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LAW MANTRA THINK BEYOND OTHERS

(National Monthly Journal, I.S.S.N 2321 6417)





Analysis on Combating Hostile takeover

Introduction
Meaning and Definition of Takeover:
The term take over
1
refers to acquisition of a company by another company. It is a
transaction or series of transactions whereby a person (individual, or group of individuals or
company) , either directly by becoming the owner of those assets or indirectly by obtaining
control of the management of the company.

Meaning and Definition of Hostile Takeovers:
A takeover which goes against the wishes of the target company's management and board of
directors. It is opposite of friendly takeover. Hostile Takeover is a type of acquisition in which,
the company being purchased (Target Company) does not want to be purchased at all, or does
not want to be purchased by a particular buyer (Acquirer) that is making a bid. In other words,
the Acquired intends to gain control of the Target Company and force it to agree to the sale.
The word 'hostile' in dictionary means 'unfriendly, aggressive'.

Hostile Takeovers is a type of method used for Corporate Restructuring. There are other
methods like Mergers & Acquisitions, Leveraged Buyout, Spin offs, etc. through which
Corporate restructuring may be done.

In India, hostile takeover is a dreaded word
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, may be since it is a method used which is not
democratic in nature and somewhat unpleasant for the management of a target company.
A hostile takeover allows a suitor to take over a target company whose management is
unwilling to agree to a merger or takeover. A takeover is considered "hostile" if the target
company's board rejects the offer, but the bidder continues to pursue it, or the bidder makes the
offer directly after having announced its firm intention to make an offer. Also when an acquirer
takes the control of a company by purchasing its shares without the knowledge of the

1
Takeover meaning,www.wikipedia.com
2
Hostile Takeover a dreaded word in India,www.legalsutr.org


management it is termed as a hostile takeover. Thus, when an acquirer silently and unilaterally,
makes efforts to gain control of a company against the wishes of the existing management,
such act amounts to hostile takeover. Hostile takeover is an attempt by outsider to wrest control
away from an incumbent management.

Defenses against Hostile Takeovers-Shark Repellents:
There are several ways to defend against a hostile takeover. The most effective methods are
those where there exist built-in defensive measures that make a company difficult to take over.
These methods are collectively referred to as "shark repellents"
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:
1. Staggered Board
2. Poison Pills
3. Buyback of Shares, Open market repurchase, Self-tenders
4. Crown Jewels
5. White Knights
6. Golden Parachutes
7. Greenmail
8. Corporate Restructurings
9. Legal/Political defenses
10. Joint Holding (or) Joint Voting Agreement
11. Interlocking shareholdings or Cross Shareholdings
12. Defensive Merger
13. Pac-Man Strategy

Analysis of the Defenses against Hostile Takeovers:

Definition and Meaning of Hostile Takeovers:
A takeover which goes against the wishes of the target company's management and board of
directors. It is opposite of friendly takeover. A hostile takeover allows a suitor to take over a
target company whose management is unwilling to agree to a merger or takeover. A takeover is
considered "hostile" if the target company's board rejects the offer, but the bidder continues to
pursue it, or the bidder makes the offer directly after having announced its firm intention to
make an offer. Also when an acquirer takes the control of a company by purchasing its shares
without the knowledge of the management it is termed as a hostile takeover. Thus, when an

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,Prasad G. Godgole , Mergers ,Acquisitions and Corporate Restructuring, Vikas Publishing House Pvt. Ltd. ,
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acquirer silently and unilaterally, makes efforts to gain control of a company against the wishes
of the existing management, such act amounts to hostile takeover. Hostile takeover is an
attempt by outsider to wrest control away from an incumbent management.

A takeover bid is hostile if the bid is initially rejected by the target Board. It is sometimes also
called unsolicited or unwelcome bid because it is offered by the acquirer without any
solicitation or approach by the target company. In a hostile takeover the directors of the target
company decide to oppose the acquiring companys offer, recommend shareholders to reject
the offer and take further defensive measures to thwart the bid.
The decision to defend may be influenced by a number of factors but more often than not it is
with the intention of (a) stopping the takeover (which in turn may be prompted by the genuine
belief of the directors that it is in interests of the company to remain independent or by a desire
of the directors to protect their own personal positions or interests); or (b) persuading the
bidder to improve the terms of its offer. There may be different motives/causes behind
launching a takeover bid and it is not necessary, as widely believed, that only poorly
performing firms are the potential targets of a hostile bid. Bidders seem to pursue companies
with strong operating managements as often as they pursue companies that have been clearly
mismanaged. In fact bidders seldom seem to be interested in a firm where a turnaround is
unlikely. For instance, truly sick companies or at least those whose problems do not appear to
be easily remedied become indigestible and survive, immune form takeover, precisely
because of their inefficiency. A bidders offers a premium, often very high, to acquire a target
and a rational bidder will offer such a premium over the market price (and incur notoriously
high transaction costs as well) only if it believes that the future value of the targets stock under
different management will exceed the price it offered the targets shareholders within a
relatively brief period. There may be a number of objectives behind mounting a hostile bid. It
may be a strategic objective like consolidation/expansion of the raider/acquirer. It may be
aimed at achieving economies of scale/critical mass/reducing costs in a particular
product/service market. It may also be aimed at acquiring substantial market share or creating a
sort of a monopoly.








Methods of hostile takeover:

Tender offer and Proxy fight are the two primary methods
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of conducting a hostile takeover.
A tender offer is a public bid for a large chunk of the target's stock at a fixed price, usually
higher than the current market value of the stock. The purchaser uses a premium price to
encourage the shareholders to sell their shares. The offer has a time limit, and it may have other
provisions that the target company must abide by if shareholders accept the offer. The bidding
company must disclose their plans for the target company and file the proper documents with
the SEBI as explained above.

In a proxy fight, the buyer doesn't attempt to buy stock. Instead, they try to convince the
shareholders to vote out current management or the current board of directors in favor of a
team that will approve the takeover. The term "proxy" refers to the shareholders' ability to let
someone else make their vote for them -- the buyer votes for the new board by proxy.

Often, a proxy fight originates within the company itself. A group of disgruntled shareholders
or even managers might seek a change in ownership, so they try to convince other shareholders
to band together. The proxy fight is popular because it bypasses many of the defenses that
companies put into place to prevent takeovers. Most of those defenses are designed to prevent
takeover by purchase of a controlling interest of stock, which the proxy fight sidesteps by
changing the opinions of the people who already own it.

Causes of a Takeover:

1. Assets at a Discount: This refers to a situation where the offeror can acquire the assets/shares
of a target at less than the value, which the offeror or its shareholders place upon them: a
process commonly referred by financial journalists as acquiring assets at a discount.

2. Earnings at a Discount: The offeror can by taking over the target acquire the right to its
earnings at a lower multiple than the market places on the offerors own profits, a process that
can be described as acquiring earnings at a discount.


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Hostile Takeover, www.legalsutra.org


3. Trade Advantage or Synergy: There is a trade advantage or an element of synergy (i.e. a
favorable effect on overall earnings by cutting costs and increase in revenue) in bringing the
two companies under a single control which is believed will result in the combined enterprise
producing greater or more earnings per share. This has been found to be one of the biggest
drivers of takeovers in the 1990s.

4. Method of Market Entry: It represents an attractive way of the offeror entering a new market
on a substantial scale.

5. Increasing the Capital of the Offeror: The offeror has particular reasons to increase its
capital base. These include the acquisition of a company a large proportion of whose assets are
liquid or easily realizable instead of making a rights issue and the acquisition of a company
with high asset backing by a company whose market capitalization includes a large amount of
goodwill.

6. Management Motives: Because of motives of the management of one/other of the
Companies, either the aggressive desire to build up a business empire or personal remuneration
or the defensive desire to make the company bid- proof.

DEFENSES TO HOSTILE TAKEOVERS:
In a takeover battle if the board/management chooses to reject a bid it may have to take
effective defensive measures in order to stall the raider from carrying out the takeover
operation. These defense mechanisms may be put in place after the bid has been made or may
have been there prior to the bid having been made. The most obvious case for defense is that
by rejecting an initial bid, the board may be seeking to receive a higher offer or inviting a
competitive bidder. By mounting a vigorous defense, the board may be able to fetch a better
price for surrendering its stake in the target. Defense may also be raised on the ground that the
companys net worth is much more than the bidder had calculated. This may be the case when
the management of the target company has some privileged and commercially sensitive
information, which, if released, would increase the market value of the firm. By mounting such
a defense, management may be able to increase the market value of the target firm to such an
extent that the bid fails, or, even if the bid succeeds, secure a higher price for their
shareholders. Another reason for mounting a defense may be the managements genuine belief


that the company is better off by remaining an independent entity. Finally, the acceptability or
rejection of a takeover bid and the extent of its regulation also depends upon the social and
political philosophy of a country.
The most commonly adopted defense strategies
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to hostile bids are:
1. Staggered Board: This defense involves an amendment of the by-laws of the company to
create a staggered board of directors. A staggered board is a board whose members are elected
in different years or in other words only part of the board comes up for election each year.
Implementation of a staggered board may cause an acquirer to have to wait for several years or
at least till the next annual general meeting before it controls the board of directors. Because
the acquirer would not control the board initially, the acquirer would not have the power to
change management or the corporations business plan. As with the other pre-tender offer
defenses, courts will allow amendment of the charter to create a staggered board of directors
provided the amendment is allowed under the governing corporation law and the amendment
was made for a valid business reason.

2. Poison Pills: A defensive tactic, which originated in the US and is mainly employed in the
US. A poison pill is a shareholder rights plan that encourages a would-be acquiring company to
talk to targets directors before seeking to acquire more than a certain percentage of the targets
stock, because not doing so will result in substantial economic harm to the acquirer as the
rights held by it will become void, and all other shareholders will be able to buy shares of the
target at half price. A rights plan can be adopted without shareholder approval and the directors
authorize the rights to be distributed as a dividend to targets shareholders. These rights can be
redeemed by the Board of Directors or exercised. If they are exercised, the resultant preferred
stock might be convertible into ordinary shares at an extremely attractive price essentially
raising the cost of the bid. Such pills are referred to as flip-overs. Alternatively, the rights
might be purchased by the issuing firm at a large premium over the issue price, with the large
shareholder excluded form the repurchase. These are known as flip-ins.

3. Buyback of Shares, Open market repurchase, Self-tenders: Critics of the buyback
strategies argue that the discriminatory effects on target shareholders will defeat value-
increasing bids. Open market purchases tend to distort shareholder preference and defeat value
increasing bids. In a model given by Bradley and Rozenweig the result of open market

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purchases is that it amounts to a special dividend payout to selling shareholders that distorts
shareholder choice. However self-tenders can be defended on the ground that buyback creates
an auction for the companies resources among competing management teams. Proponents
argue that they tend to defeat value-decreasing offers and not value increasing ones. The critics
however argue that if the target finances the self-tender through the sale of special synergy
assets the bidder may simply withdraw its bid. Self-tender is not like an auction process. Target
management is spending the shareholders money and not its own funds.

4. Crown Jewels: These are precious assets of the target often termed as Crown Jewels, which
attract the raider to bid for the companys control. On facing a hostile bid the company sells
these assets at its own initiative leaving the rest of the company intact and hence removes the
incentive for which bid was offered. Instead of selling the assets, the company may also lease
them or mortgage them so that the attraction of free assets to the predator is suppressed. By
selling these jewels the company removes the inducement that may have caused the bid.

5. White Knights: After coming to know of an initial hostile bid other rival bidders also enter
the battle often offering higher bids than the initial bidder. Among the rival bidders whose bids
are recommended by the target company are classified as white knights or this expression is
also used to refer to a an acquirer whom the target, faced with a hostile bid, approaches to save
it from being taken over by the initial bidder. However, this is not exactly a defense strategy by
the incumbent management because a white knight may successfully defend the target
company from the initial hostile bid but in most cases the company is still taken over, albeit by
the white knight. Realistically, the targets choice is between ravishment by the hostile bidder
or a hastily arranged shotgun wedding with the white knight. Only advantage is that it raises
the offer/bid value. It may also be that the white knight may offer some positions to the
incumbent management in the merged entity. However, it is only lesser of the two evils. Even
if the management of the target firms are able to retain their jobs (and this is not frequently the
case), control is generally ceded to the acquiring company. White knight enters the fray when a
hostile suitor raids the target company. The regulation 25 of SEBI Takeover regulations allows
the entry of a White Knight to offer a higher price than the predator to avert the takeover bid.
(With the higher bid offered by the white knight, the predator might not remain interested in
acquisition and hence the target company is protected from the raid.)


Alcan of Canada had bought the shares in Indian Aluminium Company at Rs.200, which was
higher than Sterlites offer in 1998. Thus Alcan emerged as the White Knight in this deal.

6. Golden Parachutes: This defense requires management to arrange employment contracts
between the management and key employees to increase their post employment compensation
in the event of a hostile takeover. When golden parachutes are created for management and key
employees, a corporation becomes less attractive to the acquirer because generous payments to
departing management and employees could financially deplete the corporation.

7. Greenmail: A targeted share repurchase, or greenmail, is the buyback of the shares owned by
a particular shareholder of the target who has made or threatened a takeover bid. The greenmail
payment is typically at a premium over the prevailing market price. A large block of shares is
held by an unfriendly company, which forces the target company to repurchase the stock at a
substantial premium to prevent the takeover. The critique of this theory is that the
management, which has mismanaged the targets assets, pays greenmail in order to perpetuate
its ability to exploit the targets. According to this view greenmail should be prohibited because
it decreases shareholders wealth and discriminates unfairly.

8. Corporate Restructurings: Asset disposals announcement by the target firm that parts of its
existing business will be sold off, e.g., sale of subsidiaries, the disposal of holdings in other
companies, sale of specific assets such as land or property, de-merging of completely unrelated
businesses, decision to concentrate on core businesses and hiving off non-core interests etc. By
doing so the target seeks to make the company less attractive for a potential acquirer.

9. Legal/Political defenses: Where the target firms seek the intervention of the regulatory
bodies or indulge in political lobbying to repel the hostile bidder. This might be in the form of
an appeal to the competition regulatory bodies that the resultant entity would violate the anti-
trust norms. But these strategies rarely succeed often resulting in delays and increase in the
costs of the bid both to the bidder and the target. However, in countries like India,
political/legal interventions can cause considerable delays which can either frustrate the initial
bidder leading it to withdraw or costs may escalate so much due to delay that the bidder may
be forced to withdraw on prudent economic considerations.



10. Joint Holding (or) Joint Voting Agreement: Two or more major shareholders may enter into
an agreement for block voting or block sale of shares rather than separate voting. This
agreement is entered into with the cooperation and blessings of target Companys management
who likes to have a control.

11. Interlocking shareholdings or Cross Shareholdings: Two or more group companies acquire
shares of each other in large quantity or one company may distribute shares to the shareholders
of its group company to avoid threats of takeover bids. If the interlocking of shareholdings is
accompanied by joint voting agreement then the joint system of defense is termed as
Pyramiding, which is the safest device or defense.

12. Defensive Merger: The directors of a threatened company may acquire another company for
shares as a defensive measure to forestall the unwelcome takeover bid. For this purpose, they
put large block of shares of their own company in the hands of shareholders of friendly
company to make their own company least attractive for takeover bid.

13. Pac-Man Strategy: This is nothing but a counter bid. The target company attempts to
takeover the hostile raider. This usually happens when the target company is larger than the
predator or is willing to leverage itself by raising funds through the issue of junk bonds.


Legal Regime:

Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers)
Regulations, 1997
SEBI regulations called the Securities and Exchange Board of India (Substantial Acquisition of
Shares and Takeovers) Regulations, 1997 deal extensively with the rights of shareholders. One
of the goals of the regulations is to protect the small shareholders in the event of a hostile
takeover.

Companies Act 1956 does not expressly mention about takeovers or acquisitions. It primarily,
only talks about Mergers & Amalgamations through Section 391-396.



SEBI (Substantial Acquisition of Shares & Takeovers) Regulations, 1997 has been enacted by
the Securities and Exchange Board of India which deals with acquisition of shares, takeovers,
etc.

Neither the term 'takeover' nor the term 'hostile' has been expressly defined under the said
Regulations, the term basically envisages the concept of an:

Acquirer:
Taking over the control or management of the target company acquires substantial quantity of
shares or voting rights of the target company.
Here the term 'substantial acquisition of shares' attains a very vital importance, irrespective
whether the corporate restructuring is through merger / acquisition / takeover.
The said SEBI Regulations have discussed this aspect of 'substantial quantity of shares or
voting rights' separately for two different purposes:

(I) For the purpose of disclosures to be made by acquirer(s):

(1) 5% or more shares or voting rights:
A person who, along with 'persons acting in concert' (PAC), if any, acquires shares or voting
rights (which when taken together with his existing holding) would entitle him to more than
5% or 10% or 14% shares or voting rights of target company, is required to disclose the
aggregate of his shareholding or voting rights to the target company and the Stock Exchanges
where the shares of the target company are traded within 2 days of receipt of intimation of
allotment of shares or acquisition of shares.

2) More than 15% shares or voting rights:
An acquirer, who holds more than 15% shares or voting rights of the target company, shall
within 21 days from the financial year ending March 31 make yearly disclosures to the
company in respect of his holdings as on the mentioned date. The target company is, in turn,
required to pass on such information to all stock exchanges where the shares of the target
company are listed, within 30 days from the financial year ending March 31 as well as the
record date fixed for the purpose of dividend declaration.

(II) For the purpose of making an open offer by the acquirer:



(1) 15% shares or voting rights:
An acquirer, who intends to acquire shares which along with his existing shareholding would
entitle him to more than 15% voting rights, can acquire such additional shares only after
making a public announcement ("PA") to acquire at least additional 20% of the voting capital
of the target company from the shareholders through an open offer.

(2) Creeping limit of 5%:
An acquirer, who is having 15% or more but less than 75% of shares or voting rights of a target
company can consolidate his holding up to 5% of the voting rights in any financial year ending
31st March. However, any additional acquisition over and above 5% can be made only after
making a public announcement.

However in pursuance of Reg. 7(1A) any purchase or sale aggregating to 2% or more of the
share capital of the target company are to be disclosed to the Target Company and the Stock
Exchange where the shares of the Target company are listed within 2 days of such purchase or
sale along with the aggregate shareholding after such acquisition / sale. An acquirer who has
made a public offer and seeks to acquire further shares under Reg. 11(1) shall not acquire such
shares during the period of 6 months from the date of closure of the public offer at a price
higher than the offer price.

(3) Consolidation of holding:
An acquirer who is having 75% shares or voting rights of a target company can acquire further
shares or voting rights only after making a public announcement specifying the number of
shares to be acquired through open offer from the shareholders of a target company SEBI.

Who Benefits:
Promoters typically defend their opposition to hostile takeover proposals on the ground that
they are not in the best interests of the shareholders.

However, shareholders usually see an immediate benefit when their company is the target of an
acquisition because the acquiring company pays for stocks at a premium price. Conversely, the
acquiring company often incurs debt to make their bid, or pays well above market value for the
target company's stocks.



But numerous empirical researches abroad has proved that stock prices rise just as much in
response to a hostile offer as they do on announcement of a friendly bid. In fact, over the short
term, the returns from a hostile offer are much better than in a friendly offer. The premiums are
comparable. In other words, hostile offers are hostile only to the promoter-managers and not to
the shareholders.

Ultimately, we must measure the costs of mergers and acquisitions on a case-by-case basis.
Some have been financial disasters, while others have resulted in successful companies that
were far stronger than their predecessors were.

Mandatory Bid Rule
When changes of control occur, minority shareholders usually have little knowledge or
influence over the transaction. The mandatory bid rule protects shareholders from abusive
tactics by involving them in the sale of control. It functionally prohibits the use of two-tier
discriminatory offers during the acquisition of control and it prevents expropriation from
minority shareholders by allowing them to sell.
The mandatory bid rule eliminates the ability of acquirers to affect a two-tier discriminatory
transaction by ensuring minority shareholders an equitable price. Upon the change of control, it
is the minority shareholders, not the acquirer, who determine the size of the acquisition. After
the adoption of the mandatory bid rule, controlling shareholders can no longer sell their stakes
at the same premium because the acquirer may also be forced to purchase the rest of the
company (at a significant cost).

Critical analysis through Cases:

HP and Compaq Case:

The most famous case of proxy fight was Hewlett-Packard's takeover of Compaq. The deal
was valued at $25 billion, but Hewlett-Packard reportedly spent huge sums on advertising to
sway shareholders. HP wasn't fighting Compaq -- they were fighting a group of investors that
included founding members of the company who opposed the merge. About 51 percent of
shareholders voted in favor of the merger. Despite attempts to halt the deal on legal grounds, it
went as planned.



Oracle's Hostile Takeover of PeopleSoft (A):

In June of 2003, PeopleSoft management announced a merger with J.D. Edwards. Within hours
of the announcement, Oracle had launched a hostile takeover attempt of PeopleSoft. Oracle's
bid raised enormously difficult questions for the PeopleSoft board, questions about whether
PeopleSoft products would continue to be supported and customers became reluctant to buy
PeopleSoft software. Managers were therefore faced with a decision about how to respond to
the bid and the uncertainty it created. To regain customer and analyst confidence, PeopleSoft's
board considered adopting a Customer Assurance Program in which customers would receive a
cash payment in the event of a takeover. This promise of a cash payment would not only
encourage customers to invest in PeopleSoft products, but also created a liability that might be
large enough to derail Oracle's takeover attempt altogether. The board therefore had to consider
the implications of a Customer Assurance Program for the welfare of the firm, its customers,
and its duties to shareholders faced with a tender offer.

ITC and East India Hotel Co.:

On Oct. 10, 2000 Arun Bajoria, a jute baron based in Calcutta, revealed that he had bought
14% of languishing textile maker Bombay Dyeing & Manufacturing and would seek a board
seat. Just three days later on October13, Renaissance Estates, a young New Delhi-based
construction company, revealed that it had accumulated more than 5% of Gesco, a real-estate
spin-off of venerable Great Eastern Shipping Co. and would bid Rs. 27 a share for a 51% stake.
Gesco's share price nearly tripled to Rs. 40 a share in the wake of the announcement. Then, in
early November, news broke that cigarette maker and hotelier ITC Ltd. had bought 5% of East
India Hotels Ltd. since the start of the year. ITC termed the buying ''routine treasury
operations.'' Aware of ITC's moves, the Oberoi family, East India's founders, has boosted its
stake to 39%, from 36%, in the past few months.

Hostile takeover of Arcelor by Mittal:



In the case of Mittals acquisition of Arcelor the management of the Arcelor was strongly
opposed to the takeover by Mittal Steel whom they sneered at as a company of Indians. Hence,
Mittal had to resort to Hostile Takeover
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.

Conclusion

Defenses against Hostile Takeovers are the modes or methods to protect the interest of the
company as well as that of Shareholders. There are certain advantages and disadvantages of a
hostile takeover and it may be difficult to categories it into a strict mould in order to say that
hostile takeover should be promoted or discouraged. It is a widely shared belief that hostile
takeovers allow the shareholders of the target company realize the best price of their
investment or in other words it promotes economic efficiency by transferring the control of
corporate resources from an inefficient management to an efficient one. While it is true that
hostile takeovers are value-maximizing to the target shareholders; some hostile takeovers may
promote efficiency, some may result in a misallocation of economic resources, and some may
be neutral in terms of economic efficiency.

In the end defenses against Hostile Takeovers are exercised when takeovers are being
exercised against the will of the company.



By:- Mohit Mittal and Harsh Sharma



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Prasad G. Godgole , Mergers ,Acquisitions and Corporate Restructuring, Vikas Publishing House Pvt. Ltd. , Noida
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