This article was first published on Lexis®PSL Corporate on 29 January 2015. Visit the LexisNexis website for a free 24 trial of Lexis®PSL.
Julian Henwood, M&A partner, casts an analytical eye over the draft Companies Act 2006 (Amendment of Part 17) Regulations 2015 that will prevent the use of cancellation schemes of arrangement to effect a takeover and predicts that increased transaction costs occasioned by the stamp duty charge applicable to certain takeovers effected by way of a transfer will not result in fewer takeovers.
Draft: The Companies Act 2006 (Amendment of Part 17) Regulations 2015, LNB News 13/01/2015 133
These draft regulations will amend the Companies Act to prevent the use of share cancellations by target companies in takeovers conducted using schemes of arrangement. Companies would in future be required to use a 'transfer' scheme of arrangement or a contractual offer, on which stamp duty may be payable. The government announced in its Autumn Statement 2014 its intention to make this change.
Since 28 April 2014 an exemption from stamp duty has been available on the transfer of shares which are traded on the AIM market of the London Stock Exchange (AIM). The analysis which follows is concerned with the stamp duty implications of a takeover of a target company which cannot benefit from this exemption. It should be noted, however, that although the company law changes discussed below will have no impact on the stamp duty effect upon a bidder for a company whose shares are traded on AIM, the transaction will in future have to be structured as a transfer scheme or a takeover offer. Either of those structures will continue to remain stamp duty exempt for the acquisition of an AIM company.
What does the draft legislation provide?
Offers and schemes
Traditionally, acquisitions of companies to which the City Code on Takeovers and Mergers (the Code) applies have been structured in one of two ways:
- a contractual takeover offer under the Companies Act 2006 (CA 2006), s 974
- a scheme of arrangement under CA 2006, Pt 26
Of the 48 public takeovers announced in 2014, 31 were structured as schemes and 17 as offers. Schemes are particularly popular on larger deals: in 2014, 8 out of the 10 largest announced takeovers were structured as schemes.
A takeover offer involves an offer of consideration (cash, bidder shares, loan notes, etc) being made by the bidder to the target's shareholders by posting them an offer document. If the offer becomes or is declared fully unconditional in accordance with its terms, then the shares of those of the target shareholders who have voluntarily accepted the offer through returning a form of acceptance - plus (if relevant) those of non-assenting minority shareholders whose shares are compulsorily acquired under the 'squeeze out' provisions in CA 2006, s 979 - will be transferred to the bidder. Stamp duty at 0.5% is payable by the bidder upon the value of the consideration paid for those of the target's shares that it acquires.
By contrast, in a scheme of arrangement structure, no offer document is posted by the bidder to the target's shareholders. Instead, the target company itself posts a scheme document to its own shareholders asking them to vote in favour of a scheme of arrangement under CA 2006, Pt 26.
Types of schemes
Although, in theory, the structure of a scheme can vary widely, the vast majority of schemes utilised for the purposes of effecting a public takeover have traditionally been 'capital reduction', or 'cancellation', schemes. In a cancellation scheme, the target shares held by existing shareholders are cancelled and new target shares issued to the bidder. In 2014, 83% of announced schemes were cancellation schemes; the others were 'transfer' schemes. Under a transfer scheme, the target shareholders are bound to transfer their shares to the bidder once the scheme conditions have been satisfied.
A scheme has to be approved by target's shareholders at a special meeting convened at the direction of the court. At the meeting the scheme must be approved by a majority in number representing 75% in value of the shareholders. Any shares held by the bidder or persons having a common interest with the bidder cannot be voted.
After the scheme has been approved by the target's shareholders, it must then be sanctioned by the court. If the scheme involves a reduction of capital, it won't become effective until the court order confirming the reduction is delivered to or, if the court so orders, registered by the Registrar. Once effective, the scheme is binding on all of the target's shareholders regardless of whether or not they voted in favour of the scheme.
Provided the requisite majority of the target's shareholders vote in favour of the scheme and court sanction is obtained, the target's share capital is reduced through the cancellation of its existing issued shares and the utilisation of the resulting capital redemption reserve to issue an equivalent number of fully paid new shares in the name of the bidder. Due to the fact that the bidder acquires shares in the target through an issue of shares, rather than via transfer, no stamp tax is payable.
A scheme becomes binding on all target shareholders (including on those who have not voted or who have voted against approval at the court meeting) once all of the above steps have been completed. Accordingly the bidder can acquire 100% of the target upon a scheme becoming effective.
The Regulations, once in force, will amend CA 2006 so as to prohibit a target company from using a capital reduction scheme of arrangement in order to facilitate a public takeover. The only two exceptions to this prohibition aren't really relevant in the context of a public takeover:
- a capital reduction scheme can still be used to effect the acquisition of a target company to which the provisions of the Code don't apply, and
- a capital reduction can be used in an intra-group reorganisation where the purpose is to impose a new holding company above the target in a situation where all of the former shareholders in the target become shareholders in the new holding company
Why is this change being made?
The change is presumably being made by the government after lobbying by the Treasury since the 'lost' annual income from stamp duty receipts will have been considerable. To take just one example (albeit the transaction was terminated), if pharmaceutical company AbbVie, Inc's 2014 £32bn offer by way of a scheme of arrangement for Shire plc had been successful and had been structured as a takeover offer, AbbVie would have paid HMRC £16m in stamp duty.
If the change is being made for stamp tax reasons, why couldn't the tax legislation have been amended instead?
It wasn't possible to impose stamp duty on the value of the new shares in the target company issued as part of a cancellation scheme of arrangement due to the fact that the EU Capital Duties Directive 2008/7/EC prohibits the imposition of any duty on an issue of shares. Instead, the government had to amend CA 2006 to prevent a target company from reducing its share capital as part of the takeover in order to ensure that all takeovers are 'treated equally in tax terms' (paras 7.3 and 7.6 of policy background to the Regulations).
What does this mean for takeovers going forward?
Although capital reduction schemes will be prohibited, it will still in theory be possible to effect a public takeover using a share transfer scheme. That mechanism has been employed far less frequently to date than a reduction scheme - for the very reason that it achieves the same end as a reduction scheme, but stamp duty is payable by the bidder. Going forward, when it comes to a choice between adopting the contractual offer route or implementing a transfer scheme, offer parties will look instead at the other factors that have typically militated in favour of a scheme of arrangement or an offer, namely:
|Minimum required approval = in excess of 50% of issued share capital (although in practice likely to be much higher to avoid minority remaining - see below).
||Minimum required approval = 75% by value plus a majority in number of shareholders present and voting either in person or by proxy at the shareholders' meeting. Non-voting shareholders and shares held by the bidder and its associates are not counted in determining whether the required approval level is achieved.
|Possibility of minority remaining if holders of less than 90% of the target company accept the offer or other conditions of CA 2006 are not met.
||Certainty of no minority remaining if the scheme is approved by the shareholders and sanctioned by the court (ie provided the twin voting thresholds above are exceeded, bidder automatically acquires 100%).
|Potentially shorter time period for obtaining control: Minimum 21 days from posting. (However, acquisition of 100% ownership after the offer has gone unconditional is not guaranteed and will depend on whether the bidder can compulsorily acquire the remaining shares pursuant to CA 2006, s 979. This may take several weeks.)
||Longer time period for obtaining control - around eight weeks from posting, but when the scheme becomes effective the bidder immediately acquires 100% of the shares of the target. In addition, likely delay between announcement and posting, even if scheme document is ready (one to two weeks) due to court process (for example, the need to obtain court permission to convene shareholders' meeting).
|No court sanction required.
||Court sanction required. Creates potential forum for objections if any target shareholder can establish that shareholders in same class not being treated equally.
|More flexibility to change terms after posting of documents.
||Little flexibility to change terms (other than price) after posting of documents without restarting full scheme timetable.
|The offer document is issued by the bidder and the offer process is controlled by the bidder.
||Scheme document is issued and scheme process is controlled by the target . The bidder will usually require an 'implementation agreement' to retain some control over the process (note the contents of such agreements are strictly regulated by the Code).
|Financial Conduct Authority-approved prospectus (or equivalent document) required in respect of any offer including shares (or other transferable securities) as consideration.
||No prospectus requirement even on a share-for-share exchange (as not an offer to the public), unless consideration shares or transferable securities amount to 10% or more of the relevant class of bidder's shares already admitted to trading.
|Market purchases can be used to increase the chances of success of an offer as they can count towards the acceptance condition (but note that they will not count for compulsory acquisition purposes if made before the posting of the offer document).
||Market purchases are of no effect since shares already owned by the bidder will not form part of the class approving the scheme, and indeed can be counter-productive where there is an active dissentient minority (as they reduce the number of shares in the class and therefore the number of shares needed for a blocking stake).
|Shares acquired pursuant to irrevocable undertakings count towards the acceptance condition and compulsory acquisition test which therefore makes it more likely that the offer will be successful.
||Irrevocable undertakings may reduce the number of shares in respect of which 75% approval must be obtained as the court may decide that it would be unfair to sanction the scheme in such circumstances (ie, where certain shareholders were obliged, pursuant to such undertakings, to vote in favour of the scheme).
|Overseas securities legislation applicable to an offer made into certain jurisdictions. For example, a cash offer may be made into the US if less than 10% of the target's shares are held by US shareholders and the documents are submitted to the Securities and Exchange Commission (SEC)) with limited share alternative (available to directors and institutions). A share offer will be subject to full SEC exchange and tender offer rules and full registration of the shares offered (if de minimis levels are not applicable and discretionary relief is not available) (with resulting SEC review period).
||Scheme generally gives rise to fewer overseas securities law restrictions where there are overseas shareholders as it involves a 'shareholder vote' rather than an individual investment decision. For example, a scheme should not be subject to SEC review or SEC exchange and tender offer rules, which leads to a much quicker timetable. However, the quality of the disclosure documents and their coverage should be substantially comparable with the disclosure used for a UK offer into the US.
|Under the Code, all conditions must be satisfied or, where applicable, waived within 21 days after the offer is declared or becomes unconditional as to acceptances.
||All conditions must be satisfied or waived by the time of the court hearing to sanction the scheme.
|It is possible to have a hostile or contested offer.
||In practice, scheme mechanics mean a scheme is very rarely used where there is a hostile bid and is generally only used for an agreed bid where continuing support of the target board is probable.
|Application to court required for order authorising bidder to exercise squeeze-out rights where such rights have not been exercisable because one or more non-accepting shareholders cannot be traced (CA 2006, ss 986(9)-986(10))
||Lost and untraceable shareholders are not likely to be relevant when considering a scheme as the required approval level for a scheme is 75% by value and majority in number. If lost and untraceable shareholders are more than a small proportion of the target company members, then there may be a requirement to advertise the relevant meetings in the press.
|The financial assistance provisions of CA 2006, s 678 will apply and, therefore, the ability for the target to provide financial assistance (eg to provide security for bidder's debt finance for the offer) will depend on its re-registration as a private company following completion of the offer.
||As part of the scheme, it is possible to obtain the authorisation of the court to acts of the target that would otherwise constitute unlawful financial assistance (CA 2006, s 681(2)(e)). However, the court may require evidence that the target, if it were a private company, could lawfully give such assistance (eg it does not amount to an unlawful dividend etc).
What will the cost implications be?
Apart from bringing all public takeovers within a charge to stamp duty, there will be no change in the former position which was always that a scheme (whether it be a capital reduction scheme or a transfer scheme) will be marginally more expensive to implement than a takeover offer due to the need to:
- obtain court sanction for the scheme, and
- to hold a shareholders' meeting to approve the scheme
However, even that marginal differential will be further narrowed due to the fact that with a share transfer scheme there is no need to have two separate court hearings (with capital reduction schemes, separate hearings are needed to get court sanction for the scheme itself and for the capital reduction).
Will this result in a lower number of takeovers taking place?
In my view, definitely not. One has to remember that in all but the very largest of public takeovers (eg the AbbVie/Shire abortive transaction referred to above) stamp duty is proportionately a small part of the overall transaction costs. The increased transaction costs occasioned by the stamp duty charge will certainly need to be factored into a bidder's calculation on the net return on its investment, but any company acquisition is made for strategic business reasons and the initial transaction costs are only one factor in a bidder's decision whether to proceed with an acquisition. Many of the factors (such as the effect on earnings per share (for a quoted bidder), contribution to group earnings before interest, taxes, depreciation and amortisation etc) are much longer term - and financially more material considerations.
In the impact assessment (para 10) in the explanatory memorandum prepared by the Department for Business, Innovation and Skills, the government states its view that, in the context of the value of a takeover as a whole, the charge to stamp duty is unlikely to deter companies from pursuing takeovers.
Julian Henwood has advised on over 20 public takeovers. As well as having over 25 years' experience of mid-market M&A, Julian also has a deep understanding of the project management of international M&A. He travels frequently to visit clients in their home country, and regularly negotiates deals outside the UK. Julian would like to thank Mike Murphy for his input. Mike is a corporate tax partner at the firm and has many years of experience advising on the UK tax aspects of public takeovers.
Interviewed by Kate Beaumont.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.