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Corporate analysis: Julian Henwood, M&A partner at Wragge Lawrence Graham & Co, 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 2006 (CA 2006) 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 its intention to make this change in its Autumn Statement 2014.
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.
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:
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, eight out of the ten 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:
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.
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).
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:
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:
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).
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.
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