Equal and unequal treatment clauses in takeovers of companies with dual class share structures

It is often argued that takeovers are difficult in companies with a dual class share structure because the founders and others hold a large number of voting shares and therefore control the company. However, from the point of view of good corporate governance, it is very important that the possibility of a takeover of the company, i.e. a change of control, is open. This article examines the arrangements that can be used to facilitate a takeover, assuming the introduction of a dual class share structure.〔For the argument that the issue of introducing a dual class share structure should be dealt with primarily by including the clause in the charter or articles of incorporation (hereinafter referred to as "articles of incorporation") at the time of the IPO, See, Berger & Fisch & Solomon (2023)〕.

In this regard, it has been suggested that companies adopting a dual class share structure should include in their articles of incorporation the granting of a control premium in the event of a takeover, so that shareholders with a high proportion of voting rights have an incentive to tender their shares in a takeover bid, thereby increasing the likelihood of a successful takeover (Position A, a type of 'unequal treatment clause', See, Smith(2017)). For example, a specific clause might read: 'In the event of a takeover procedure (e.g., takeover bid), high vote shares may receive an X% higher consideration than low vote shares'. Such an arrangement is a noteworthy approach that focuses on the incentives of shareholders holding high vote shares.

However, if a company with a dual class share structure has a clause such as (A) in its articles of incorporation, the payment of a control premium for high vote shares will require more acquisition funds than in the case of a normal takeover. This could act as a disincentive to complete a takeover. It should be noted that, in many jurisdictions, takeover bids in relation to companies issuing class shares are made on a class-by-class basis, which means that an acquirer may make a takeover bid on different terms for each class of shares, even if the target company does not provide for an arrangement as described in (A). However, even in this case, the payment of a control premium for high vote shares is effectively required, and the total amount of acquisition financing is likely to be higher when acquiring a company that has adopted a dual class share structure.

On the other hand, in the US since the 2000s, some companies that have adopted a dual class share structure appear to have introduced clauses that grant voting rights in proportion to the percentage of shares held during the takeover procedure (See, Smith(2017); Petrucci (2023)) (Position B, a kind of "equal treatment clause"). Such clauses are problematic because they cause shareholders with high vote shares to lose control and the associated control premium, thereby reducing the incentive for shareholders with high vote shares to tender their shares to the bid. To overcome the problems associated with the equal treatment clause in (B), the use of a type of 'unequal treatment clause' as in (A) has been advocated.

Under clause (B), however, the high vote shareholder is no longer the controlling shareholder under the clause at the time of the takeover procedure, and if many of the other shareholders who were low vote shareholders accept the takeover bid, there is a good chance that the takeover will be completed. In light of the above considerations, in order to facilitate takeovers in companies with a dual class share structure, it would be more desirable to introduce a clause in the articles of incorporation that "allows high vote shareholders to lose control (and premium)" (position B) than a clause that "takes into account the control premium of high vote shareholders" (position A). In other words, an "equal treatment clause" (position (B)) would be preferable to an "unequal treatment clause" (position (A)) in the phase of corporate takeovers.

There may be some criticism that clause (B), which allows shareholders with high vote rights to lose control during the takeover procedure, would undermine the importance of introducing a dual class share structure in the first place. However, the introduction of a dual class share structure is not only important as a takeover defence. The fact that founders and others hold a high proportion of voting rights, and above a certain level of voting rights, enables them to do various things as majority shareholders under company law. It may be a reasonable option to introduce a clause in the articles of incorporation that facilitates a takeover of the company in exchange for such advantages for the founder shareholders and others under a dual class share structure.

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Hiroyuki Watanabe is a Visiting Scholar at University of London (IALS), Professor of Law in Japan (2009-2023) and ECGI Academic Member (since 2020). His research areas include corporate law, securities law, and finance law. His main current interest is the fundamental structural changes in recent times in capital markets and corporate governance in Japan.

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