Under German takeover law the bidder in a voluntary public takeover is given two options with regard to what the bidder offers the shareholders of the target company as compensation for their shares. The bidder may offer either a compensation in cash or an exchange of shares, provided the offered shares are ‘liquid’ and are admitted to an organized market (Sec. 31(2) 1st sentence of the German Public Takeover Act (WpÜG)). In the first judicial ruling on the matter, on 11 January 2021, the Higher Regional Court of Frankfurt a.M. (OLG Frankfurt a.M.) has now imposed rather strict requirements on the ‘liquidity’ criterion. Since the German Financial Supervisory authority (BaFin) has already adopted the Court’s requirements in a decision issued subsequent to the court judgement, share exchange offers will be available in Germany in the future to none but only a rather small group of listed bidders.

What is the legal status quo?

The German Takeover Act does not provide for any definition on the term of ‘liquid’ shares. As a result, the question which requirements shares have to meet to be considered ‘liquid’ has been debated among legal scholars since the enactment of the German Takeover Act.

With its ruling, the Court positioned itself in this debate, by adopting an opinion that, up to that point, had only been upheld by very few scholars and also stands in stark contrast to the prior ruling practice of BaFin. The Court held that whether shares are ‘liquid’ or not should be determined pursuant to rather strict and formal criteria described in further detail below significantly restricting the scope of application for share exchange offers in Germany.

What was the Court’s ruling on?

The Court was presented with the appeal of Heidelberger Beteiligungs AG, a German stock corporation, against a prohibition order of BaFin regarding the intended takeover of Biofrontera AG – also a German stock corporation – in which Heidelberger Beteiligungs AG had offered its own shares as compensation by way of a share exchange offer.

The grounds on which the BaFin based its prohibition order were in line with its regular ruling practice to date:

• Whether shares are ‘liquid’ can only be assessed on the basis of a detailed review of all information available in each given case and requires a forecast decision on the expected liquidity of the exchange shares for the period immediately after execution of the takeover bid.
• Such an assessment should not be made on the basis of simple formal criteria, but requires a comprehensive forecast as outlined above.
• Where this forecast is negative – as it was the case here –, the takeover offer has to be prohibited.

What did the Court decide?

The Court dismissed the appeal and upheld the decision of BaFin. However, in contrast to BaFin’s analysis and without any apparent need, the Court based its dismissal of the bidders appeal on far more restrictive – and explicitly formal – criteria:

Starting point: What purpose does the ‘liquidity’ criterion serve?

• First, the Court established that any requirements for the ‘liquidity’ criterion would have to take account of the purpose of Sec. 31(2) WpÜG. This means that in case of public takeover bids, both permitted types of mandatory consideration (i.e. cash consideration and shares offered in exchange) must guarantee a minimum level of protection for the shareholders of the target company with regard to their interest in the consideration being equivalent in value to their shares in the target company; the level of protection provided must be as equal as possible for each type of consideration.
• Therefore, shares offered in exchange for shares of the target company were only to be considered ‘liquid’ if they are at least as valuable for the shareholders of the target company as a compensation in cash.
• For this to be the case, the shareholders must be able to sell the shares without further ado and at any time shortly after the execution of the takeover bid for a purchase price which fulfills the statutory minimum price requirements for the shares they originally held in the target company.

If shares are ‘liquid’ or not must be determined by formal requirements

Based on those observations, the Court established, that whether a share can be considered ‘liquid’ or not should primarily be determined by the formal criteria set out by Art. 22(1) Commission Regulation (EC) No. 1287/2006. This Commission Regulation serves to implement the MiFiD Directive 2004/39/EC of the European Parliament and of the Council as regards record-keeping obligations for investment firms, transaction reporting, market transparency and admission of financial instruments to trading. Although Commission Regulation (EC) No. 1287/2006 does not relate to public takeovers, the Court considered the definition of a liquid market contained therein as a suitable point of reference as it was promulgated at about the same time as the European Public Takeover Directive which is implemented in Germany by the German Takeover Act.

Pursuant to Art. 22(1) Commission Regulation (EC) No. 1287/2006 shares of an issuer should be considered to have a liquid market, if (i) the shares are traded daily, (ii) with a free float of not less than 500 million Euro and either (iii) the average daily number of transactions in the shares is not less than 500 or (iv) the average daily turnover for the shares is not less than 2 million Euro.

Notably, the Court added that the requirements of Art. 22(1) Commission Regulation (EC) No. 1287/2006 should not be applied as a strict rule but rather as guideline allowing for some leeway. However, the Court also emphasized that when shares do not meet these requirements, they could only be considered ‘liquid’ in exceptional cases, i.e. provided the shares presented sufficient certainty that a shareholder would at any time and without further ado be able to sell them on the stock exchange with a similar probability as if the requirements were met.

Exchange offers from smaller bidding companies undesirable

The Court explicitly dismissed the appellant’s argument that such strict requirements would reduce the number of admissible shares to a small group of bidders, since as of today only about 80 listed German issuers would be able to fulfill them.

What are the implications for share exchange offers under German takeover law?

The ruling of the Court has already been reflected in a subsequent recent decision by BaFin issued on 23 February 2021 by which the takeover offer of 4basebio AG to the shareholders of KROMI Logistik AG – providing for an exchange offer with the bidder’s own shares – was prohibited.

• In this decision, the BaFin’s prohibition order was now solely based on the assessment of whether the bidder’s shares met the requirements of Art. 22(1) Commission Regulation (EC) No. 1287/2006 as established by the Court’s ruling.
• In particular, the ruling did not contain any indication that those requirements would allow for some leeway so that no deviations would be permitted in exceptional cases.

Therefore, bidders for a German listed company considering to offer shares rather than cash as consideration will now have to expect BaFin to base its assessments on the admissibility of share exchange offers solely and strictly on the formal requirements of Art. 22(1) Commission Regulation (EC) No. 1287/2006. This new approach taken by BaFin will mean that share exchange offers will become even more of an exception in German public takeovers as it is already the case today.

Authored by Tim Brandi and Simon Kiefer.