The Swiss Takeover Board (“TOB“) applies a relaxed standard to modifications of participation plans concerning the target’s board members and executives (“PPs“). This conflicts with the doctrine of ancillary benefits. In a recent newsletter the TOB seemed to announce a change in the doctrine of modifications to PPs in connection with a public offer so as to align it with the doctrine of ancillary benefits. However, in subsequent orders, the TOB has backtracked on its previous announcement.

By Ralph Malacrida (Reference: CapLaw-2023-60)

1) Introduction

A public tender offer for shares of a Swiss listed company typically succeeds only if the target’s board of directors and management are supportive of the offer and if the bidder has the prospect of being able to buy 100% of the target’s shares. Therefore, executive (equity) compensation is a key factor in public offers. Most listed companies offer participation plans to board members, senior management and key employees. In view of a takeover offer involving a change of control over the target company, PPs either provide for special rules or must be modified to enable the beneficiaries of restricted shares or unvested awards to either sell or exchange their interests or benefit from a cash settlement rather than end up as minority shareholders in a delisted target company. Likewise, a bidder will not want to launch a public offer if it is not able to acquire 100% of the target shares.

The treatment of PPs in the context of public offers can raise complex questions, in particular concerning the applicability of general principles of takeover law, the legality of modifications to existing plans, and/or the provision of additional benefits in connection with a public offer. Swiss law on public offers does not provide for special rules regarding PPs. Therefore, the TOB must deal with these issues on the grounds of general principles of Swiss takeover law, trying to find middle ground between the interests of the target companies, the members of the board and management, the shareholders and the bidders. The TOB has issued a plethora of orders dealing with the treatment of PPs in the context of public tender offers. However, there is a misalignment of the TOB’s doctrine of modifications of PPs and its general doctrine of ancillary benefits. Since the TOB generally omits to state the detailed reasons upon which its conclusions are based, the TOB’s practice is a continuing conundrum. 

The most recent twist on the treatment of PPs in connection with public offers is evidenced by the TOB’s release of a newsletter on 10 May 2023 (the “Newsletter“) and the TOB’s subsequent orders. In the Newsletter, the TOB seemed to announce a tightening of standards – but in subsequent orders backtracked on its previous announcement. Market participants are now left to wonder how the conundrum continues. 

2) Participation Plans

PPs are available in many forms. Common elements of board and executive compensation involve one or more of the followings features.

– Short term incentive plans are variable incentive plans for key employees designed to deliver executive management compensation that is competitive and recognizes employees for their contributions in achieving short-term performance objectives as established by the board of directors or, if delegated to it, the compensation committee. The short term incentive programme is typically tied to cash payments, but may involve any other form of remuneration.

– Long term incentive plans are variable incentive programmes designed to deliver executive management compensation that recognizes employees for their contributions in achieving long-term performance objectives as established by the board of directors, or, if delegated to it, the compensation committee, and aligns executive management and board members with shareholders in focusing on long-term growth and stock performance. The long-term incentive awards are typically structured as awards in the form of stock options, restricted stock units, performance stock units or cash, or may consist of shares, restricted shares, deferred stock units, share appreciation rights, other financial instruments or derivatives, and any other form of remuneration.

– Retention bonuses are extra payments given to selected employees as a way of persuading them not to leave the company at a time when it is experiencing big changes (notably a change of control).

3) Interests of Bidder, Members of Target’s Board/Management, and Shareholders

In a takeover scenario the shareholders of a target company are interested in receiving an opportunity to sell shares at a premium to trading value and in being treated equally with managers or board members who are holders of shares and/or equity awards.

The members of the board and the key employees expect to receive a cash compensation (or an equivalent roll-over) in relation to the shares or equity awards received under the applicable PPs. As a matter of fact, the board members and senior management of the target company are instrumental for the success of a public offer and therefore have clout in negotiating terms concerning their own compensation.

Finally, it is in the interest of the bidder to be able to acquire 100% of the target company, keep transaction costs low, and retain key employees. If proposed bonuses or modifications to existing PPs involve costs or risks, the bidder will want to reflect this in a reduced offer price. In consequence, in the run up to a change of control takeover transaction, the bidder is the antagonist of the members of the board and management when it comes to modifying board and executive compensation. 

The TOB’s task is to weigh the interests of the protagonists in a takeover process against the applicable rules and regulations of Swiss takeover law, including the price rules and the principle of equal treatment, which are the key criteria to assess modifications to PPs.

4) Guiding Principles in Change of Control Offers

a) Before Publication of an Offer

The minimum price rule (article 135 (2) FMIA) is relevant if shares in the target are purchased by a bidder or parties acting in concert with the bidder before a public offer is made that results in a change of control (see article 9 (6) Takeover Ordinance). According to the minimum price rule, the offer price must be at least equal to the higher of the stock exchange price and the highest price paid by the bidder and the persons acting in concert with the bidder for equity securities of the target company during the preceding twelve months. 

The bidder and the target company are acting in concert as of the time when they sign a transaction agreement (see e.g. TOB Order 770/01 of 26 August 2022 in the matter Sunrise Communications Group AG, N 30). Therefore, for as long as the bidder and the target company are negotiating a transaction agreement, the minimum price rule does not apply to agreements between the target and its board or management regarding compensation matters.

As a matter of principle, the best price rule applies to purchases after a public offer is published (see below clause 4b)). Exceptionally, in the event of a “combined overall transaction” (gekoppelte Gesamttransaktion) the best price rule applies even if shares in the target are purchased before a public offer is made. This is intended to prevent circumventions of the best price rule (TOB Order 849/02 of 15 August 2023 in the matter of Schaffner Holding AG, rec. 15 f.; TOB Order 846/02 of 4 August 2023 in the matter of Von Roll Holding AG, rec. 12; TOB Order 846/01 of 23 June 2023 in the matter of Von Roll Holding AG, rec. 28; TOB Order 730/01 of 28 May 2019 in the matter of Alpiq Holding AG, rec. 22). A combined overall transaction is deemed to occur if a purchase agreement and a public offer are linked and subject to the same conditions (except conditions that are necessary or essential to complete the purchase or the offer).

For example, a combined overall transaction would be assumed if during the pre-offer phase the target company agreed with a member of senior management – who holds equity awards – to pay an additional special bonus, conditional on the successful completion of the public offer. In this scenario, the best price rule would apply, and the value of the additional bonus would have to be taken into account when determining the total price paid to the senior manager for his tendered shares.

b) After Publication of the Offer

According to the best price rule (article 10 (1) Takeover Ordinance), if a bidder buys equity securities of the target company at a price which is above the offer price during the period between the publication of the offer and six months after the expiry of the additional acceptance period, the bidder must offer the higher price to all recipients of the offer. The best price rule is a reflection of the principle of equal treatment, which provides that holders of equity securities of the same type must be treated equally (TOB Order 849/02 of 15 August 2023 in the matter of Schaffner Holding AG, rec. 6; TOB Order 846/02 of 4 August 2023 in the matter of Von Roll Holding AG, rec. 4; TOB Order 846/01 of 23 June 2023 in the matter of Von Roll Holding AG, rec. 18). The best price rule is violated if the price paid for equity securities or derivatives by the bidder or a person acting in concert with the bidder (within the meaning of article 11 (1) Takeover Ordinance) is higher than the offer price. As pointed out above (see clause 4a)), in the event of a “combined overall transaction” the best price rule may apply to transactions that were entered into before the publication of the offer.

If a selling shareholder receives not only the official offer price but also other (ancillary) benefits from the bidder or a person acting in concert with the bidder, the value of these benefits must be added to the official offer price with the effect that the offer price must be increased to comply with the best price rule. Conversely, if a selling shareholder provides benefits to the bidder, the value of these benefits may be deducted from the offer price (see article 43 (4) FMIO-FINMA). 

It is the bidder’s responsibility to determine whether ancillary benefits exist and to value these benefits (TOB Order 849/02 of 15 August 2023 in the matter of Schaffner Holding AG, rec. 8; TOB Order 846/02 of 4 August 2023 in the matter of Von Roll Holding AG, rec. 6; TOB Order 846/01 of 23 June 2023 in the matter of Von Roll Holding AG, rec. 21). If a bidder anticipates a risk of the review body and/or the TOB identifying ancillary benefits, the bidder will want to appoint a valuation expert to determine and value these potential benefits prior to the publication of the offer so as to ensure that no shareholder receives more than the official offer price. Typically, the bidder seeks formal pre-clearance by the TOB to avoid the risk of breaching price rules.

5) The TOB’s Doctrine of Modifications to PPs

a) Relaxed Standard

In a public offer for shares in a Swiss listed company, where the buyer is purchasing the target as a whole, equity awards are usually either cashed out or rolled over.

Quite often, existing PPs provide for the unblocking of restricted shares, the acceleration of unvested equity awards and/or cash settlement in connection with a change of control transaction. If the awards being cashed out are subject to performance-vesting conditions, the applicable level of performance will need to be determined either by agreement between the bidder and the target company or based on the terms of existing PPs. If existing PPs do not address change of control scenarios, the target company will have to modify the PPs to permit the unblocking of shares, the acceleration of the unvested equity awards and/or cash settlements, subject to compliance with any limitations imposed by employment and corporate law. 

While these modifications to PPs are favourable for employees, they are not necessarily ideal for the acquiring bidder. When shares are unblocked and options become fully vested and are exercised, target employees have less incentive to stick around and will be open to offers from elsewhere. Therefore, modifications to PPs are sometimes combined with the payment of retention bonuses to key employees.

The bidder and the target company are acting in concert as soon as they have entered into a transaction agreement. As of that point in time, equity awards or bonus payments made by the target company in favour of the target’s employees or members of the board are subject to compliance with the best price rule and the duty to treat shareholders equally (TOB Order 823/01 in the matter of Valora Holding AG, N 8 and 29; TOB Order 770/01 of 26 August 2020 in the matter Sunrise Communications Group AG, N 11 and 30). 

In essence, the TOB has applied a relaxed standard when reviewing bonus payments and modifications to existing PPs by taking the view that customary modifications do not result in the applicability or violation of the best price rule so that no valuations must be produced to determine the value of potential benefits.

b) Modifications to PPs

By way of illustration, the TOB has confirmed that the best price rule does not apply or is not violated in relation to the following modifications of existing PPs:

– The termination of blocking periods in relation to restricted shares, which allows the beneficiaries to tender their shares during the additional acceptance period (TOB Order 849/04 of 6 November 2023 in the matter Schaffner Holding AG N 11; TOB Order 823/01 of 25 July 2022 in the matter Valora Holding AG N 36; TOB Order802/02 of 14 January 2022 in the matter Vifor Pharma AG N 36). 

– The acceleration of vesting periods in relation to equity (share or option) awards (TOB Order 802/02 of 14 January 2022 in the matter Vifor Pharma AG; TOB Order 823/01 of 25 July 2022 in the matter Valora Holding AG, N 44), even if entitlements are not reduced pro rata temporis provided that existing PPs do not require such a reduction (TOB Order 770/01 of 26 August 2020 in the matter Sunrise Communications Group AG, N 33 et seq.). 

– The cash settlement of rights to physical delivery of shares, which complies with the best price rule if the beneficiaries receive a cash settlement corresponding to the offer price or the intrinsic value of any “in the money-options” or the value determined as per Black Scholes or a binominal model for “out of the money-options” (TOB Order 849/04 in the matter Schaffner Holding AG N 13; TOB Order 823/01 of 25 July 2022 in the matter of Valora Holding AG N 49; TOB Order 802/02 of 14 January 2022 in the matter of Vifor Pharma AG N 39; TOB Order 638/03 in the matter Charles Vögele Holding AG N 20; TOB Order 678/02 of 28 February 2018 in the matter Goldbach Group AG, N 14 et seq.).

– The modification of awards without physical delivery (cash awards, phantom stocks) (TOB Order 652/01 of 14 February 2017 in the matter Actelion AG, N 38).

c) Pre-Offer Arrangements relating to Executive Compensation

Apart from the modifications to PPs that are referred to in clause 5b) above, which are typically agreed in the transaction agreement between the bidder and the target company, the TOB has confirmed that any modification to PPs or additional management or board compensation arrangements before the public offer is made falls outside the scope of the best price rule in the absence of a “combined overall transaction”. 

More precisely, if the target decides to improve the terms of a long term or short term incentive plan or agrees to pay a retention bonus or other bonuses to management or members of the board, these pre-offer compensation arrangements fall outside the scope of the best price rule if they are (a) agreed before a public offer is made and (b) not linked to or contingent on the success of the public offer or the tendering of shares by the respective members of the management or the board (TOB Order 849/02 in the matter Schaffner Holding AG N 14 et seq.; TOB Order 846/02 of 4 August 2023 in the matter Von Roll Holding AG, N 22 et seq.; TOB Order 846/01 in the matter Von Roll Holding AG, N 40 et seq.). 

The TOB has not explained why arrangements between the target company (represented by the board of directors) and the members of the board and management concerning modifications to their compensation shortly before a transaction agreement is signed between the target company and the bidder should be exempt from scrutiny of price and equal treatment rules simply because of the absence of a formal condition linking these arrangements to the completion of the public tender offer. The TOB said that abuses should not be tolerated but has not specified the scenarios in which circumventions of the price and equal treatment rules should be assumed.

d) Conflicting Doctrines on Modifications to PPs and Ancillary Benefits

In its orders on modifications of existing PPs the TOB has not given detailed reasons for its conclusions and whether these conclusions were in line with or deviating from the doctrine of ancillary benefits. As a result of this, anyone reading these orders is left to speculate as to the possible route by which the results were achieved. This prevents the practitioners and the parties concerned from ascertaining the basis upon which similar cases will probably be decided in the future. 

On the one hand, the TOB has developed the doctrine of ancillary benefits, deciding that, if a bidder not only pays a shareholder the official offer price but also provides other ancillary benefits, these benefits must be taken into account when calculating the total offer price received by a shareholder (TOB 623/01 of 25 February 2016 in the matter Kuoni Reisen Holding AG, N 27). 

On the other hand, to illustrate the doctrine of modifications of PPs, the TOB held in several orders that the unlocking of restricted shares by terminating the blocking period so that employees may tender their shares into the offer does not involve a “purchase of shares” as per article 10 (1) Takeover Ordinance so that the best price rule does not apply (TOB Order 823/01 of 25 July 2022 in the matter Valora Holding AG, N 36), with the effect that the value attributable to the unlocking of the shares does not need to be determined. Likewise, the TOB has decided that the acceleration of vesting periods as a matter of principle does not violate the best price rule (see orders listed in clause 5c) above). 

This reasoning is not properly balanced. As of signing a transaction agreement, the bidder is acting in concert with the target company so that the actions of the target company are actions of the bidder and vice-versa. If the target/bidder unlocks restricted shares to allow their tendering into the offer, the unlocking has a value for the employee who is given the possibility of selling his/her shares (usually at a premium). The link between the unlocking of the shares by the target/bidder and the contemplated purchase of the shares by the bidder is evident. The purpose of unlocking shares is to enable their purchase and sale during the additional offer period. Therefore, it is not clear why the TOB is saying that the unlocking of restricted shares is not related to a “purchase of shares” and falls outside the scope of the best price rule whilst at the same time it insists that ancillary benefits fall within the scope of, and violate, the price rules. The same question arises in relation to the accelerated vesting of equity awards.

6) TOB Newsletter of 10 May 2023

a) Content of the Letter and Subsequent TOB Orders

On 10 May 2023 the TOB published the Newsletter dealing with the treatment of PPs in connection with public takeover bids. The TOB seemed to announce a policy change for the purpose of rebalancing its contradictory doctrines on modifications of PPs and ancillary benefits:

“Ancillary services provided in connection with a public takeover bid must first be valued by the bidder. In a second step, the Review Body must verify the appropriateness of this valuation (see Federal Administrative Court decision of 30 November 2010 in the matter Quadrant AG, N 7.3 f.). In order to comply with the best price rule, the Review Body must issue a positive assurance and perform appropriate audit procedures (see Swiss Auditing Standard 880: Auditing of Public Takeover Bids, para. 54). At its last meeting, the TOB confirmed that this practice should be applied by analogy to benefits from employee participation plans of the target company that are modified in connection with a public takeover bid. In particular, a vesting triggered or accelerated by a change of control is also deemed to be a modification (newsletter of the TOB dated 10 May 2023, as referred to in TOB Order 849/04 of 6 November in the matter Schaffner Holding AG, N 7 et seq.).”

According to this Newsletter the TOB seemed to announce a tightening of its relaxed standard in relation to modifications of PPs in connection with public offers because according to past practice the TOB had treated accelerations of vesting periods as modifications not violating the best price rule so that no valuations had to be commissioned (see clause 5b) above). The question raised by the Newsletter was whether henceforth customary modifications to PPs would fall under suspicion of involving (ancillary) benefits and therefore require valuations of the benefits conveyed to members of the board and employees to determine compliance with the best price rule.

However, in a recent order of the TOB, it “clarified” that the Newsletter was meant to confirm the standard practice of the TOB and to highlight that benefits related to PPs may be relevant under the best price rule (TOB Order 849/04 of 6 November 2023 in the matter Schaffner Holding AG, N 8). The narrative inconsistency of this statement is twofold: first, modifications of PP’s were generally held to be outside the scope of (or not violating) the best price rule, and, second, the TOB’s doctrine of ancillary benefits is misaligned with its doctrine of modifications of PPs. In consequence, the conundrum continues.

b) Consequences

Looking at the Newsletter and the subsequent orders of the TOB, market participants are trying to understand whether or not the TOB intends to reconcile the doctrine of ancillary benefits with the doctrine of modifications of PPs. 

Two scenarios are possible: 

– One scenario is that the TOB shies away from unifying the two doctrines, with the result that two divergent standards apply in the field of the price rules and the equal treatment principle in connection with a public offer: (a) a strict standard for ancillary benefits that are provided by the bidder to selected shareholders (other than compensation of executive management and board members) or to co-investors and (b) a relaxed standard for benefits provided by the target in the form of modifications to executive compensation, usually for the benefit of the members of the board and management. In this scenario, on the one hand, shareholders may be put at a financial disadvantage in two respects. First, shareholders do not receive the benefits that executives receive and, second, the bidder may reduce the offer price to balance out additional costs arising from the target’s (increased) costs related to executive compensation. On the other hand, in this scenario shareholders may benefit from a higher number of public offers providing them with sales opportunities at a premium.  

– In the other scenario the TOB tries to unify two conflicting doctrines and focus the attention of bidders on the risk of PP modifications possibly failing to comply with the best price rule. The effect of this would be that PPs and their modifications would come under increasing scrutiny of bidders. Bidders will not want to bear the financial risk for decisions that were taken by the target and its employees. At the same time, since bidders were not involved in the target’s business operations, they are not well placed to assess whether a proposed modification to PPs results in adequate compensation. Therefore, due diligence requests will become more extensive. Furthermore, bidders will attach greater importance to the negotiation of adequate terms in the transaction agreement and special compensation arrangements for target employees. This includes the treatment of target equity awards that are subject to performance conditions and the determination of the level of achievement of any performance metrics. In any event, negotiations between the bidder and the target on modifications to PPs and executive compensation would start much earlier than today. If due diligence becomes (too) burdensome and negotiations with the target’s board and management on PPs become very challenging at an early stage of the process, the risk of potential takeover transactions failing would increase, thus depriving shareholders of attractive sales opportunities.

7) Conclusion and Outlook

The treatment of PPs in the context of public offers represents a critical workstream for a bidder in its acquisition of a Swiss listed company. It is a key factor in any successful transaction. Modifications to PPs and special bonus payments may be relevant transactions under the price rules. 

In defining the scope of relevant transactions and the standard of review, the TOB is walking a fine line. On one side, it must avoid regulatory overreach that would prevent takeovers from happening or impose obstacles to the takeover process both in terms of timing and costs. On the other side, it must not take a laissez-faire approach by turning a blind eye on modifications to executive compensation in connection with public offers and thus tolerate unequal treatment of shareholders. 

It is not yet clear whether the TOB will go in the direction of leaving things unchanged by continuing to apply different standards to modifications of PPs and ancillary benefits or whether it intends to tighten the standard of review in relation to PPs and executive compensation, as it seemed to have indicated in the Newsletter. In any event, the distinction may become less relevant if target companies were tempted to pre-empt any increasing scrutiny by resorting to pre-offer modifications and arrangements concerning PPs and executive compensation, which according to the TOB’s recent decisions are outside the scope of takeover law as long as they are not formally linked to the public offer (subject to clear circumventions of the law). It remains to be seen how the TOB would react to a notable increase in pre-offer modifications of PPs and executive compensation – given the fact that Swiss takeover law is designed principally to ensure that shareholders in a target company are treated fairly.

Ralph Malacrida (ralph.malacrida@baerkarrer.ch)