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Take-over season in Germany

A new German take-over law, which came into effect on 1 January 2002, brings more transparency and clarity to equity transactions and could improve exit prospects for venture capitalists. Michael Roos and Christian Cornett of SJ Berwin explain the new regulations and how they will affect the private equity industry.

The IPO-fever, which ravaged Germany in 1999 and 2000, is expected by some to be followed by take-over fever: ever since Mannesmann, one of the former pillars of the ‘Deutschland AG' world, was taken over by Vodafone, take-overs have become both the dominating mantra and trauma in the German market for corporate control.  At the crest of this wave, the German Chancellor himself ordered a commission of high-ranking industrial chiefs and experts to discuss the issues involved in establishing a German take-over law. While the proposed EU regulation fell apart, the new German law came into effect on 1 January 2002.

Here, we cover the take-over developments in Germany and try to anticipate potential changes while focusing on what the new German Take-over Act means for private equity in Germany.

General principles of the new Act

Take-Overs have been known in Germany for years, however, so far, there has not been any statutory regulation. The need for rules to play by, however, was recognised long ago. As the voluntary take-over code, the so-called Kodex, introduced in October 1995, has never been fully accepted, these principles have now been replaced by a new German Take-over Act: On 1 January 2002, the so-called Securities Purchase and Takeover Act (Gesetz zur Regelung von öffentlichen Angeboten zum Erwerb von Wertpapieren und von Unternehmensübernahmen - WpÜG, hereafter ‘Securities Acquisition and Take-over Act' short ‘Take-over Act' or the ‘Act') came into force. The Act introduces the first binding take-over law in Germany.

Most of the key principles and a number of the mechanisms of the new German Act are quite similar to mechanisms in other European jurisdictions, whether contained in statute or in other regimes, e.g. the UK City Code. Under the new law, a mandatory offer is triggered at a threshold of 30 per cent, the concert party concept applies, an assurance of payment is required, no special deals for board members are allowed etc. Amongst other issues, the concept of ‘acting in concert' is being incorporated for the first time into the German take-over regulations.

In general, the time-frame for carrying out a take-over is similar to the one in other jurisdictions: except for a special period of ten business days before the offer is published, during which the offer is under review for approval by the Federal Office for Securities Trading (Bundesaufsichtsamt für den Wertpapierhandel, BAWe), the time table for a public take-over bid under the new German Act is similar to the process in many modern take-over regimes: a 28 day announcement period (e.g. similar to the one in the UK) is followed by an offer period of between 28 and 70 days. An interfering competing offer resets the timetable.

Under the new German Act, the contents of offer document must include the latest financial statements, recent dealings, grounds for conditional acceptance on the offer etc - again, all similar to the procedures in other jurisdictions. And while the structure of the statute may seem unusual at first glance, in general, anyone familiar with market oriented take-over mechanisms in other jurisdictions will consider the German Act rather fair, despite its formal regime to be supervised by the Federal Office for Securities Trading. Nonetheless, some loopholes remain, thus offering various possibilities under the new Act.

Applicability of the Act

The Act applies not only to take-overs but also to all public acquisition offers, i.e. those bids not aimed at acquiring control or those aimed merely at the consolidation of an existing position of control. All such bids are now supervised by the Federal Office for Securities Trading. The Act foremost regulates the acquisition of shares and securities in German stock companies (Aktiengesellschaften, AG) which are domiciled in Germany and whose shares are listed on an organised market within the European Economic Area.

Mandatory offers - and loopholes

Under the Act anyone who acquires control, i.e. at least 30 per cent of the voting rights of a listed company, is under an obligation to make a mandatory bid for all shares of the target company. Under the previous self-regulatory take-over principles (now abolished and de facto not widely followed), the threshold was 50 per cent. Thus the threshold for determining the existence of control has been reduced from the current 50 per cent to 30 per cent. In a number of cases, voting rights held by a third party will be attributed to the bidder, e.g. shares held by a subsidiary company, shares held by a third party on behalf of the bidder, or shares which the bidder can acquire unilaterally, e.g. through qualified call options etc.

While the reduction of the threshold from 50 per cent to 30 per cent generally widens the scope of the Act, the change has resulted in regulatory arbitrage, and the race for loopholes started last year. A number of players, including private equity houses, realised that regulatory arbitrage offered various possibilities, both in connection with public to private transactions and in facilitating well structured and convenient exits, e.g. in connection with a reverse merger. A number of such transactions were structured in the last days before the Act came into force and have been carried out since. One strategy has been to pass the 30 per cent threshold, but not the 50 per cent threshold, before 1 January 2002 and consolidate the shareholdings after the law has come into force, since such consolidation does not trigger a mandatory bid under the Act and was also not caught by the now abolished voluntary regime. This has proved to be a source of creativity for a number of players.  A number of take-overs were structured accordingly for as long as both corporate investors and private equity houses (as well as their advisers) were enjoying the loophole.

Just like a number of stakes were acquired - or qualified call options agreed - in order to pass the 30 per cent threshold before 1 January 2002 (and thus avoid all mandatory offer rules), it seems evident, that the current shareholder structures will allow for a number of creative solutions to avoid/benefit from the new rules.  However, the solutions depend on the shareholder structure of the target company and its desire to exit.

Consideration for the shares

The Act states that the offeror must offer the shareholders of the target company adequate consideration. When determining ‘adequate consideration', the average stock exchange price of the shares in the target company and acquisitions of shares in the target company by the offeror (or persons acting in concert with the offeror) must be taken into account, however, where the transaction is stretched over more than three months, private equity houses should notice that the Act allows various ways for block trades in advance etc.

Consideration for the shares must be in cash or liquid shares admitted to trading on an organised market. Where compensation consists of shares, however, the shares offered must grant voting rights if the offer is made with respect to shares conferring voting rights. Consideration must be paid in cash where a total of at least five per cent of the target company has been acquired for payment in cash in the three months prior to the announcement of the decision to make the offer.  De facto, this rule will frequently (e.g. in a buy and build concept) allow a more flexible structuring of the take-over under the Act than under other take-over regimes (e.g. the UK City Code) in relation to a required offer in cash because the relevant reference period is only three months and deals are often structured so as to avoid the effect of this provision.  With respect to timing, it is worth pointing out that a cash offer must also be made in cases where, during the take-over, the offeror has acquired more than one per cent of the shares in the target company against cash within the acceptance period.

Frustrating actions

As in most jurisdictions, the management board of the target company is generally not permitted to do anything that might prevent an offer from succeeding.  However, contrary to the abolished EU take-over concept and existing rules in other European jurisdictions, the Act, in its final form, permits the management board of the target company to take the relevant defensive measures provided they have been approved by its supervisory board. This will inter alia allow for the use of authorised share capital as a defence instrument (e.g. by using shares as consideration for an acquisition). However, since generally other capital measures can only be used as a defence to the extent that the general meeting has authorised such measures, it may well be doubtful how effective the potential frustrating actions will be.  For private equity transactions structured as MBOs, this aspect of the Act can generally be disregarded, because private equity houses will have assured the co-operation of the management in advance.

On the other hand, private equity houses should really be aware of the possibility for the management to use authorised capital as acquisition currency, since this may open very attractive exit opportunities. This may, for example, be the case in situations where a public offer is not welcomed by a target company, and private equity houses may well consider offering existing portfolio-holdings to target companies to be used as a defence (poison-pills). Likewise, when a target is defending a hostile take-over-bid, private equity houses may well get the chance to buy a minor crown jewel - or even two.

Please also note that, contrary to other jurisdictions, German corporate law does neither recognise ‘golden shares' (e.g. providing veto-rights) nor multiple voting shares which effectively might prevent a take-over. Thus, in general, the arsenal of defence measures which could be taken by the management board to prevent a take-over is fairly limited.  Equally, there is no reason to suggest, that - just as before the Act came into force - good offers will be rejected - especially not where the offer is in cash. The private equity industry should therefore not feel threatened by the much-discussed possibility of frustrating actions.

Squeeze out

The Act also modifies the German Stock Corporation Act (Aktiengesetz) and introduces the squeeze-out concept to German law. Although introduced together with the Act and contrary to foreign regimes, the German squeeze-out provisions do not depend on the Offer itself and frequently the price to be paid under the squeeze-out will not be connected to the offer-price (except where the squeeze-out is made very shortly after the offer).

Under the new German law, any shareholder of a German Stock Corporation holding 95 per cent of the shares in a stock corporation can resolve, in a general stockholder's meeting, to transfer the shares held by the minority shareholders to himself in exchange for a cash compensation at market value. The minority shareholders may have the validity of the cash compensation examined by a special court procedure (Spruchstellenverfahren), however, they cannot contest the squeeze-out itself.

Seen from an investor's perspective, the new squeeze-out concept will inter alia be of help in public-to-private scenarios. In addition, a number of event-driven hedge funds have already recognised the potential of this new opportunity.

Summary - outlook

The new German Securities Acquisition and Take-over Act achieves considerably more clarity and greater transparency in German capital market related equity transactions.  Furthermore, owing to the ‘acting in concert' concept, avoidance of the regulations will now be more difficult. Yet, while the enforceability of the Act is widely guaranteed, the Act also contains rewarding loopholes. Whilst the potential for defensive and frustrating action by the target's board remains an obstacle to effective corporate control, it should not do any real damage to the private equity industry.

Bearing in mind that the German Tax Reform has enabled German companies to sell their stakes in other companies without taxable realisation of capital gains (an issue to be covered in a separate article in a future issue of AltAssets), purchasers have the chance to buy cheaply - and sellers are motivated to sell.

Thus, given this background, most analysts expect the number of take-overs in Germany to increase. The new Act promotes such take-overs de facto. The private-equity community, in particular, is expecting a large number of public to private transactions.

Copyright © 2002 SJ Berwin

Michael Roos is a partner and Christian Cornett an associate in the Frankfurt office of SJ Berwin.

SJ Berwin is a pan-European law firm with a particular focus on private equity. It has offices in London, Frankfurt, Munich, Berlin, Madrid, Paris and Brussels. If you would like further information on our services to the private equity industry please contact Jonathan Blake or Simon Witney in our London office 020 7533 2222 or visit our website at www.sjberwin.com