United Kingdom: More than a stamp duty saving

Author: | Published: 1 Apr 2008
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In January this year, an article in The Times drew attention to the fact that in 2002 only eight UK-listed companies, worth in aggregate £11.5 billion ($23 billion), were bought by way of a scheme, whereas in 2007 the figure was 47, worth in aggregate £58 billion. The Times estimated that this had cost the government about £290 million in lost stamp duty (the UK transfer tax of 0.5%, which would otherwise be payable by the purchaser on a transfer of shares). One advantage of structuring the acquisition of a UK-listed company as a scheme is the stamp duty saving for the bidder, but schemes have a number of other advantages in comparison with takeover offers in the UK.

One of the first tactical questions a bidder for a UK-listed company will need to consider is whether to structure its bid as a takeover offer or a scheme. While the answer does of course depend on the bidder's tactical and commercial objectives and the circumstances of the target, advisers often refer to a well-rehearsed list of pros and cons. Recent developments in the UK have gone some way to soften the cons traditionally associated with schemes.

Offer

A takeover effected by way of an offer involves a contract between the bidder and the shareholders of the target (the target is not technically a party to the contract). The financial terms, conditions and other provisions of the contract are set out in an offering circular prepared by the bidder (the offer document). Target shareholders accept the offer by returning a form of acceptance or accepting electronically through the CREST system for uncertificated dematerialised shares. It is also usual (but at the election of the bidder rather than being a requirement), to include a condition to the offer that the bidder has acquired or agreed to acquire (either pursuant to the offer or otherwise) shares carrying more than 90% of the voting rights in the target. This allows the bidder to use statutory powers (under section 979 of the Companies Act 2006) to force minority shareholders that have not accepted the offer to sell their shares on the same terms as under the offer and so to obtain 100% ownership (compulsory acquisition or squeeze-out power).

Scheme

A takeover effected by a scheme involves a court procedure under section 425 of the Companies Act 1985 (the procedure remains largely unchanged under part 26 of the Companies Act 2006 which comes into force on April 6 2008) proposed by the target to its shareholders; the preparation and issue of court documentation and a circular to target shareholders, prepared and issued by the target itself; the passing of target shareholder resolutions to approve the scheme at a shareholder meeting of the target, by a majority representing 75% in value of those voting, of each relevant class of target shareholders (excluding any already held by the bidder); and court approval of the scheme, after the shareholder meeting, to give effect to the takeover. The court order provides for either the transfer of target shares to the bidder or the cancellation of the existing target shares, in return for the issue of new target shares to the bidder. It is important to note that a scheme binds 100% of shareholders irrespective of whether or how they voted.

It is also important to understand that neither a scheme nor an offer is the same as a true statutory merger process, which is used in some continental jurisdictions as well as under Delaware law – the target company loses its separate corporate identity and is merged with the bidder. With an offer or scheme the target remains in existence after the takeover, with a separate corporate identity, as a subsidiary of the bidder.

Pros and cons

Regardless of whether the bidder proceeds by way of an offer or a scheme, it must comply with the applicable rules of the Takeover Code (some of which are summarised below). The Code regulates many of the terms of the offer or scheme as well as aspects of the conduct of those involved.

Stamp duty saving

Takeovers structured by way of an offer in the UK are subject to stamp duty of 0.5%, payable by the bidder on the transfer of target shares; schemes structured as a cancellation of target shares and reissue to the bidder (a cancellation or reduction scheme) fall outside the stamp duty regime. On large transactions this can represent a significant saving. However, a scheme is a court process and is more complex than an offer. It therefore involves additional advisers' fees and transaction costs. Accordingly, on smaller deals the stamp duty saving can be outweighed by the additional transaction costs.

Bidders should also bear in mind that if loan notes are offered as an alternative to cash, which can be an attractive alternative to UK resident individual shareholders for tax planning purposes, a transfer scheme rather than a cancellation scheme should be used for shares opted for the loan note alternative, to achieve the relevant tax planning objective. In that case, the scheme being stuctured as a transfer and not a cancellation of target shares, the bidder will be required to pay stamp duty in respect of the transfer of those shares.

Speed, certainty and interloper risk

It must be a condition of any offer that the bidder has acquired or agreed to acquire (either pursuant to the offer or otherwise) shares carrying more than 50% of the voting rights in the target. If this is achieved, a bidder can declare its offer unconditional as to acceptances as quickly as the twenty first day after posting the offer document to target shareholders, and if all other conditions to the offer have been satisfied or (where permissible) waived, it can close its takeover offer at that time. Once an offer has been declared unconditional as to acceptances, there is no longer a risk of a rival bidder obtaining control of the target.

In contrast, a scheme requires both: (i) shareholder approval, at the shareholder meeting convened by the target for approving the scheme which must be held at least 21 days after the posting of the scheme document under the rules of the Takeover Code, and; (ii) court approval, at a court hearing which will be held three weeks or more after the shareholder meeting. Accordingly, the bidder is exposed to the risk of an interloper making a rival bid until the scheme is effective, which is on registration of the court order approving the scheme (in the case of a reduction scheme), some three weeks or more after the shareholder meeting. That is three weeks after the earliest date on which an offer could, in theory, have closed.

For example, on the attempted acquisition of Countrywide by 3i, a takeover structured as a scheme was announced by 3i on December 12 2006. But at the court meeting and EGM of Countrywide shareholders on January 26 2007 the scheme was rejected, as it only had the support of 58% of Countrywide shareholders. On February 5 2007 Apollo emerged as a rival (and ultimately successful) bidder for Countrywide. Had the 3i scheme been structured as an offer, it could have been declared unconditional as to acceptances on January 26 2007 (or earlier if acceptances in excess of 50% were received before that date but after day 21) and the period of 3i's exposure to interloper risk would have been reduced. In addition, even if target shareholders had approved the 3i scheme on January 26 2007, it would not have become effective before the rival Apollo offer was announced and may not therefore have been successful in any event.

However, once approved by shareholders by the requisite majorities (a majority in number representing 75% in value of target shareholders voting, whether in person or by proxy, at the shareholder meeting convened by the target for the purposes of approving the scheme) and approved by the court, a scheme is binding on 100% of shareholders, regardless of whether or how they voted. Under an offer, in contrast, a bidder wishing to acquire 100% could only do so by making use of the squeeze-out procedure to force minority shareholders that have not accepted the offer to sell their shares on the terms of the offer. This process takes a minimum of six weeks from when the offer closes and the bidder must achieve 90% before it can make use of this process. If there are a large number of lost or untraceable shareholders, as is often the case in companies with a large retail shareholder base, this may make it difficult for a bidder to use the squeeze-out procedure.

So, although a scheme involves a higher acceptance threshold and takes longer to obtain control than an offer, leaving the bidder exposed to interloper risk for longer, it is a quicker and more certain way of delivering 100% control to the bidder. This is the key attraction of a scheme over an offer.This is the most likely reason why 3i proceded by way of a scheme rather than an offer. In addition, recent market practice has seen the inclusion of a number of deal protection measures in the increasingly sophisticated implementation agreements entered into between bidder and target on schemes; in order to offer some protection against the increased interloper risk. Such deal protection measures have included:

  • Limiting the information given to a second bidder by restricting it to the information already given to the original bidder.
  • Prohibiting the target agreeing a second break fee with a rival bidder.
  • Mandatory vote provisions requiring the target to put the original bidder's proposal before shareholders even in the event of a rival offer.
  • Rights to match or top a rival offer within a period of about 48 hours without the target board withdrawing its recommendation within that period.
  • The recent battle for Resolution saw the introduction of a target shareholder resolution encouraging the target directors to disregard rival bids made after the date of the shareholder meeting. This shareholder direction has the express purpose of making the scheme timetable more comparable with an offer timetable.

Market purchases and irrevocables

In an offer, a rival bidder can prevent the original bidder from achieving 100% by purchasing 10% (or slightly less, allowing for a margin of dead register and shareholder apathy) to prevent the squeeze-out procedure being used. But it would need to launch a rival bid and obtain over 50% to prevent the offer from being completed. The recent example of Sir Tom Hunter's stake-building in Dobbies Garden Centre illustrates this – Hunter's actions meant that Tesco could only acquire 65.5% and was unable to de-list the company (for which 75% is required). Nonetheless, Tesco did achieve control of its target.

In a scheme a rival can prevent the scheme from becoming effective by acquiring 25% and voting down the scheme. As described above, a scheme must be approved by a majority in number representing 75% in value of the target shareholders. Therefore, a minority of 25% is enough to block a scheme. In reality, less than 25% would be enough to block a scheme if one takes into account the likely dead register and shareholder apathy. Standard Life's recommended offer for Resolution to be implemented by way of scheme of arrangement in October 2007 failed for that very reason when Pearl took a blocking stake of approximately 24% in Resolution. In the case of Dickson Poon's bid for Harvey Nichols in 2002, the bidding vehicle already held a stake of over 50% in the target. As a result, Deutsche Asset Management, which held 15%, was able to block the scheme because it had voting power equivalent to 30% at the court meeting.

How does a bidder wishing to proceed by scheme mitigate against this risk? A bidder could consider making market purchases or seeking irrevocable undertakings.

In an offer, a bidder can acquire up to 29.9% of target shares in the market (at or below its offer price) without triggering a requirement to make a mandatory offer for the target. By doing so, the bidder will discourage rival offerors from seeking to acquire the target, and the shares acquired will count towards the acceptance condition. If a bidder on an offer holds or buys target shares before its offer is announced, such shares will not constitute shares to which the offer relates for the purposes of the squeeze-out procedure. Therefore by acquiring shares in this way the bidder makes it more difficult for it to acquire sole control. In contrast, if the bidder acquires shares after its offer has been announced, such shares will constitute shares to which the offer relates and will count towards the 90% threshold for the squeeze-out procedure.

However, for a bidder proceeding by way of a scheme, market purchases will not support its scheme in the same way, because such purchases reduce the total number of shares from which the 75% approval is required. It is well established that the bidder in a takeover cannot form part of the wider class of target shareholders able to vote to approve the scheme. Any target shares held or acquired by a bidder cannot therefore be voted on a scheme involving the target and that bidder, and such shares do not count in the number of votes to be taken into account on the scheme – for example a bidder wishing to acquire a company with 100 shares needs the approval of shareholders holding 75 of those shares, and if the bidder buys 20 shares, it then needs the approval of 75% of the remaining 80, that is, 60 shares. When a bidder buys shares in the market on a scheme it concentrates the influence of the remaining target shares and makes it easier for a rival to block the scheme. In the absence of market purchases by the bidder, using the same example, a rival wishing to block the scheme would need to obtain 25 shares to vote down the scheme, whereas that rival would only need to obtain 20 shares to do so after the bidder buys 20 shares.

That said, market purchases have been used effectively in recent transactions: KKR/Boots, ABP/DPW, Pearl/Resolution, Crest Nicholson with the bidder holdings ranging between 14% and 28%. There are advantages in market purchases made by a second competing bidder. First, the bidder will be able to vote on any rival bidder's proposals, potentially blocking that transaction. Second, a rival is unlikely to be able to agree a substantial break fee with the target in the way that the first bidder is able to, but market purchases may provide some upside if the first bidder pays more.

Flexibility

As an offer does not require court approval and the offer document simply represents a contract between the bidder and target shareholders, an offer provides the greatest flexibility in terms of both timetable and ability to amend the offer terms.

In contrast, a scheme must follow a court timetable and approval process, and changes to the timetable and terms of the scheme typically require court approval. A scheme was in the past seen as unattractive because of this perceived lack of flexibility. However, schemes have been used in a series of recent competitive situations, including the acquisitions of iSoft, Countrywide, John Laing and Resolution. In addition, bidders on the acquisition of Corus by Tata Steel used schemes; and a scheme is being used on the acquisition of Imprint, both of which involved Takeover Panel auctions. In its recent practice the court has taken a pragmatic approach to its treatment of schemes.

Control of process

The bidder controls the offer. Although information on the target will be contained in the offer document, this can largely be obtained from public sources and target co-operation is not a pre-requisite.

A scheme, on the other hand, is an arrangement proposed by the target board to target shareholders. The target publishes the scheme document and controls the court process.

However, a bidder wishing to proceed by way of scheme can achieve a high degree of control through contractual rights in the implementation agreement entered into between bidder and target on a scheme and by securing contractual protections and conduct provisions. In fact, the protections that a bidder secures under an implementation agreement may be better than to those it would have achieved if it had proceeded by way of an offer, although practice is developing in the UK and merger/implementation agreements are sometimes used in offers.

It should be noted that the Takeover Panel has recently highlighted that it has not excluded the possibility of a takeover offer by way of scheme being implemented in the absence of a recommendation from the target board. However, this route has not yet been successfully followed. It would present significant challenges in terms of both control and process.

Overseas shareholders

If a bidder proposes to offer its own securities in whole or in part as a consideration to target shareholders and if significant numbers of target shareholders are outside the UK and the EU, the requirements of overseas securities regulations can be onerous. In addition, in the UK a prospectus will be required for the offering of bidder shares. This attracts both statutory and common law liability.

In contrast, a scheme can be a significant advantage to a bidder when significant numbers of target shareholders are based overseas. For example, in the US, Section 3(a)(10) of the Securities Act 1933 provides an exemption for schemes allowing bidders to offer their securities as consideration without the need to prepare an SEC compliant registration document or to comply with US tender offer rules. Exemptions also exist under the applicable regimes in a number of other jurisdictions, including Australia, Canada and South Africa. In addition, in the UK an equivalent document rather than a prospectus can be used when bidder securities are offered pursuant to a scheme. But although this avoids statutory liability, the bidder remains liable at common law and so the benefits may be marginal.

When to use an offer

As outlined above and as highlighted in July 2007 and February 2008 IFLR, scheme technology has developed in recent years, Panel rule changes have increased transparency and changes to court procedures and timetable have made the process more certain and quicker. M&A practitioners continue to push the edges of the envelope, such that many advisers start from the position that new transactions will probably proceed by way of scheme.

This raises the question – when is it preferable to proceed by way of offer?

1) To reduce transaction costs: on smaller deals, reduced advisory fees and simplicity of an offer may make the offer route more attractive.

2) Speed to defeat any potential rival bidder: When the bidder wants to deliver a knock-out blow on announcement and to announce an unconditional offer as soon as possible, a contractual offer remains the fastest route. For example, in BSkyB's acquisitions of both Easynet and 365 Media Group, BSkyB successfully used a combination of irrevocables, together with announcing and posting the offer document on the same day and market purchases. BSkyB immediately made market purchases on announcement and within hours of the announcement it had acquired or agreed to acquire more than 50% of its target.

3) Multiple classes of shares: when a target has a complex share capital with different classes of shares and/or has convertible debt instruments (and particularly when holdings of one class are tightly concentrated), each class of shares will likely represent a different class of shareholder and each class will be required to approve the scheme. As a result, there is risk that minority holders in one class will be able to hold bidders to ransom, even though they may be a tiny minority overall. In such circumstances it may be preferable to proceed by way of an offer to prevent one class of target securities having a disproportionate influence over the transaction.

Summary table
Offer Scheme
Shareholder approval 50%+ acceptances required for control. Approval by a majority in number representing 75% in value gives 100% of target.
Speed and certainty of obtaining 100% 90%+ acceptances required for squeeze out and ability to secure 100% of target. Court order binds 100% of shareholders irrespective of whether or how they voted.
Court approval and flexibility Bidder maintains maximum flexibility to amend terms and timetable of the offer. Court approval is required, but recent court practice and timetables show flexibility and pragmatism.
Speed to obtain control and interloper risk A bidder can close a takeover offer on D+21. After the offer has been declared unconditional as to acceptances, there is no risk of a rival obtaining control. Target shareholder meeting must be held no earlier than D+21.
After the shareholder meeting the bidder is exposed to interloper risk until scheme effective date.
Irrevocables Can be used effectively. Present risks of class issues and exercise of court discretion.
Market purchases Can be used effectively. Have been used effectively, but present risk in competitive situations.
Ability of minority to block 10% of target shares can block squeeze out. 25% of target shares (and less given dead register and shareholder apathy) can block a scheme.
Control of the process An offer is a process controlled by the bidder. A scheme involves a court process controlled by the target.
The bidder achieves control through contractual rights included in an implementation or merger agreement.
Transaction costs 0.5% of the value of the consideration will be payable by the bidder for the UK transfer tax (stamp duty / SDRT). No stamp duty or SDRT is payable on a reduction scheme. However, it is a more complex process and will involve additional fees.
Treatment under overseas securities regimes No exemption available. Bidders can often offer securities as consideration in the US and elsewhere without the need to prepare an SEC-compliant registration document, or comply with the US tender offer rules.
Financial assistance Separate exercise required. Scheme allows other objectives to be achieved beyond the acquisition of the target, such as sanctioning acts that would otherwise constitute unlawful financial assistance.
Prospectus No exemption available. A bidder offering shares as consideration can use the equivalent document exemption and avoid statutory prospectus liability.

Author biographies

Malcolm Lombers

Herbert Smith

Malcolm Lombers is a partner in the corporate division of Herbert Smith. He focuses on UK and cross border M&A and public company takeovers.

Mark Bardell

Herbert Smith

Mark Bardell is a senior associate in the corporate division. His practice extends across a wide variety of domestic and cross-border corporate, corporate finance and M&A work, with a particular focus on UK public M&A.

Andy Radford

Herbert Smith

Andy Radford is an associate in the corporate division of Herbert Smith. His practice extends across a wide variety of domestic and cross-border corporate, corporate finance and M&A work, including takeovers, mergers and acquisitions and joint ventures.