FRENCH UPDATE – LVMH’s Stake-Building in Hermès through Undisclosed Cash-Settled Derivatives Prompts French Parliament to Examine Disclosure Rules
[stextbox id=”custom”]Editors’ Note: Olivier Diaz is the Managing Partner of Darrois Villey Maillot Brochier and a member of XBMA’s Legal Roundtable. As one of France’s leading M&A lawyers, Mr. Diaz has extensive experience with the French disclosure requirements discussed below. Mr. Diaz’s paper highlights a trend that is developing across several jurisdictions, including the U.S. and U.K., of modernizing disclosure rules to keep up with the proliferation of derivatives that have enabled acquirors to fly below the radar. We invite papers from other jurisdictions on this topic.[/stextbox]
- On October 23, 2010, LVMH announced that it had built up a position of more than 17% in Hermès, mainly through equity swaps which had not been previously disclosed.
- LVMH’s method of stake-building has prompted the French parliament to consider a change to the French rules regarding the disclosure of interests in public companies to include cash-settled derivatives.
- The founding Hermès family responded to LVMH’s announcement by contributing a majority of its shares to a family controlled holding company. The AMF, France’s securities regulator, and the Paris Court of Appeals, confirmed that this capital restructuring could be carried out without triggering a mandatory tender offer.
Hermès, the famous luxury-goods manufacturer, was admitted to the Paris stock exchange in 1993 as a “société en commandite par actions” (limited partnership), a rare form for a public company. The founding family owns the general partner and its members collectively own more than 70% of the shares (limited partners’ interests).
LVMH announced on October 23, 2010 that it owned 14% of the shares of Hermès, with the option to acquire a further 3%, and that it had acquired the major part of its shares through cash-settled equity swaps that had been transformed at the last moment into physically settled derivatives. Since then, LVMH has acquired more shares and owns more than 20% of Hermès share capital.
To clarify beyond any doubt that it would remain the company’s controlling and majority shareholder for the long term, the members of the family decided to regroup the majority of their individual holding in a family-owned company (the “Family Holding Company”) that would consequently own more than 50% of the share capital. In addition, the Family Holding Company would have a right of first refusal on the shares owned separately by the family members.
The Hermès family applied to the AMF, France’s securities regulator, for an exemption from the mandatory take-over rule (see §2 hereafter), which was granted on January 7, 2011. Some minority shareholders challenged this exemption. The Paris court of appeals, in a judgment of September 15, 2011, rejected their action and upheld the AMF exemption decision.
2. Regrouping in a family holding company and mandatory take-over rules
Under French take-over rules, any person coming to hold more than 30% of the shares and voting rights in a French public company must file a tender offer on terms complying with compulsory take-over rules.
However, the AMF can give exemptions in a limited number of cases, among which the regrouping (“reclassement”) in a company to the extent that (i) the persons regrouping their shares can be seen as belonging to a “group” and (ii) the regrouping does not modify the control of the public company.
The notion of “group” in the context of a family is not defined by the AMF regulations.
Both the AMF and the Court of Appeals decided in this case that a group did not exist merely because of family connections.
On the other hand, the AMF and the Court reviewed the situation of the Hermès family members pragmatically, and recognized that they were acting as a “group”, mainly because of their control of the general partner, the public acknowledgement of their control over the company, the stability of their holding over the years and the fact that they generally voted their shares in limited partners’ meeting in the same fashion, even though the family members did not declare themselves historically as acting in concert.
The AMF and the Court also accepted that the restructuring did not alter the public company’s control, since ultimately the shares contributed to the Family Holing Company would be owned –although indirectly- by the same persons.
3. Projected changes to the disclosure rules
Under French law, a person must disclose its interest in a public company when it crosses certain thresholds in terms of shares or voting rights. The first of these thresholds is 5%, the other thresholds being 10, 15, 20, 25, 30, 50, 2/3, 90 and 95%. The failure to disclose can entail substantial penalties (up to 10 million euros or ten times the profit realized) as well as the deprivation of the voting rights attached to the shares above the threshold(s) that has failed to be disclosed.
For the computation of the interest of a person in a company, certain rights to shares must be taken into consideration, e.g. shares owned by a third party action in concert with that person or shares which that person may acquire at its discretion. Other types interests, including certain economic interests, are not aggregated but must be separately disclosed when the legal thresholds are otherwise met.
Therefore, cash-settled equity derivatives are unknown to an issuer for as long as a legal threshold is not crossed through the acquisition of shares or other assimilated interests, unless the counterparty to the cash-settled derivative is acting in concert with, or on behalf of, the beneficiary. On the other hand, physically settled equity derivatives (or derivative which the beneficiary can decide to settle in shares) must be assimilated to shares.
This inconsistency was used by LVMH to withhold from the public its economic interest in Hermès, since LVMH had otherwise acquired over the past 10 years a number of shares that was slightly below 5%.
In October 2010, LVMH agreed with the banks to modify the derivatives to provide for physical settlement, and acquired the underlying shares, at which point it disclosed its entire interest, to the surprise of Hermès, the public and the AMF.
The AMF has since then decided to launch an investigation in LVMH’s stake-building.
In the recent past, Wendel (a French financial investment company) had also used cash-settled equity derivatives to facilitate its stake-building in Saint Gobain. The derivatives were not amended to become physically settled derivatives as in the LVMH/Hermès case, but Wendel’s acquisitions of Saint Gobain shares were facilitated by the unwinding of the position of the banks counterparty to the derivatives, when such derivatives were terminated.
In this case, the AMF, in a decision of December 13, 2010, considered that Wendel wrongfully withheld from the public the material information that it was preparing to acquire a significant interest in Saint Gobain.
These two cases made it evident that French disclosure requirements were not suited to the modern techniques of stake-building.
This led a member of the French higher parliamentary chamber (the “Sénat”) to propose the introduction of a provision whereby cash settled derivatives should be added to the shares owned by a person in the computation of its disclosure obligations.
This provision is expected to pass but there is still parliamentary debate as to whether the shares underlying such derivatives should be taken into account for the computation of the 30% threshold for the obligation to launch a mandatory tender offer.