All companies are equal, but some companies are more equal than others

The new Industrial Strategy under the May Government and its implications for regulating takeovers in the UK

By Dr Georgina Tsagas, Lecturer in Law (University of Bristol Law School).

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The regulation of takeovers constitutes a highly sensitive topic insofar as takeovers may be the means by which control over a typically dominant corporation in one EU Member State is transferred from its holder to a foreign acquirer. The issue of how takeovers are regulated is therefore not only of interest to investors and the broader business community, but is ultimately an issue which attracts the interest of national governments and industry-specific authorities, as it can affect important institutions within a Member States’ economy.

The phrase ‘All animals are equal, but some animals are more equal than others’ is one of the most memorable phrases of George Orwell’s highly political literary book ‘The animal farm’. The story narrates how the animals of the farm attempt to revolt against man as their ruler in order to create a farm which will be run by all animals on an equal basis. However, certain animals eventually prevail over others abusing their power, collaborating with the former ruler and dominating in the same way in which the ruler they had overthrown had. ‘The animal farm’ constitutes a satirical allegory of the Russian Revolution and in essence criticizes the way in which control is in fact exercised in societies that have otherwise been founded on the ideology of equality. Though not a society per se, but rather a union of Member States, the EU has been founded on similar principles of equality or rather principles of ‘non-discrimination’ introducing the four freedoms which apply to natural, as well as to legal persons throughout the Union.

Out of the four freedoms, the free movement of capital is of most relevance to the Commission’s goal of facilitating takeover activity throughout the EU. Directive 2004/25/EC of the European Parliament and the Council of 21 April 2004 on Takeover Bids, known as the 13th Directive on Takeovers, was adopted in 2004 with a deadline of implementation by 2006. As part of the Financial Services Action Plan in Europe, it has been one of the key steps taken towards achieving the single market and has played an important role in the creation of the modern regulatory framework for European corporate law. The 13th Directive on Takeover Bids was intended to constitute the harmonised regulatory framework that would effectively regulate and facilitate cross-border takeovers.

An options-free version of the Takeover Directive fosters the free movement of capital, as it removes the perceived barriers to cross-border investments and subsequently takeover activity, by allowing a bidder to gain control over the targeted publicly listed company through the unrestricted acquisition of shares. Interestingly enough, the proposal for the Takeover Directive was greatly influenced by the UK. The UK, possessing the most active takeover market in the EU, had managed to introduce the provisions which form the basis of UK regulation on takeover bids encompassed in the UK City Code on Takeovers and Mergers (the City Code), with the aim of breaking down the laws of other Member States, such as Germany and the Netherlands, that were hostile towards an open market for corporate control.

In terms of financial welfare, hostile takeovers possess a specific positive rationale of replacing a less productive management with a more competent one. The British economy, predominantly based on the efficiency of its companies, has so far provided for rules that favour the success of such acquisitions. The non-frustration rule of the Code, Rule 21, prohibits directors from using any sort of defence mechanism to block an acquisition, once a bid is imminent, without first obtaining shareholder approval. In the UK the policy underlying company and financial law has generally developed along the lines of affording shareholders significant protection against management.  This is most evident in the case of the City Code, which provides shareholders with the exclusive right to decide on the merits of a bid.

Times have changed and following Theresa May’s speech opting for a hard Brexit and leaving the single market, the UK may even opt for vetting foreign takeovers of British firms.  In January 2017 BEIS (The Business, Energy and Industrial Strategy) Select Committee conducted an inquiry into the Government’s Industrial Strategy under the Government of Theresa May, considering whether foreign takeovers of UK companies should be prevented and on what grounds. The scope of the inquiry reads as follows:

“The Committee will consider what the Government means by industrial strategy and questions how interventionist in the free market it should be, such as whether it should prevent foreign takeover of UK companies.

Priorities for the private sector, in terms of what businesses want from a revamped industrial strategy, the pros and cons of a sectorial approach and possible geographical emphasis will also be explored by the Committee.

It will also look at the industrial strategies of previous governments and of other countries to see if there are any lessons to be learnt.” (See House of Commons Library, Briefing Paper, Number 07682, 31 January 2017, Industrial Strategy by Federico More 2.6.)

The takeover of Arm Holdings, a Cambridge-based technology firm, by Japanese firm Softbank in 2016, the attempted takeover of Pfizer by AstraZeneca in 2014, and earlier on, the takeover of Cadbury by Kraft in 2010, all led to debates which questioned the UK’s openness to foreign acquisitions. However, no attempt had been made to significantly alter the UK rules which facilitate an open market for corporate control. It is unlikely that the inquiry will lead to the adoption of an overhaul of the provisions of the City Code. Brexit, however, is likely to pave the way for changes to be made in the law by possibly introducing a broader public interest test in the assessment of mergers and acquisitions, or by allowing the Secretary of State to intervene in takeover bids in selected areas of the economy and in cases where the said companies are considered of strategic importance.

So, to paraphrase this well-known quote from Orwell’s book as per the title of this blog, it is safe to say that we will likely witness a change in the UK’s approach with regard to its openness to foreign takeovers. States’ and private parties’ actions to protect domestic companies should of course not always be attributed to their nationalistic concerns of protecting the national company from a ‘foreigner’. Many ethical issues that come along with a change in corporate control, some of which have not been taken into account by policy makers in the past, deserve attention. The fate of stakeholders, employees, or projects of the company, including R&D projects, with the change of corporate control are matters that cannot easily be predicted but should nevertheless be considered during a change in corporate control.

A note of caution. A policy which aims to protect the British industry is somewhat at odds with a policy that aims to maintain an economy which is open to business and foreign investment.  There is a fine balance to be struck between these two objectives and the regulatory framework will play a key role in maintaining that balance. It is ultimately a matter of deciding not only whether a takeover of a company should go through or not and on what grounds, but also who is best equipped to make that decision and the risks involved in changing the dynamics that already exist in a free market economy.

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