There was a time when schemes of arrangement were seen as a
cumbersome and inflexible alternative to a conventional offer to
effect take-privates in the UK. Potential bidders are becoming
increasingly aware of the advantages of this procedure and several
high-profile UK take-privates by financial sponsors have been
completed recently by scheme of arrangement under section 425 of
the Companies Act 1985 (the Act), including the take-privates of
Debenhams, New Look and DFS.
Recommended bids only
Using a scheme of arrangement will not be an option if the bid
is hostile. The directors of the target, not the bidder, must
initiate the scheme of arrangement, so the bidder must have their
cooperation.
A scheme of arrangement is simply a statutory procedure by which
a UK company can make an arrangement with its shareholders
(or any class of them) and the court gives effect to that
arrangement, bringing it into force. Procedurally the deal will be
announced in the normal way but instead of an offer document, the
target's shareholders receive a scheme document containing notice
of a shareholders' meeting to approve the scheme and of any other
resolutions required for the scheme to be implemented (for example
to approve a reduction of capital or to change constitutional
documents). The meeting is then held and, if approved by the
shareholders, the scheme is sanctioned by the court. The scheme
becomes effective when the court order is filed at Companies House
and the target can then immediately be re-registered as a private
company. The court has complete discretion as to whether or not to
approve a scheme of arrangement, but in practice it is highly
unlikely that the court's sanction will not be given if the
shareholders have approved the scheme.
Difficulties can arise, even if the target's board initially
recommends a bid by way of a scheme, if a higher competing offer
then materializes. The target's board is primarily in control of
the process, so it could withdraw the scheme at any time before the
final court order being made if it considers it to be in the best
interests of the shareholders (and is likely to do so of course if
a superior bid is made). Although there is scope to revise the
scheme with the consent of the court (for example, to increase the
offer price), in a truly competitive situation it is more likely
that bidders will switch to conventional offers to allow them to be
more responsive to changes and to operate independently of the
target company's board. The court will not let a company run two
schemes concurrently, although there might be scope for the bidder
who is ultimately successful to revert to a scheme. On the bid for
Debenhams in the autumn of 2003, Baroness Retail Limited launched
its competing bid as a conventional offer, but with an express term
that the bidder was entitled to convert the offer to a scheme.
Baroness Retail ultimately opted for a scheme once its bid was
recommended, which meant it had to follow the full court timetable
for a scheme. Conversely, the Silvestor consortium bidding for
Canary Wharf originally started with a scheme, with an option to
convert to a conventional offer, which was exercised when it became
apparent that it would be difficult to reach the 75% acceptance
threshold due to the competing Brascan offer.
|
Practical difficulties arising from
failure to obtain 100% control
- Minority shareholders (either 50 in number
or those holding at least 5% in nominal value)
can apply to court to cancel a resolution under
section 54 of the Act re-registering the public
target (a plc) as a private company (a limited
company). This resolution is required to enable
the target to provide financial assistance by
way of security for the acquisition facilities
lent to the bidder, and is normally a condition
subsequent under the bidder's financing
agreements.
- Similarly, the financial assistance
whitewash resolution by shareholders can be
challenged by a minority (who need to hold at
least 10% in nominal value of any class of
shares). Even if not challenged, the fact that
the target is not wholly owned will delay the
date on which the security can be given by four
weeks unless every shareholder votes in
favour.
- There will be a leakage of cash to the
minority shareholders each time dividends are
declared at the target level. Not declaring
dividends is the easy answer, but this has the
knock-on problem of finding an alternative
mechanism by which cash can lawfully be pushed
up to the bidder to service interest on the
acquisition debt without giving rise to the
potential of an unfair prejudice action by a
disgruntled minority shareholder under section
459 of the Act.
- Administrative problems. These include the
inability to hold shareholder meetings at short
notice and the risk of section 459 unfair
prejudice actions if restructurings are planned
or the target's dividend policy is
changed.
- Untraceable shareholders. If the compulsory
acquisition process cannot be gone through at
the time of the offer, the acquirer will lose
the ability to sweep up any shares held by
untraceable shareholders. This has many
practical ramifications: not least that a
proportionate amount of all distributions made
by the target will need to be held on trust for
those untraceable shareholders. It will be
difficult to rectify this.
- The lenders' security package could be
adversely affected by a minority shareholding
in the target. At worst, full security might
never be granted if the minority shareholders
successfully challenge the acquisition finance
security under section 54, section 157 or
section 459 of the Act. At best their existence
could affect both the value of the business and
the choice of how and at what level the
security can be enforced.
- Lastly, the presence of the minority
shareholders could cause complications on any
exit.
|
Acceptance threshold
To obtain full control of the target, private equity bidders
using a scheme only need the approval of the majority of the
relevant members voting at the court-convened shareholders'
meeting: the majority must represent at least 75% in value of all
the shares held by those who vote at that meeting. Once those
thresholds are met, and the court sanctions the scheme, the bidder
will acquire 100% of the target. Contrast this with a conventional
offer, where the bidder can take advantage of the squeeze-out
procedure under section 429 of the Act to acquire the minority
shares only once it has obtained acceptances from 90% of the shares
to which the offer relates. The scheme route will avoid the risk of
the bidder being left with minority investors whose views must be
taken into account, as happened on the Fitness First and Pizza
Express bids (both in 2003), where shareholders with an aggregate
holding in excess of 10% did not accept the offers, requiring the
private equity-backed bidder to complete with the minority
investors remaining as shareholders in the target company (see box:
Practical difficulties arising from the failure to obtain 100%
control).
However, as with any take-private, it will still be important
for the bidder contemplating an offer by way of scheme of
arrangement to carry out due diligence on the target's shareholder
base and identify any significant shareholders that are likely to
be against the take-private. The particular considerations for a
scheme are that if the shareholders' meeting is poorly attended, a
small number of shareholders will be able to defeat the proposal
because the 75% threshold only applies to members who vote at the
shareholders meeting (in person or by proxy), as opposed to all
those who are entitled to vote. So this might give added weight to
an active and dissenting minority.
Unlike a conventional offer, market purchases will not assist a
bidder that has opted for a scheme because the shares held by the
bidder or persons connected with the bidder will be excluded for
the purpose of voting at the shareholders' meeting.
Stamp duty saving
One of the advantages of using a scheme of arrangement rather
than a traditional tender offer is that the bidder could make stamp
duty savings (of 0.5% of the offer value) on the acquisition of the
target's shares by adopting a cancellation scheme of arrangement.
This involves the cancellation of all shares in the target by a
reduction in the target's capital, followed by an issue of new
shares to the bidder. As there is no transfer of shares for this
type of scheme, no stamp duty will be payable, in direct contrast
to a conventional offer, where the bidder acquires shares directly
from the target's shareholders.
Timing
Because a scheme of arrangement is a court-based procedure, the
timetable will be driven by the court and its ability to
accommodate the required hearings. Various formal steps will have
to be taken to comply with court procedures. Consequently, when
using a conventional offer it might be possible to obtain a simple
majority of acceptances from target's shareholders and achieve
control of target earlier than under a scheme, where control only
passes on the day the court order is registered with Companies
House. However, it is unlikely that a conventional private equity
offer would be declared unconditional at 50%, particularly if banks
were financing the bid. Even if the 90% level of acceptances were
achieved, the bidder would have to squeeze out the outstanding
minority shareholders. In practice, the scheme route is likely to
result in 100% control being obtained more quickly than under an
offer (see box: Obtaining 100% control).
The City Code on Takeovers and Mergers applies to a takeover of
a UK public company by way of a scheme, and although strict
adherence to the time limits set out in the Code will not usually
be required, the Panel on Takeovers and Mergers (which administers
the Code) will have to approve the overall timetable for a scheme
and must be consulted as it would be in connection with a
conventional offer.
Irrevocables
It is usual practice on a conventional bid to obtain irrevocable
undertakings from key shareholders. With a scheme, though, there
can be some debate as to whether a shareholder that gives an
irrevocable undertaking to vote in favour of a scheme should be
treated as a different class of shareholder from those that have
not given undertakings. This might impact on the process for, and
likelihood of, approval of the scheme. Legal advice must be taken
on particular terms of any undertakings before they are agreed to
ensure that their terms do not have the effect of creating a
separate class of shareholder by, for example, including provisions
that lead to the giver of the undertaking having different
interests to other shareholders, such as an obligation to pay a
break fee.
Share options triggered
A bidder will want to avoid any holders of share options granted
by the target exercising those options and becoming minority
shareholders in the target after the bidder has acquired control.
If a scheme is used, the scheme can provide that all such share
options are triggered at the moment the scheme becomes effective.
As part of the scheme, the target's constitutional documents are
often amended to adopt a sweeper provision that, on exercise, the
holders of target share options obtain shares in the bidder
instead.
Additional considerations for lenders
There are several implications of the decision to opt for a
scheme for the banks financing a take-private. The certain
funds requirement of the Code will apply in the same way as a
conventional offer. (Rule 2.5 of the Code provides that the
financial adviser to the bidder is required to confirm that the
bidder has enough resources to satisfy the offer in full, which
necessitates funding documents being signed up in advance of an
offer being made and the banks accepting an obligation, with
limited exceptions, to fund if the offer becomes unconditional.)
But the banks will only be required to fund once the scheme has
become effective and the bidder has acquired 100% of the target's
shares.
Accordingly, banks can avoid any risk of the target not becoming
wholly owned by bidder. They will also have the additional comfort
that this is likely to be achieved more quickly than under a
conventional offer (see box: Obtaining 100% control).
Banks will also be able to take full security from the target
group quicker than would normally be possible under a conventional
offer. Granting security for acquisition facilities will, of
course, constitute unlawful financial assistance under section 151
of the Act unless the whitewash procedure is completed. Under a
conventional offer, banks have to wait until completion of the
squeeze-out process before the target or its UK subsidiaries can go
through the whitewash procedure and grant guarantees and security
in respect of the acquisition debt. Until then, banks are forced to
rely solely on security over the target's shares granted by bidder.
This is not without risk - dissenting shareholders have the ability
to apply to court to set aside the financial assistance whitewash.
However, using a scheme of arrangement, the financial assistance
given by the target could (under the Act) be approved in the scheme
itself allowing the target to secure the acquisition debt
immediately after the scheme becomes effective. In practice a court
is likely to require evidence in the form of a witness statement
from a target director that the whitewash procedure could be
completed if it had to be - in other words, effectively a solvency
declaration in the terms that would be required under the whitewash
procedure. Whether the directors are willing to give the required
witness statement may depend on the circumstances of a particular
transaction.
Although the court order cannot sanction any subsidiaries of the
target giving financial assistance, those companies will become
wholly owned subsidiaries of the bidder as soon as the scheme
becomes effective. As the target can immediately be re-registered
as a private company, the whitewash procedure can be completed much
more quickly in relation to the target's subsidiaries than where
the acquisition is by way of a conventional offer.
Increasing role to play
The private equity market has now accepted that the scheme of
arrangement certainly has its role to play in UK take-privates. In
recent transactions, private equity acquirers have asked financing
banks for the loan documentation to provide funding for an offer,
whether it is structured as a scheme or as a conventional bid.
Although many people might still not be as familiar with schemes of
arrangement, the advantages they offer will mean that the UK
private equity market will increasingly see schemes of arrangement
being used.
Obtaining 100% control
| Traditional offer |
Scheme |
- Bidder has to obtain acceptances from 90%
of shares to which offer relates. The
equivalent trigger percentage permitting
minority squeeze-out varies around Europe; for
example, the percentage in Germany, France and
The Netherlands is 95% and in Italy is 98%. In
Spain, there is no such procedure.
BUT any shares acquired by the bidder (or any
connected parties) before the bid is launched
will not count (in other words, it is 90% of
the total shares excluding any acquired by the
bidder in advance of the offer) (market
purchases by the bidder after the offer is made
will, however, count) AND there will always be
a small percentage of shareholders who are
untraceable, or who will not respond to the
offer, or who are in jurisdictions, such as the
US, whose securities laws may prohibit the
offer being made to them (if there are any
holdings in such jurisdictions, the bidder will
make separate offers in accordance with such
securities laws; if there are only a small
number of shareholders, it is unlikely to go to
this expense, but is thereby increasing the
difficulty of achieving the 90%
threshold).
|
- Bidder has to have the approval of a
majority in number of shareholders voting at a
court-convened meeting, which together
represent at least 75% in value of the shares
held by the members who vote. Any shares held
by the bidder (or any connected parties) at
whatever time acquired, will be excluded from
voting.
|
- The procedure under the Act takes six weeks
from the date that bidder sends notice to the
minority shareholders that it has satisfied the
90% threshold and is operating the squeeze-out
procedure
|
- 100% control is achieved as soon as the
court order is lodged with the Registrar of
Companies, which could be up to 14 days before
the first possible date on which the compulsory
squeeze-out could be completed under a
conventional offer process had they started at
the same time.
|
Differences between a scheme and an offer
| Issue |
Acquisition by recommended takeover
offer |
Acquisition by scheme of
arrangement |
| Certainty of acquisition of 100% of
target |
50.01% acceptance gives offeror
control of the target but 75% will in practice be
the minimum threshold acceptable to lending
banks.
90% acceptance enables bidder to compulsorily acquire
minority. |
Binding on all members of the target
if approved by a majority in number representing
75% in value of the members present and voting at a
meeting convened by the court and if subsequently
sanctioned by the court. |
| Market purchases |
Market purchases can be made
tactically to achieve the 50% control threshold and
the 90% compulsory acquisition threshold. |
Market purchases will be irrelevant in
the court-convened meeting because the offeror will
not be able to vote on the scheme resolution. |
| Timetable |
Normal Takeover Code timetable would
apply. It would usually be expected that control of
50% would be acquired under a takeover offer within
60 days after posting of documents (assuming all
other conditions have been satisfied/waived).
However, acquiring 100% control could take up to
five months after the 90% threshold has been
reached. |
Timetable has to be agreed with the
court. Period for acquiring 100% control could be
shorter than for an offer because of the time
limits under the compulsory acquisition procedures.
However, actual control of the target does not pass
under a scheme until it is sanctioned by the court
– which could be one month slower than under an
offer. |
| Stamp duty saving |
Stamp duty will be payable by the
offeror. |
It is possible to structure the scheme
as a cancellation scheme to avoid stamp duty being
payable. Under a cancellation scheme target shares
are cancelled rather than being transferred to the
bidder. |
| Control of documentation |
Control by bidder (that is,
Newco). |
Control by the target. In particular
there is the risk that the target directors may
withdraw the scheme at any time before the court
sanctions the scheme. A scheme cannot be used for a
hostile offer. |
| Flexibility |
A bidder has flexibility to respond in
the event of a competing offer. |
Less flexibility than with an offer.
If a higher offer is made after the court-convened
meeting but before the court has sanctioned the
scheme, the target's directors may feel obliged to
withdraw the scheme or at least convene a further
shareholders' meeting. |
| Costs and documents |
The documents involved and their
preparation will probably be simpler. |
Actual costs of a scheme are likely to
be slightly greater in view of the involvement of
the court and the need to instruct counsel. The
directors may also be required to spend additional
time on the documents and supporting documents
required by the court. This is likely to be
outweighed by any stamp duty saving. |
Author
biography
Marco
Compagnoni
Lovells
Marco Compagnoni, head of private equity, has been a partner at
Lovells since 1993. He specializes in acting for financial sponsors
and equity investors in domestic and cross-border acquisitions and
sales, both public and private. Compagnoni has recently acted on
the successful bid for the Telegraph Group, and completed the sale
of Westminster Healthcare.
Lovells is an international law firm whose award-winning
European private equity practice operates from its offices in
France, Germany, Italy, the Netherlands and Spain, as well as the
UK.
Lovells
Atlantic House
Holborn Viaduct
London, EC1A 2FG
Tel: +44 (0) 20 7296 2000
Fax: +44 (0) 20 7296 2001