Schemes of Arrangement

30/11/2009

(1) Is Lehman Brothers testing the ground?

In recent years the corporate world has seen a substantial increase in the use of schemes of arrangements (under Part 26 of the Companies Act 2006) both in solvent and insolvent cases. The legislation in this area has remained untouched for the best part of a hundred years but the world of business has changed dramatically in that period, resulting in the courts being asked to opine on issues which were far from contemplation at the time of the legislation.

The Court of Appeal has recently had to consider a proposed scheme arising out of the collapse of the Lehman Brothers Group. Lehman Brothers International (Europe) was put in administration on 15 September 2008, with the administrators applying for an order that next day that they be permitted to propose a scheme of arrangement between the creditors and Lehman Brothers with a view to reaching a compromise in relation to client assets held on trust by Lehman Brothers.

The London Investment Banking Association (LIBA) argued that although there should indeed be proper measures to facilitate the return of assets, the fundamental issue arose as to whether the court has the jurisdiction to distribute propriety rights of beneficiaries which are held on trust, by way of a scheme of arrangement. The LIBA argued that a beneficiary under a trust is not a creditor of his trustee vis a vis the assets comprised in the trust and nor does a trustee acquire any ownership rights in the assets which he holds on trust. In other words, the assets never form part of the trustees' estate so in short the assets held on trust by a trustee are not available to his creditors upon insolvency. The beneficiary is entitled to insist that his assets remain outside any collective scheme for the creditors of the trustee.

The administrators' approach was simple. They argued that it was fully within the court's jurisdiction to sanction the variation of proprietary rights.

The judgement clarified that the use of a scheme in insolvency situations must seek to provide an arrangement with the members or creditors in their capacity as such. In other words the scheme of arrangement cannot be used to rearrange rights held in a different capacity. The decision clearly highlights the difficulties insolvency practitioners face when dealing with the collapse of large complicated financial institutions.

(2) The alternative to traditional offers under the Code: Pros and Cons

Similarly, the past year has seen a rising number of public takeovers being structured as schemes of arrangement. Before the specific rules that govern takeovers effected by way of schemes were formalised in 2008, the Code operated on the basis that takeovers occurred via contractual offers capable of acceptance by shareholders. The formalised procedure now offers more clarity when solvent public companies structure schemes under the Code.

Taking into account the circumstances of each potential takeover, there are several important factors that the bidder should bear in mind when deciding whether to structure a takeover by way of a scheme:

• Certainty of the acquisition of 100% of the target company under a scheme (if so approved by shareholders and sanctioned by the court) is attractive to a bidder if it is reluctant to tolerate minority shareholders following the takeover. With this certainty comes the availability of merger relief and merger accounting, which is on hand only if the bidder acquires at least 90% of the target company.


• A scheme may be attractive as the level of approval required from shareholders for a 100% acquisition of the target company is lower than that of an offer. However, one should be mindful that it is also easier for minority shareholders to block a scheme as a smaller percentage of votes are required to do so. Further, the court hearing to sanction the scheme provides an additional forum for shareholder objection.


• Where the scheme is structured as a cancellation scheme, there is no stamp duty payable on the transfer of the shares in the target company. This often translates into enormous savings that outweighs the higher costs involved in implementing a scheme. The costs of implementing a scheme are usually greater due to the need to instruct counsel to present the scheme and due to the time expended on producing additional court documents.


• A scheme is effective in overcoming the difficulties frequently faced in an offer situation in respect of dealing with lost / untraceable shareholders and foreign securities legislation regulating overseas shareholders.


• A disadvantage of the scheme is that the timetable is protracted and rigid and gives a competing bidder more time to intervene. A bidder can take over eight weeks to gain 100% control of a target company, whereas a simple agreed offer can take just a minimum of 21 days.


• A scheme is normally not considered to be a 'public offer', and as such, rarely triggers the need for a prospectus.


• The implementation and timing of a scheme is often controlled by the target company and its directors whereas the offer process is dictated by the bidder. Consequently, the bidder usually requests an implementation agreement so as to retain some control over the scheme process. It is also for this reason that a scheme is generally not used in a hostile situation, as the board of the target company has to co-operate with the bidder.


• It is much more cumbersome to amend the terms of a scheme (other than the price) as the court's permission is generally required to send new documents to shareholders and to hold a fresh shareholders' meeting. It is also often necessary to restart the timetable.

The Panel's codification of the scheme process has streamlined the procedures and with more certainty, there are some clear advantages in proceeding with a takeover by way of a scheme. However, as with traditional offers, parties should always seek professional advice before entering into negotiations to ensure that the most efficient structure is adopted.

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