Outlook: Inducement fees
Friday 14 May 1999
LARGELY UNNOTICED, a new practice has crept into the British takeover scene - that of offering "inducement fees". It works like this. The target company agrees to pay a fee to the bidder in the event of the takeover not going through, either because of a higher, rival bid, or for some other reason.
In the US, such fees are pretty much routine and most recent transatlantic mergers have involved some form of them. For instance, Lucas Varity agreed to pay TWR pounds 30m in the event that it was outbid by Federal-Mogul. In recent months they have started to crop up in pure British takeovers too. What is at present a steady stream could easily turn into a flood.
There are two ways of looking at this practice. The charitable view is that such fees act as a necessary encouragement for a bid that might otherwise not be made. Venture capital funds in particular are nervous about incurring the heavy costs of a takeover if there is a possibility they might be outbid. It can be argued, therefore, that inducement fees support the interests of shareholders by acting as a catalyst for a takeover.
The less charitable view is that such fees are basically just poison pills, designed to frustrate alternative higher offers. If the fee is a substantial one, then it might act as a deterrent. There have almost certainly been cases where it is deliberately designed as such. For instance, company A agrees inducement fee with company B in order to avoid hostile bid from company C. It is only possible to speculate on the names of such cases. The history of inducement fees goes back to the Guinness battle for Distillers, when in an attempt to fight off a hostile bid from Argyll, Distillers agreed to indemnify Guinness's bid costs. Most company lawyers would these days take the view that indemnifying bid costs amounts to a breach of the Companies Act, in that it is tantamount to the company buying its own shares. So now they call it something different - an inducement fee. Essentially it amounts to the same thing, though.
Should the Takeover Panel stop the practice before it gets out of hand? An outright ban would be hard to justify, especially in the case of financial bidders. And it would be unfair as well as possibly impractical to try and make the distinction. The Panel is probably right, therefore, in attempting to impose a ceiling on such fees - of, say, 1 per cent of the value of the transaction. This is large enough to cover the costs of most transactions but small enough not to act as a significant deterrent to rivals.
Those who go above this level, risk falling foul of Panel rules designed to prevent actions that frustrate potential bidders. But technically, there's nothing to stop them.
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