Stub equity in focus: Takeovers panel finalises revised guidance on insider participation

Following the consultation process commenced at the end of last year, the Takeovers Panel has recently published its revised Guidance Note 19 on insider participation in control transactions. We discuss the key changes to the Panel’s consultation draft and the implications for private equity transactions below.

In brief

• Following the consultation process commenced at the end of last year, the Takeovers Panel has recently published its revised Guidance Note 19 on insider participation in control transactions.
• The revised Guidance Note 19 contains the first substantive changes to the Guidance Note since 2007.
• In the revised guidance, the Panel has specifically addressed stub equity arrangements in the context of when an independent board committee (IBC) should normally be formed.
• In particular, the Panel notes that an insider who may receive a material stake or special advantages or rights from a holding of stub equity may be regarded as lacking independence until they rule out taking up the equity or commit to taking it up for no more than a small portion of their shareholding. The Panel has, however, acknowledged that the potential for a conflict of interest to arise will depend on the circumstances.
• The effect of the revised guidance is that particular care will need to be taken when it comes to managing potential conflicts of interest where stub equity and other relevant arrangements are being considered for directors in a potential control transaction. In particular, the changes made to the consultation draft mean issues of independence will need to be considered at an early stage.
• Importantly, directors’ duties will also need to be considered in managing any conflicts of interest that arise in connection with potential offers of stub equity and other arrangements.

Background

On 8 August 2023, following the consultation process commenced at the end of last year, the Takeovers Panel published a revised Guidance Note 19 on insider participation in control transactions.¹ The revised guidance note followed the receipt of submissions from 7 respondents, which are set out in the Panel’s response statement.²

We discuss the key changes to the final version of Guidance Note 19 from the Panel’s consultation paper below.³

The panel’s new Guidance Note 19

By way of recap, the key substantive changes brought in by the revised Guidance Note 19 are to:

• clarify the circumstances where the Panel considers a person may be an ‘insider’ or a ‘participating insider’, including by broadening the definition ‘participating insider’ to include an insider who is a bidder or potential bidder or who has a relationship with a bidder or potential bidder;
• clarify the Panel’s expectations as to when an ‘insider’ should disclose to the board or relevant sub-committee any approach that might lead to a control proposal;
• provide a non-exhaustive list of factors that the Panel will consider when determining whether unacceptable circumstances exist based on recent Panel decisions;
• provide that if all directors on a target board are ‘participating insiders’, the target should consider appointing at least one independent director to form an IBC; and
• provide additional guidance in relation to the Panel’s expectations regarding protocols adopted to manage potential conflicts of interests of participating insiders and the disclosure of insider participation to shareholders.

The changes specifically confirm that the guidance is applicable to takeover bids, schemes of arrangement and any other transactions that affect or are likely to affect control or potential control of a company or the acquisition or proposed acquisition of a substantial interest in a company.

The Panel also notes that the topic of insider participation is complex and content specific, and that the guidance note does not aim to be exhaustive in setting out all the circumstances in which an insider may, or may not, become a participating insider. The Panel’s approach to insiders is one of substance over form.

Key changes to the consultation draft

The key changes to the Panel’s final guidance from the consultation draft last year are below.

Definition of “insider” and notification by insiders

In its response statement, the Panel noted that it had received a number of submissions in relation to the updated definition of ‘insider’ and when an insider should notify the board or any relevant sub-committee of the target of any approaches that might lead to a control proposal.

The Panel has subsequently amended the final guidance so that an ‘insider’ does not capture a shareholder with material non-public information obtained through that person’s nominee on the board of the target, or the target’s advisers. This was in response to submissions that shareholders do not have a fiduciary relationship with the target and that it is common for prospective bidders to offer such arrangements to target shareholders under strict confidentiality.

The Panel also received submissions that it was unnecessary to include advisers as ‘insiders’ given that typically their role and duties in relation to conflicts will be set out in applicable mandate letters.

Stub equity arrangements

In relation to stub equity arrangements (that is, in simple terms, equity in the bidder or bid vehicle offered to target shareholders), the Panel referred to submissions stating that:

1. a director (or other insider) who has agreed or intends to take up an offer of stub equity for all or a substantial part of their shareholding should be regarded as a ‘participating insider’, as their interests diverge from the interests of other shareholders at that point; and
2. revised guidance should address that, if the proposed bid includes an offer of unlisted stub equity, an insider may be regarded as lacking independence unless and until they rule out taking up the equity or commit to take it up for no more than a small portion of their shareholding, and that an IBC may need to be formed immediately excluding a director who does not do so.

In response to these submissions, the Panel has clarified that the guidance does not aim to be exhaustive in setting out all the circumstances in which an insider may, or may not, become a participating insider and that the Panel’s approach is one of substance over form.

Importantly, however, the Panel has noted in the revised guidance that a director may be regarded as lacking independence unless and until they rule out taking up the relevant equity or commit to taking it up for no more than a small portion of their shareholding. The Panel has nonetheless specifically noted in its response that it had not prescribed an IBC be formed immediately excluding any such director in these circumstances, given stub equity arrangements are complex and that the potential for a conflict of interest to arise will depend on the circumstances.

Approach where all directors are participating insiders

As we noted in our article, ‘I’m an insider, I been burned by the fire: The Australian Takeovers Panel’s consultation paper on insider participation’, in the consultation draft of the revised Guidance Note 19, the Panel noted that companies should consider the appointment of an independent director to form an IBC where all directors are participating insiders. Consistent with our comments in that article, the Panel noted in its response statement that it received submissions that, while it may be desirable, there will be considerable practical difficulties in finding a truly independent director who will be prepared to go on to a target board without any underlying knowledge of the target’s business, operations and affairs, for the sole purpose of responding to a takeover bid or a scheme of arrangement.

In its response, the Panel acknowledged that it may be challenging to appoint at least one independent director to form an IBC, but that the Panel considers it is nonetheless best practice and that the consultation draft position reflected the Panel’s expectations.

Implications for private equity transactions

While the revised Guidance Note 19 is relevant to a range of scenarios involving the participation of insiders in control transactions, it has particular relevance for private equity transactions. This is because such transactions often involve the offer of stub equity to shareholders of the target and/or arrangements (including employment arrangements) with management in relation to the future operation of the target business.

The key principles emerging from the revised guidance are as follows:

1. a target director (such as the managing director) who is given an understanding by, or proposes to enter into, an agreement with a potential bidder to receive stub equity or to enter into certain employment arrangements with significant compensation or incentives in connection with a control transaction may be regarded as a ‘participating insider’;
2. where directors of the company are or may become a ‘participating insider’, the Panel’s view is that normally this will involve appointing an IBC and establishing appropriate protocols; and
3. circumstances which involve an insider potentially receiving a material stake or special advantages or rights from a holding of stub equity may compromise that person’s independence until the person rules out taking up the equity or commits to taking it up for no more than a small portion of their shares.

The effect of the revised guidance above is that, when it comes to managing conflicts of interest, particular care will need to be taken where stub equity and other relevant arrangements are being considered for directors in a potential control transaction. This is particularly so given the Panel has now noted that normally an IBC should be formed where a director may become a ‘participating insider’. As such, the Panel’s revised guidance means issues of independence will need to be considered at an early stage. Directors’ duties in relation to managing conflicts will also be relevant.

We welcome the clarity provided in the Panel’s response statement that it has not prescribed that an IBC be formed immediately excluding any director that has not ruled out taking up the equity or committing to take no more than a small portion of their shareholding. As the Panel notes, stub equity arrangements are complex, and issues of conflicts of interest will be specific to the circumstances.

1. See TP23/027.
2. Takeovers Panel, Public Consultation Response Statement: Guidance Note 19 – Insider Participation in Control Transactions (Response Statement, 8 August 2023).
3. Please refer to our article ‘I’m an insider, I been burned by the fire: The Australian Takeovers Panel’s consultation paper on insider participation’ by Tony Damian, Amelia Morgan and Michael Kralic for further detail on the background to and the key changes to Guidance Note 19 proposed in the consultation paper.