Process deeds in Australian Public M&A transactions

A process deed is an agreement entered into between a prospective bidder and a target company as a precursor to the entry into a binding implementation agreement

There has been a recent increase in the use of process deeds in Australian Public M&A transactions. We estimate that in the order of approximately 10% of proposed friendly change of control transactions would now involve a process deed, with the percentage being higher than this for larger size transactions.

A process deed is an agreement entered into between a prospective bidder and a target company as a precursor to the entry into a binding implementation agreement. The document describes the parties' obligations to progress the prospective bidder's non-binding proposal to acquire the target. In some cases, the entry into the process deed is announced together with a public statement by the target board to the effect that it "intends to recommend" the bidder's proposal, subject to certain qualifications.

Although the scope of the obligations contained in the process deed varies between transactions, it is common for them to include a suite of exclusivity provisions, similar to those typically seen in a binding implementation agreement. The Takeovers Panel has considered pre-deal exclusivity provisions in two recent matters involving process deeds, which demonstrates that such arrangements can be subject to close regulatory scrutiny.

By way of example, such an arrangement (in the form of a confidentiality and exclusivity agreement) was entered into in November 2022 by Origin Energy Limited in connection with the receipt of an indicative proposal from a consortium led by Brookfield Asset Management to acquire all of the issued shares in Origin by scheme of arrangement (valuing the company at A$18.4 billion on an enterprise value basis). The ASX announcement disclosing the non-binding proposal also noted that, based on current information and market conditions at the time, it was the Origin board's intention to unanimously recommend the proposal to its shareholders.

This article considers this market development and describes some of the benefits of the use of process deeds (and pre-deal exclusivity arrangements) for both bidders and target companies.

What is a process deed?

A process deed is a non-binding agreement entered into between a prospective bidder and a target company setting out the parties' obligations to progress the prospective bidder's proposal to acquire the target company.

A process deed is a precursor to entering into a scheme or bid implementation agreement. It is typically entered into in circumstances where the target company receives an indicative non-binding offer from a prospective bidder on terms which the target board is inclined to support in principle, and in respect of which the target board is prepared to grant due diligence access to the bidder.

Process deeds commonly include provisions dealing with access to exclusive due diligence, the preparation and negotiation of a formal implementation agreement and exclusivity provisions in favour of the bidder. In more limited cases, cost reimbursement provisions in favour of the bidder (for example, in circumstances where the target company proceeds with a competing proposal) are also included.

In many cases, the entry into the process deed is announced in conjunction with a public statement by the target board to the effect that it "intends to recommend" the bidder's proposal, in the absence of a superior proposal and subject to certain qualifications. These qualifications typically include the entry into a binding implementation agreement on acceptable terms and an independent expert concluding that the transaction is fair and reasonable and in the best interests of target shareholders.

In order for the target board to be able to provide a statement of intended support of the bidder's proposal at the time of entry into the process deed, it would need to have undertaken a comprehensive assessment of the terms of the bidder's proposal, including from a value perspective, at the relevant time.

The entry into the process deed is generally disclosed to the market.

Benefits for bidder

Some benefits of entering into a process deed from a prospective bidder's perspective include:

• certainty of target board support at a certain offer price, without having to improve (or further improve) its offer, thereby effectively setting a "cap" on the offer price;

• certainty of target board intended support before spending significant time and resources undertaking due diligence and (if required) seeking funding commitments from investors and financiers; and

• the benefit of certain deal protection mechanisms commonly found in implementation agreements at the non-binding stage, as well as the option to walk away from the proposal if the bidder is not satisfied with the outcome of its due diligence review.

Benefits for target

Some benefits of entering into a process deed from a target's perspective include:

• as the indicative proposal and the material terms of the process deed are publicly announced, it can assist the target to manage its continuous disclosure obligations in the early stages of the process by ensuring that the market is fully informed;

• the target can potentially extract a higher offer price from the bidder in exchange for providing exclusivity and an intended board recommendation (which is publicly announced). This seems to have occurred in the Origin Energy example mentioned above;

• the target board's public statement of intended support for the proposal may effectively set a "floor price" for the transaction to proceed;

• potentially increasing deal certainty by demonstrating the bidder's strong commitment to the process;

• it can have the effect of putting a stop to a potentially declining share price, at least in the short term; and

• enabling the target to set the scope and parameters of the due diligence process.

Takeovers Panel guidance

The Takeovers Panel (Panel) considered pre-deal exclusivity arrangements under two separate process deeds in the recent decisions of AusNet Services Limited 01 [2021] ATP 9 and Virtus Health Limited [2022] ATP 5.

In each of those matters, the Panel made a declaration of unacceptable circumstances and orders (including that the process deed be ineffective unless certain amendments were made within the specified timeframe).

Following AusNet 01 and Virtus, there are a few key takeaways apparent from the Panel's approach to process deeds and pre-deal exclusivity, including:

• the Panel considers the exclusivity arrangements as a whole when assessing them (i.e. a declaration of unacceptable circumstances may be based upon the combination of a number of individual factors);

• "no talk" and "no due diligence" restrictions should be subject to an appropriate fiduciary carve out (or "fiduciary out") allowing the target's board to engage with rival bidders when it would otherwise be a breach of their fiduciary duties not to do so (i.e. "hard exclusivity" will likely be unacceptable);

• the length of the exclusivity is an important factor and will need to be relatively short (in AusNet 01, the minimum 8 week exclusivity period was considered to be "at the longer end of market practice"); and

• the inclusion of matching rights and notification obligations may increase the anti-competitive effect of the process deed, and in particular, matching rights may undermine the effectiveness of a fiduciary out provision in circumstances where any counterproposal need not be binding. Accordingly, the inclusion of any such terms should be considered carefully in the context of the other deal protection measures.

Closing comments

The traditional process of only announcing a transaction once the parties have agreed binding terms is still the preferred approach in most circumstances, as it avoids any premature disclosure of the bidder's proposal during the pre-deal stage, which is a key desire for most bidders. However, this is being countered by a target's desire to disclose the state of negotiations in advance of definitive arrangements being entered into.

While market practice relating to process deeds and pre-deal exclusivity arrangements is still evolving, we expect the trend of greater uptake of process deeds (and pre-deal exclusivity arrangements) to continue, particularly for larger transactions.

Parties contemplating utilising a process deed should carefully consider the relevant Takeovers Panel guidance, market disclosure expectations and applicable regulatory considerations. In particular, target boards need to ensure they retain the flexibility necessary to satisfy both their directors' duties and market expectations.

Disclaimer – The views expressed in this article are the personal views of the authors and are purely informative in nature.