Section 631 of the Corporations Act provides that, once a bidder publicly announces a takeover proposal, offers under a takeover bid must be made by that bidder within two months unless ASIC grants relief. The underlying policy of the rule is to prevent a false market developing in the shares of the target company by the making of misleading announcements of takeover bids (which often have the effect of increasing the price of the target's shares to at least the amount being offered under the bid) and to require bidders to formally make their bid sooner rather than later. 

The two month rule has never applied to schemes and there now appears to be a growing trend of potential bidders using 'bear hug' tactics against potential targets to avoid being caught by this rule in relation to takeover bids. This article explores whether the amendments made to the UK Takeovers Code in September 2011, which essentially require a potential bidder to make a formal offer within 28 days of an approach or withdraw, might usefully be considered for adoption in Australia in order to limit the ability of bidders to 'dance' around a target in the market without being required to make a formal takeover bid.

'Bear hugs' (or 'virtual bids') occur where a bidder, as part of a strategy to pressure a target to accept a takeover proposal, makes the proposal on an 'indicative, non-binding and highly conditional' basis, without prior warning. 

If the approach is announced by the target company then the hope is that shareholders, and market pressure, will force the target's board to co-operate with the bidder in implementing the proposal (hence the concept of a 'bear hug'). If the 'bear hug' is not successful and the target remains firmly disinterested, the bidder retains the option of going around the board and targeting shareholders directly with a hostile takeover bid or withdrawing as gracefully as possible, despite the two month rule because, so the bidder would argue, it did not propose, let alone publicly propose, to make a takeover bid as required by section 631 of the Corporations Act.

A recent example of the bear hug in action was the approach made by private equity firm Pacific Equity Partners (PEP) to Spotless Group Ltd (Spotless). PEP first approached Spotless on 16 November 2011 with an 'indicative, non-binding and conditional' proposal to acquire 100 percent of the shares on issue in Spotless for an indicative price of $2.63 in cash per share. The approach was announced by Spotless to the market shortly after receipt. 

Negotiations between the parties continued for almost six months (well beyond two months past the date of the initial approach) before Spotless agreed to enter into an agreement with PEP to implement a scheme of arrangement. It has been suggested that growing pressure from key shareholders in Spotless, over this time, to accept PEP's bid was a significant factor in the company's decision to come to terms. In the meantime, the ongoing bid negotiations are likely to have caused significant disruption to Spotless, if for no other reason than because it would have taken up time and resources that could have otherwise been directed elsewhere. 

It may be noted that the 'bear hug' strategy has not always been successful. For example, a similar strategy was used by Canada Pension Plan Investment Board and Ontario Teachers’ Pension Plan in their highly publicised attempt to acquire Transurban Group in 2009, which ultimately did not succeed. 

Whether or not using the 'bear hug' approach to avoid the deadline imposed by the two month rule is within the strict letter of the rule, protracted negotiations such as those which took place between PEP and Spotless would certainly appear to be at odds with its spirit. Nevertheless, there was no public comment on the situation from regulators, so it would appear that if the situation is to change it will need to be as the result of legislative reform.

If it was decided that legislative action was required, some guidance might be taken from amendments made to the Takeovers Code in the United Kingdom in September 2011. There, the rule now is that a target must announce that it has received an approach from a potential bidder if the target is 'the subject of rumour and speculation or there is an untoward movement in its share price'. A target must also announce the possibility of an offer even before the potential bidder has made any kind of approach if the target 'is the subject of rumour and speculation or there is an untoward movement in its share price and the target believes it is the actions of the potential bidder that have contributed to that situation'. 

Whether a target is 'the subject of rumour and speculation or there is an untoward movement in its share price' is a matter to be determined by the UK Panel on Takeovers and Mergers (UK Panel). The UK Panel has stated that targets should consult with it as to whether an announcement is necessary if the target becomes subject to rumour or speculation or there is a movement in its share price of 10 percent or more (although smaller movements might also prompt consultations in certain limited circumstances). The UK Takeovers Code specifically prohibits any attempt by a potential bidder to prevent a target from making an announcement in relation to an approach. 

If a target announces that it has received an offer or a 'possible offer' from a bidder then that announcement triggers the start of a 28 day period in which the bidder must commit to making an offer or publicly withdraw whatever proposal it had put forward. If the bidder elects not to make an offer and decides to withdraw, that bidder is unable to make a further approach to the target for six months from the date of withdrawal (unless relief is obtained from the UK Panel). 

Arguably, the big advantage of the UK approach of requiring a bidder to firm up a 'possible bid' within 28 days, is also its biggest drawback. It means that a bidder must be ready to make a bid (including having matters like funding sorted out) within one month of making the first approach of substance to the target or risk being frozen out for six months. The need to have all aspects of a bid close to finalisation before the first approach may create difficulties for some bidders, particularly in circumstances where negotiations or due diligence enquiries necessitate a change in the bid structure. For example, a price increase could mean that the amount of funding required would change substantially during the course of negotiations.

It has been said that one driver for the amendments to the UK Takeovers Code was the lengthy and torturous saga of Kraft's ultimately successful takeover of Cadbury Schweppes in 2010. It remains to be seen whether the continued use of the 'bear hug' style tactics will result in Australia heading in a similar direction (perhaps with a two month period to firm up a bid as opposed to the UK's 28 days). If so, it would be taking a step towards ending the 'dancing' around the two month rule that has become increasingly common in Australian takeovers.