journal of Business Law | September 2006