Bursting the rules on warranties in public deals

In contrast to private company acquisitions, bidders for public company targets typically do not receive the benefit of detailed warranties regarding the target company they are seeking to acquire. However, as demonstrated by a recent transaction completed by Oracle Corporation (Oracle), warranty style protection should not be ruled out in public company deals.

Oracle acquisition of RuleBurst

Oracle recently completed the acquisition of RuleBurst Holdings Limited (RuleBurst), an unlisted public company in the IT industry with hundreds of shareholders, noteholders and optionholders and operations in Australia, United States, Europe and Asia. The acquisition was effected through the use of three inter-conditional schemes of arrangement in respect of the shares, notes and options in RuleBurst. The purchase price for the transaction was in the order of A$150 million.

Despite RuleBurst being a public company with a broad spread of security holders, Oracle was able to obtain the benefit of warranty style protections in relation to RuleBurst and its business, equivalent to the detailed warranties customarily obtained by buyers in private acquisition transactions in the United States.

This outcome was achieved by structuring the transaction so that part of the purchase price that would otherwise be payable to security holders was placed into an escrow account pending the outcome of any claims by Oracle in respect of the enumerated ‘Adjustment Matters’ (factual statements in the nature of warranties) not being correct. A representative was appointed by the security holders to respond to any claims made by Oracle and a portion of the purchase price set aside to fund the representative.

After 12 months, any amount remaining in the escrow account after all claims have been agreed or settled will be distributed to the former security holders.

Application to other public company transactions

The Oracle transaction involved the acquisition of an unlisted public company, as was the case when a similar transaction structure, pioneered by Freehills, was used in the acquisition of Cashcard back in 2004.

However, there is no reason why such a structure could not be used to acquire a listed public company.

Continuously disclosing entities

Companies listed on the ASX have continuous disclosure obligations and on that basis one might argue that warranties in relation to such a target do not provide significant additional comfort to a bidder so as to justify it seeking the additional warranty protections. However, even where a listed target is in full compliance with its continuous disclosure obligations, this only provides comfort to a bidder in relation to the disclosure of information that is known to the company. There is no comfort on matters that the target is not aware of and which may pose significant risks for the bidder which may cause it not to proceed with the transaction.

Accordingly, when faced with a valuation gap arising because of differing views on risk, warranties in a public deal may assist the parties to bridge that gap. Just like they do in a private transaction. As in private deals, the process of negotiating, and having disclosure against these warranties, in some instances, puts more rigour into the ‘data room’ compilation by the target, thereby improving the level of information available to the bidder.

Role of the target board

If the board of the target considers that it is appropriate to structure the transaction so that it involves warranties being given to the bidder, the target board will be responsible for negotiating and agreeing the content of those warranties with the bidder. The package of warranties will then be put to security holders for approval as part of the overall vote on the transaction.

As shareholders will not necessarily have visibility on whether particular warranties are accurate or not, it is expected that the target board would express a view to security holders in the meeting documents regarding the accuracy or otherwise of the warranties.

Escrow amount

The amount of the purchase price escrowed is likely to have an impact on an independent expert’s assessment of the transaction. In the Oracle transaction, the amount payable to security holders, excluding the escrowed consideration, was in excess of the valuation ranges assessed by the expert in relation to each type of security. Accordingly, it was not necessary for the expert to consider whether or not the escrowed consideration (or any part of it) would ultimately be paid to security holders in order to opine that the proposed schemes were in the best interests of security holders.

If the consideration payable to shareholders, excluding the escrowed amount, is below the mid-point of the expert’s valuation range, but would exceed the mid-point of that range if some or all of the escrowed amount was paid to shareholders, the expert is likely to have to decide how to assess the value of the consideration being escrowed.

Conclusion

Transactions involving the acquisition of public companies are almost invariably approached by bidders and targets on the assumption that warranty style protection will not be provided to the bidder. However, as the Oracle and Cashcard transactions demonstrate, this assumption should be tested on a deal by deal basis as it is certainly possible to structure transactions involving public companies so as
to give the bidder protections that are akin to those negotiated in transactions involving the acquisition of private companies.

* Freehills acted for Oracle Corporation on the acquisition of RuleBurst Holdings Limited.

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