History of the City Code

In the UK, hostile takeovers did not occur until 1953, when Charles Clore, for the first time, sent a tender offer directly to the shareholders of shoe retailer J. Sears & Co.103 He informed one of the J. Sears & Co. directors of his interest in purchasing the company and asked the board to recommend to its shareholders so that they can accept an offer from him. The board turned down his proposal. As Armour has argued, Clore’s first attempt appeared as an enormous shock for the target board in particular, as well as for the City in general.104 Responding to this, the target board was desperate to frustrate these unwanted bids, so as to protect themselves against losing their positions in the company.

The emergence of the hostile takeovers at that time is explained by a number of factors.105 For the first time, the Companies Act 1948 required companies to disclose information on their current earnings, which made them more readily detectable by outsiders.106 The sharply increasing tax burden on companies also caused a large reduction in company profits. According to the findings of Bull and Vice, generally speaking the dividend to shareholders was reduced from 52% of gross trading profits in 1938 to 20% in 1952.107 Because of the low level of distribution to shareholders, share prices failed to keep pace with companies’ growth. Furthermore, under the restructuring of British industry, the main focus of

103 _{For more details regarding this case, see Richard Roberts, ‘Regulatory Responses to the Rise of the Market for Corporate}

Control in Britain in the 1950s’ (1992) 34 Business History 183, 185-7.

104_{John Armour, ‘Enforcement Strategies in UK Corporate Governance: A Roadmap and Empirical Assessment’ in John} Armour and Jennifer Payne (eds),Rationality in Company Law: Essays in Honour of DD Prentice (Hart Publishing 2009) 112.

105 _{For a more comprehensive analysis of the reasons for the emergence of hostile takeovers in the UK, see Andrew S.}

Johnston, ‘Takeover Regulation: Historical and Theoretical Perspectives on the City Code’(2007) 66 Cambridge law Journal 422, 427.

106_{Ross Cranston, ‘The Rise and Rise of the Hostile Takeover’ in Klaus J. Hopt and Eddy Wymeersch (eds), European}

Takeovers: Law and Practice (Butterworths Tolley 1992) 79.

manufacturing shifted from textiles and heavy capital goods to light electrical engineering and machine tools. These changes made the differences between efficient and inefficient companies more visible than before, so indicating a growing number of undervalued target companies that were taken over by the hostile bidders, with the aim of realising maximum profits on return.108

In another famous case in 1953, the board of Savoy Hotel Ltd adopted a complex scheme known as ‘the Worcester Scheme’ to frustrate a bid, with the aim of preventing a bidder from changing into offices its wholly owned subsidiary Berkeley Hotel Ltd, without the approval of its shareholders.109 The Board of Trade appointed Mr. E. Milner Holland, Q.C., a leading barrister in company matters, to investigate the conduct of the Savoy Hotel’s board, and to report whether the board’s action was improper.110 _{After the investigation, Mr.} Holland concluded that the action of the directors was invalid, although they believed that it had been in the best interests of the company and its shareholders, because in his opinion, ‘such a use of directors powers … however proper the emotive behind it, is not a purpose for which those powers were conferred on the Board …’ and the shareholders of the Savoy Hotel were not given the opportunity to ‘alter the decision of their present board as to the present or future use of the property of the Company’ as they were not consulted.111

Uncertainty regarding the target board’s right to take action upon a hostile bid emphasised its discretion in using defensive measures to thwart an unwanted bid. In the meantime, the hostile bidders were free to doing whatever they should to make their bid succeed. However, it was the target shareholders who really lost out in this practice, as they were not normally

108_{ibid 29.}

109 _{For more details regarding this case,seeL.C.B. Gower, ‘Corporate Control: The Battle for the Berkeley’ (1955) 68}

Harvard LawReview 1176, 1176-1194.

110_{Under Section 165 of the Companies Act 1948, the Board of Trade can appoint an inspector to report on the legal}

position.

111 _{The Savoy Hotel Limited and the Berkeley Hotel Company Limited: Investigation under Section 165(b) of the Company}

given the opportunity to have voice an opinion on the takeover bid.112 As a result, there was a strong need for regulatory intervention to protect shareholders’ interests. In response to this, the courts applied the proper purpose doctrine to scrutinise takeover defences.113 However, institutional investors, who were the main lobby group for takeover-related legislation in the UK, called for a Code of Conduct to regulate hostile takeovers by enacting proper law, because the delay caused by the litigation and the uncertainty of courts’ decisions were not acceptable.114

As a result, in 1959, the Governor of the Bank of England set up a City Working Party, formed of representatives from institutional investment entities, merchant and commercial banks, and major organisations in City,115 to produce the first set of regulations specifically dealing with takeovers, based on the philosophy that takeovers were beneficial to the business community if they were properly regulated. Notes on the Amalgamations of British Businesses (Notes) was published in October 1959, laying down the general principles that there should be no interference in the free market for the shares of companies, that shareholders are entitled to make the decision on whether to sell or retain their shares, and that shareholders should be given adequate and timely information in order to enable them to make a sound decision.116 It can be seen that the principle of shareholder primacy was established at the beginning of regulatory experience of takeovers in the UK.

As Johnston has commented, the Notes was regarded as the first experiment in self- regulation in the UK in relation to takeovers, and in many ways shaped the form of the City

112 _{Jonathan Mukwiri, ‘The Myth of Tactical Litigation in UK Takeovers’ (2008) 8 Journal of Corporate Law Studies 373,}

374.

113 _{Hogg v Cramphorn[1967] Ch 254.} 114 _{Johnston (n105) 442.}

115_{The Issuing House Committee, The Accepting Houses Committee, The Association of Investment Trusts, The} Committee of London Clearing Bankers, The British Insurance Association and the Stock Exchange.

Code that was to come later.117 However, the absence of mechanisms for adjudication and enforcement meant that the Notes’ influence on the UK takeover market was still inadequate in terms of protecting shareholders.118 The increasing adoption of takeover defences by target boards, along with the call for a statute to regulate takeovers, led to revising and extending the Notes and, in 1967, the drafting of a new set of takeover rules by the Bank of England’s City Working Party:119 ‘the City Code’ came into effect on 27 March 1968. The Takeover Panel was established on the same day, to supervise the administration of the City Code and give authoritative rulings and advice on its application. The UK’s non-statutory takeover regime was formally established at that point and was well received by City participants in general.