This article was originally published in the schoenherr roadmap`10 - if you would like to receive a complimentary copy of this publication, please visit: http://www.schoenherr.eu/roadmap.
The last few months were dominated by out of control stock markets and a previously unseen liquidity crunch. Companies with unhealthy balance sheets had difficulty rolling over debt as banks only considered this if the company simultaneously took on additional equity. That in turn was not an easy task as stock prices were down and far from reflective of what management thought to be the intrinsic value of the company. Often thought of, but rarely implemented, were equity PIPEs.
An equity PIPE is a transaction among one or more (mostly institutional) investors on the one hand and a listed joint stock company on the other hand.
Main advantages
Compared to a classic rights issue, equity PIPEs have several advantages for the issuer. The main advantages are: more flexibility, better planning, swift implementation, lower cost, less disclosure and a positive sign to the overall market1. For the investor an equity PIPE is a very liquid investment. The shares issued are usually traded; thus, the investor can exit the market anytime. Alternatively the investor can choose to run an auction, as would be the normal course of action for non-public investments. The latter may make sense if the investor not only wants to sell off its shares but also a debt package.
The legal framework
Whether or not a classic equity PIPE can be implemented primarily depends on whether or not the existing subscription rights can be waived. The background is the following. The investor is usually interested in acquiring a certain package. Conversely, the issuer is interested in raising a certain amount of money. Sec. 153 Stock Company Act (AktG) provides for a subscription right of all existing shareholders, which can be waived by a shareholders' resolution with a ¾ majority vote, if justified cause can be established2. Establishing good cause is usually hard to do in case of a pure cash rights issue ("money is money"). One argument could be that the investor is offering additional cash or assets that could not be obtained in a rights issue over the market3. Eventually it would also suffice to establish that classic rights issues over the market had previously failed and the company is in need of cash.
In summary, a classic equity PIPE requires one or more core shareholders in support of the deal (¾ majority vote) and a justified reason to waive the subscription rights of the existing shareholders. If either of those prerequisites is a problem, issuers sometimes try to sell secondary PIPEs. In a secondary PIPE the investor undertakes to subscribe some or all of the shares issued but not underwritten in a classic rights issue, provided it is allocated a certain minimum number of shares and that one or more core shareholders undertake to ensure that the investor will obtain such minimum number of shares. As such, the secondary PIPE really follows the classic rights issue and does not replace it; many of the advantages mentioned above do not hold true for secondary PIPEs. A secondary PIPE may nevertheless still make sense if the issuer is interested in having the investor on board for strategic reasons.
Due diligence and insider trading
The framework for a due diligence is not any different than for other public deals. The main issues relate to confidentiality obligations towards the issuer, its shareholders and third party contractors; the equal treatment rule (Sec. 47a Stock Company Act (AktG))4; and insider trading regulations.
In practice things can turn quite complex, in particular once it is to be determined if and under what conditions non-public information may be disclosed and which implications such disclosure has in relation to insider trading regulation for documentation and the further process (in particular the ad-hoc disclosure duties pursuant to Sec. 48d Exchange Act (BörseG) and the prohibition against abusing insider information pursuant to Sec. 48b Exchange Act (BörseG)).
It should be noted that not every type of non-public information qualifies as insider information5. If, however, it does so qualify, then the investment decision must not be based on it. The investor may, however, abandon the deal on the basis of insider information later received; such case does not qualify as a prohibited use of insider information in the meaning of Sec. 48b Exchange Act (BörseG). Therefore it is of utmost importance to properly document which information is obtained when and to what extent such information was considered in the decision-making process.
Issuer Warranties – Worth anything?
Investors will usually only be willing to invest if there are certain warranties as to the issuer and the business. If there is one or more supportive core shareholders the investor should insist on those warranties being given by the core shareholders. This is because recovery from the issuer in case of breaches of issuer warranties may be barred for breaches of capital maintenance rules pursuant to Sec. 52 Stock Company Act (AktG) or the equal treatment rule pursuant to Sec. 47a Stock Company Act (AktG).
In respect of Sec. 52 Stock Company Act (AktG), the only thing that is more or less established is that recovery is permissible out of the annual distributable profit or a permissible down-payment in respect of future annual profit pursuant to Sec. 54a Stock Company Act (AktG)6. In respect of the equal treatment rule, it is a point of debate whether warranties benefitting the investor and affording better protection than the rules on prospectus liability for other shareholders should be considered void as they cannot be justified (sachlich gerechtfertigt)7. An argument for such justification is that the issuer was in need of the financing offered, such financing was not available over the market in that form and the investor would not have invested had the issuer not granted such warranties.
In times of out-of-control capital markets and a previously unseen liquidity crunch, equity PIPEs are an interesting alternative for raising equity capital for issuers.
This article was originally published in the schoenherr roadmap`10 - if you would like to receive a complimentary copy of this publication, please visit: http://www.schoenherr.eu/roadmap.
Footnotes
1 See. Gerhard, GesKr 2006, 289 ff.
2 The waiver of the existing shareholders' subscription right is generally deemed "justified" if it is required to achieve a particular purpose which lies in the interest of the issuer, the waiver is capable of and the most lenient way to achieve such purpose and the interests of the issuer outweigh the interests of the shareholders; see. Winner in Doralt/Notwotny/Kalss, AktG § 153 Rz 108.
3 Nagele in Jabornegg/Strasser, AktG4 § 153 Rz 36.
4 See. Doralt/Winner in Doralt/Nowotny/Kalss, § 47a AktG Rz 19.
5 Sec. 48a Exchange Act (BörseG) defines insider-information as particular, precise information, not yet known to the public market, relating to a security or an issuer that, if it were to become public could significantly influence the price of a security.
6 See. Saurer in Doralt/Nowotny/Kalss, § 52 AktG Rz 3 und 9.
7 See. Gerhard, GesKr 2006, 289 ff.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
