An increasing number of iconic home-grown listed companies are acquired by foreign firms such as Raffles Hotel, Robinsons department store, Asia Pacific Breweries, and Fraser & Neave.2 The trend has raised public concerns of whether the government, should do more to protect local brands in Singapore. This leads to the question of whether no-frustration rule should be abolished from the Singapore Code on Takeovers and Mergers to allow the target board to erect defensive measures to frustrate the bid. In particular, whether the Delaware position in the United States should be adopted instead. Delaware is chosen as a comparator for this paper as the majority of companies listed in NASDAQ and NYSE are incorporated in Delaware.
Part I of this paper will discuss the objective of having the no-frustration rule in Singapore to circumscribe defensive measures. While some academics view deal protection measures as a form of defensive measures, such discussion is outside the scope of this paper. Part II will explore the Delaware position in the United States (“US”) and its features. Part III and IV will explore the pros and cons of adopting features of the Delaware position in Singapore, with references to the experience of other jurisdictions where appropriate. The paper concludes that the costs of adopting the Delaware position far outweigh the potential benefits for Singapore and advocates for a continuation of the current regulation.
Objective of the no-frustration rule in Singapore
No-frustration rule is enunciated in General Principle 7 and Rule 5 of the Singapore Code on Takeovers and Mergers (“Code”),3 inspired by the United Kingdom (“UK”).4 The
Securities Industry Council (“SIC”) regulates compliance and imposes sanctions for contraventions. The rule prohibits the target board from taking actions that frustrate an offer, unless with shareholders’ approval. Such actions include:
- issuance of shares to third parties;5
- disposal of material amount of assets;6
- issuance of subscription rights;7 and
- distribution of interim dividends.8
Controls the agency problem
The prohibition circumvents the principal-agent problem that plagues corporate law.9 The separation of ownership and control leads to conflicts of interest between managers and shareholders.10 The broad purpose of no-frustration rule is to prevent such conflicts in a bid context.11
The rule ensures that target shareholders are given sovereignty over their ownership. In friendly bid, studies have shown that CEOs are more likely to negotiate for a lower bid premium in return for an augmented golden parachute, consulting contracts, or special bonuses.12 Under the “passivity thesis”, 13 managers are often exposed to potential loss of office that motivates them to initiate defensive measures to protect their self-interests, even while shareholders are keen on making profits through such hostile takeovers. Accordingly, strong takeover defences may provide private benefits to managers at the cost of higher premium to shareholders14 and become an instance of target mismanagement.15
Arguably, issuing shares to the management may circumvent the agency problem.16 Nonetheless, it is not a panacea. As seen in Enron and WorldCom scandal, stock-based salaries fuel managers’ greed and incentivises unethical practices.17 Therefore, the no-frustration rule provides a more viable solution to the agency problem.
Guarantees an active market for corporate control
The no-frustration rule also ensures “the efficient working of the market for corporate control” and a constant supply of potential bidders.18 When management under performs, low share prices may attract hostile bidders who will replace the board upon obtaining control.19 The threat of hostile bids has the disciplinary effect for ineffective managements. Hence, limiting the board’s ability to defeat hostile bids prevents entrenchment of an inefficient management. 20 Such benefits are observed in Australia where there is a correlation between a change of management and increased post-bid performance.21
Admittedly, Singapore has a weak market for corporate control22 because most companies are majority-controlled such that directors are largely nominees of majority shareholders.23 However, the rule remains useful in “insecure blockholders control” situations,24 a situation where there are more than one significant blockholders such that no one controlled the board. In such situation, the no-frustration rule limits the defensive measures that can be taken by nominees of these insecure blockholders.25
Ensures cost savings and efficiency
Absent strong defensive measures taken by the target board, takeover process can be completed quicker, cheaper, and with greater certainty.26 There are also substantial cost savings because defence measures incur costs for the target company.27
Without strong defensive measures that may defeat a takeover, the no-frustration rule also paves the way for mergers that create synergies between merged companies and increases social welfare.28 Both the bidder and target will enjoy the various benefits of the takeovers.29
The Delaware position
The experience of companies under the Delaware law however, has shown that there are hidden costs from proceeding with hostile takeovers and positive functions of takeover defences.30 This leads to Delaware judges,31 the regulators of the board’s response to bids, to confer the target board a broad authority to erect defensive measures when a bid is imminent without shareholders’ approval including:
- issuing shares to third parties or issuing rights plan to current shareholders at a heavy discount;32
- distributing interim dividend33 provided the company was not insolvent;34 and
- selling material assets provided they do not amount to “substantially all of the company’s assets”.35
The most powerful defence is the issuance of shareholders rights plan, or poison pills.36 There are two common types of poison pills, “flip-in” and “flip-over” pills.37 The former allows target shareholders to purchase shares in the target while the latter allows target shareholders to purchase shares in the prospective bidder.38 For both types, the poison pills are triggered when a hostile bidder acquires 15% or more of the target’s shares,39 making available an option to purchase shares at a discount, pushing the target’s shares upwards, diluting the bidder’s potential shareholdings, and rendering the deal unattractive to the bidder.40
The company, led by shareholders, may sue the directors in a derivative action for improperly erected defensive measures amounting to breach of their fiduciary duties. To determine the validity of the defensive measures,41 the board must show that:
- the board had “reasonable grounds for believing that a danger to corporate policy and effectiveness existed”; 42 and
- the “defensive response was reasonable in relation to the threat posed”.43
If the two requirements are not met, the directors are found to be in breach of their fiduciary duties, and the defences may be removed.44 The requirements balance the interest of shareholders and the discretion conferred to the board. In practice however, the court confers broad discretion to the board to determine how to pursue shareholders’ interest.45 Under the first requirement, threats such as potential injury to the corporation or its assets, diminution of a long-term corporate strategy,46 loss of opportunity to propose a better alternative,47 and the risk of shareholders coercion48 justify implementation of defensive measures. While good faith is necessary, it is not alone sufficient.49 Under the second requirement, the defensive measures should not be coercive, intrusive, or preclusive.50
The analysis above shows several features of the Delaware law in relation to defensive measures namely:
- the absence of no-frustration rule and availability of defensive measures such as poison pills, distribution of interim dividend, and sales of companies’ assets;
- an assessment of the effect of the threat of hostile bid to the target company’s policy and effectiveness; and
- a proportionality analysis of the defence measure against the threat of hostile bid.
In the US, shareholders may remove the measures by removing the directors with cause,51 for instance in a proxy contest, where bidder attempts to control the company by electing the directors with the shareholders support.52 This applies unless the companies adopt a staggered board,53 such that triggering the poison pills is tantamount to board veto. However, this is inapplicable in Singapore, as directors may be removed with or without cause as long as ordinary resolution is passed.54
Potential benefits to Singapore in adopting Delaware’s approach
There are various potential benefits of the aforementioned features of Delaware approach. First, the target has stronger bargaining power. Second, the features increase shareholders’ and society’s welfare. Third, the target may better protect non-investor stakeholders. Fourth, it removes the pressure on the board to only consider short-term projects.
Strengthen target board’s bargaining power and role
The first feature of Delaware approach appears to allow the target board to act collectively to increase its bargaining power with the potential hostile bidders. 55 Such bargaining power is crucial where the target shareholders are dispersed and are unable to bargain collectively.56 From the bidder’s perspective, proceeding to a hostile bid is less appealing compared to offering a higher premium,57 given various additional costs such as out-of-pocket and reputational costs.58 Acting on behalf of shareholders, the board may turn the potential hostile bid into a negotiated bid, and extract more in a negotiated bid compared to a target with weak defence measures. However, as later examined, whether the board in Singapore may enjoy such flexibility from simply removing the no-frustration rule is questionable.59
Increase shareholders’ and society’s welfare
Strong defensive measures also removes herding effect on shareholders to sell. In partial offer situation, where there is no guarantee that the takeover will take place, 60 uninformed shareholders may be pressured to sell their shares. 61 Additionally, where founder shareholders face an “insecure blockholders control” situation and fear that bidders are unappreciative of the company’s long-term value, defensive measures allow founder shareholders to ward-off such bidders.62
The third feature of balancing the defence measure’s appropriateness against the threat of hostile bid also recognises the inefficiency of capital markets.63 Managers and controlling shareholders who possess private information are arguably at a better position to assess the fundamental value of the company and decide whether shareholders will profit more by remaining independent or selling the company to the potential hostile bidder.64
Management may protect stakeholders adversely affected by the bid
The second feature under Delaware law of assessing the effect of a hostile takeover to the target provides protection for employees, customers, and creditors from asset-raiding bidders.65 The Code in contrast, is “not concerned with the … disadvantages of a take-over or merger”, but only with ensuring compliance of the Code.66
Absence of such an assessment may cause detriment to the company stakeholders as seen in the takeover of British icon Cadbury by American company Kraft Foods in the UK, that results in closure of numerous factories and job losses for Cadbury employees.67 The situation arose after Kraft shifted the manufacturing activities of Cadbury to Poland despite its promise before the acquisition to keep the factories in the UK, angering labor unions, and provoking a sense of economic nationalism. 68
Detriment to customers’ expectation is also observed in Singapore, following takeovers by foreign bidders. Upon Heineken’s acquisition of Asia Pacific Breweries, producer of Tiger Beer, a newspaper noted “Tiger time will not be Singapore time anymore”.69 The company’s image, campaigns, and marketing are no longer associated with Singapore.70 Detriment to customers, employees, and other non-investing stakeholders could have been avoided if the target board is conferred the powers to erect stronger defensive measures. Even if the threat of hostile takeover may improve the position of non-investing stakeholders, there is no guarantee of such positive outcome given the concentrated shareholding structure of companies in Singapore as later argued.71
Ensure considerations of long-term benefits
The second feature also removes the pressure on managers to focus on the short-term results following a bid. Often, hostile bids cause the target board to be discouraged from making decisions that only produces benefits in the long-term.72 Instead, where the target board is permitted to justify erecting defences with potential threats to long-term corporate strategy,73 the pressure to focus on short-term projects is removed.
Cons of adopting the Delaware position
On the flipside, there are strong reasons not to adopt the position in Singapore. First, abolishing no-frustration rule in Singapore does not necessarily lead to the benefits enjoyed in the US because of company law and Listing Manual restraints. Second, there may be detriment to shareholders, the group that should be protected by the Code. Third, shareholders should be given priority protection over non-investor stakeholders. Fourth, management decisions are not always affected by hostile bids. Lastly, there are various costs associated with adopting the approach and little practical benefits in return.
Abolishing the no-frustration rule does not increase the target’s bargaining power
Even if Singapore abolished the no-frustration rule, it is submitted there is “minimal scope for director-deployed defences” because of the limitations placed by Singapore’s company law.74 This paper will consider a Singapore regime in the absence of the no-frustration rule.
First, shares and warrants issuance are “only available with pre or post-bid shareholder approval”75 because while the Code allows directors to issue shares and warrants to existing shareholders, the Companies Act still require shareholders’ approval.76 The strategy of issuing shareholders’ rights plan at a discount also remains unfeasible because it violates the sacrosanct equal treatment principle.77 While one may argue that poison pills do not violate the equal treatment principle because “the warrant provides a contingent right applicable to all shareholders”,78 the argument is unlikely to be accepted by the SIC because effectively, the strategy still discriminates some shareholders.
Even if the SIC accepts that poison pills do not contravene the equality principle, the board’s power to issue shares is limited by its fiduciary duties to act for a proper purpose.79 Case law suggests that the power to issue shares should not be used for “the purposes of securing the directors’ control of the company”.80 The feasibility of adopting Delaware’s second feature of proportionality analysis in place of the duty against improper purpose in a bid context will be discussed below.
While the board may then distribute extraordinary dividends from its profits81 to reduce the value of the company similar to Delaware,82 this strategy is unfavored because it may affect the company’s performance in the short-run given limited cash.
Clearly, simply abolishing no-frustration rule from the Code does not lead to strengthening of the target board’s power. To achieve such degree of flexibility for the target, major changes need to be made across the statutes.
Social welfare is not necessarily increased
The value of reducing shareholders’ herding effect is arguably less relevant in Singapore. The mandatory bid rule adequately ensures that all shareholders enjoy an equal increase in premium, 83 preventing the “occurrence of preferential share purchases and uneven pricing”. 84 Additionally, as there are contrasting empirical studies about benefits of defensive measures, 85 it cannot be said with certainty that shareholders benefit from increased bid premium or a better deal.86
Even if potent defensive measures may lead to subsequent bidders offering higher price, there are unintended consequences of discouraging first bidders. The premium increase is a result of the bidder free riding on information generated from the first bidder. 87 Consequently, free riding discourages companies from being the first bidder given the uncertainty of success, harms target shareholders, and creates a less active market for corporate control.88 This position is extremely undesirable in Singapore that already has a lackluster takeover landscape. 89 Hence, there is no increase in social welfare from permitting potent defensive measures, especially as takeovers inherently increase social welfare.90
The fact that the board may possess private information reflecting the shares’ hidden value is not conclusive to decide the board as better positioned to assess the company’s valuation, considering their self-serving interests. 91 The board may communicate such private information in their recommendation to the shareholders, the main tool to convince shareholders to reject the bid.92 The high concentration of institutional, nominee, and state shareholders in Singapore93 also makes it likely that the blockholders have access to such information. Accordingly, shareholders are equally positioned to assess the value of the company.94
Management’s primary duty to shareholders
Although engaging in a proportionality analysis tends to protect non-investor groups such as customers, employees, and creditors, the management does not owe a fiduciary duty to these groups but to the company, and is primarily required to consider the interest of shareholders alone.95 As the fundamental tenet of the Code is “fair and equal treatment of all shareholders”,96 interests of non-investor stakeholders should be given effect only as far as they are aligned with the aggregate shareholders interest. In situations where the bidder is offering an attractive premium, it is in the shareholders interest to accept the offer.97
A successful takeover is not always detrimental to non-investing stakeholders. In fact, stakeholders of the target companies may perform better following the acquisition given the ability to expand.98 For instance, Asia Pacific Breweries increased its performance and benefited stakeholders following Heineken’s takeover because of its expansion to Vietnam markets.99
Even if public sentiment is evoked following acquisitions of Singapore’s iconic brands, national interest is not at stake because the aforementioned companies are engaged in unregulated industries.100 Furthermore, public sentiment is likely to be transient in nature.101
Where protected industries are concerned, other regulations such as industry specific statutes 102 and competition law 103 prevent foreign companies from taking over these companies.104
No guarantee of long-term benefits
Admittedly, studies have also suggest that the threat of hostile bids affect management decisions on beneficial long-term projects. 105 However, the Delaware and Singapore approach will produce different results only where shareholders would choose not to defer to the directors. 106 Therefore, implicit in the Delaware approach is the assumption that shareholders often make the wrong decision such as focusing solely on short-term benefits, which mandates for a broad discretion to be conferred to the board.107 This is largely inapplicable in Singapore. The high concentration of state ownership in Singapore usually having long-term investment horizon and private information disprove hypothesis of directors being pressured to prioritise short-term investments. 108 While institutional shareholders are more likely to quickly cash out on their investment,109 studies have shown the lack of short selling.110 In view of Singapore’s concentrated shareholding structure,111 shifting powers from the shareholders to directors is unjustified and undesirable.
Practically difficult to implement
If Singapore decides to adopt features of the Delaware approach, there are various costs involved. These include complexity costs of maintaining a fusion regime with contrasting fundamental tenet, uncertainty costs, loss of shareholders’ flexibility, costs of educating the legal profession, and possible public backlash from institutional shareholders and state investment bodies who dominate Singapore’s corporate landscape.
More importantly, the Delaware approach relied on the court’s active role. Inappropriate defence measure results in breach of fiduciary duties and personal liabilities of directors. In contrast, breach of the Code only leads to private reprimand, public censure, or temporary sanctions on the company of Code-related work because of the Code’s non-statutory nature.112 Fiduciary duties under the Companies Act only requires the directors to act in good faith and for a proper purpose,113 which is not always sufficient to meet the second feature of Delaware approach.114 Adopting the Delaware approach necessarily requires involvement of courts or the SIC to make a value judgment on the commercial advantage and disadvantage of the takeover for the target, “tying up court resources which could be more gainfully employed”,115 and running contrary to the spirit of the Code as simply a “standard of conduct” to ensure fairness to shareholders.116
Limited practical benefits
The various costs are unlikely to be balanced with sufficient benefits. There are hardly any hostile takeovers in Singapore and Asia. Hostile takeovers can “only take place in companies with dispersed stock ownership”, 117 which is rare in Singapore landscape dominated with companies having concentrated stock ownership.118 In Hong Kong for instance, which has a more active takeovers market compared to Singapore and similar corporate shareholding structure, an assessment of 60 reported takeovers show only three could be considered as a hostile takeover,119 which later morphed to become negotiated bids. Thus, the unfavorable culture for hostile bids, complemented with stringent shareholders protection, provides little room for strong defensive measures.
Contrary to international trend
Takeover laws in common law countries globally are moving towards adopting no-frustration rule. In New Zealand, Rule 38 of the Takeover Code120 and Baigent v DMcL Wallace Ltd established the no frustration rule to circumvent the agency problem.121 In Canada, while its company law provides discretion to the board to consider non-investor stakeholders interest, the target board is similarly prohibited from taking frustrating actions without the shareholders’ approval under its securities law.122 The European Economic Community also recently inserted the no-frustration rule in its takeover directive in view of the high concentration of institutional shareholders.123
Even in the UK where the rule was criticized following the takeover of national-brand Cadbury by Kraft, the rule was not abolished. 124 Instead, the UK legislator implemented “put-up and shut-up” rule and prohibition of deal protection measures and inducement fees to strengthen the target board’s position by methods other than defensive measures.125 Therefore, a comparative analysis reflects that having the no-frustration rule remain the preferred position in Commonwealth countries for its various benefits.
In sum, while adopting the features of Delaware approach in Singapore may better protect stakeholders and founder shareholders facing “insecure blockholders control” situation, it does not bring significant practical benefits considering the extent of the agency problem and Singapore’s concentrated state and institutional ownership.
Should Singapore choose to abolish no-frustration rule and engage in proportionality analysis, the amendment runs counter to the spirit of the Code as a standard of conduct to ensure fairness to all shareholders and falsely assumes that shareholders are insufficiently informed to form the best decision for the company.
Even when one view proportionality analysis as procedural inquiry aligned with the Code’s spirit, there are various complexity costs in adopting Delaware given contrasting regulators of takeovers and assessment of directors’ fiduciary duties. In return, there are little benefits to strengthen the target’s position in light of various shareholders’ protection in Singapore’s Companies Act and Listing Manual.
Therefore, it is submitted that the no-frustration rule should be maintained in light of the various benefits including ensuring certainty, vibrancy of takeovers, accountability of directors, and protection of shareholders interest.
Author: Claudia Tan, then-student at Singapore Management University School of Law (graduated 2018). This article was originally published on 12 September 2017 at SMU Lexicon. Due to space constraints, the appropriate citations can be found here.
This article does not constitute legal advice or a legal opinion on any matter discussed and, accordingly, it should not be relied upon. It should not be regarded as a comprehensive statement of the law and practice in this area. If you require any advice or information, please speak to practicing lawyer in your jurisdiction. No individual who is a member, partner, shareholder or consultant of, in or to any constituent part of Interstellar Group Pte. Ltd. accepts or assumes responsibility, or has any liability, to any person in respect of this article. Singapore Management University has no responsibility or liability to any person in respect of this article.