Monday, October 22, 2007
Today, I'll be looking at the scheme of arrangement. A scheme of arrangement is a reorganization of a company's capital structure or its debts which is binding on creditors and shareholders. It is not a structure available or utilized in the United States, but instead is prevalent in countries modeled upon the English company law system (England, Australia, New Zealand, South Africa, etc.), as currently embodied in Section 425 of the English Companies Act 1985. The structure can be best analogized to a U.S. merger, although there are distinct differences between the two structures.
There are two types of scheme of arrangement: a creditors' scheme and a members' or shareholders' scheme. A creditors' scheme is generally used by companies in financial difficulties; the creditors can agree to defer payments and effect a restructuring of the indebtedness of the corporation. A members' scheme is used to effect corporate reorganizations, particularly a combination with another company. In general, a scheme of arrangement is carried out in three steps:
- The court is approached to order a meeting of creditors or shareholders directly affected;
- The scheme in general must be approved by a vote of more than 50 per cent of the creditors or members present and voting who represent 75 per cent of the total debts or nominal value of the shares of those present and voting at the meeting (the law may vary depending upon the country but this is the law in England); and
- The scheme is referred back to the court for confirmation.
In England, the scheme of arrangement has seen growing popularity. This is for three reasons. First, in the 2003 Debenhams transaction, the unsolicited bidders used a scheme of arrangement to successfully initiate a hostile offer. Previously, the scheme was not thought to be as flexible an instrument, and the offer the only possible structure in unsolicited situations. Post-Debenhams, bidders in English takeovers governed by the takeover code have made wider use of this structure over an offer in both hostile and friendly situations (NB. the same thing has happened in Australia in light of a similar event in the Australian Leisure & Hospitality Limited bid). Second, the scheme of arrangement ensures a squeeze-out with a lesser threshold amount. Under a takeover bid in these countries, 90 percent or more of the target is generally required under the law to trigger compulsory acquisition of the remaining minority shareholders' shares. In contrast, a scheme of arrangement can potentially still succeed with only 75 percent in value and a majority vote. This is particularly important in leveraged buy-outs where a white-wash proceeding is generally necessary because of the financial assistance the target corporation is giving the bidder, and bidders need to meet the voting thresholds of a scheme anyway in order to effect it (for more on what a whitewash proceeding and financial assistance are under English law see here). Finally, a scheme of arrangement can be extended into the United States with only minimum Securities Act and Exchange Act compliance.
This last point is due to the exemption under Section 3(a)(10) of the Securities Act. It states:
Except with respect to a security exchanged in a case under title 11 of the United States Code, any security which is issued in exchange for one or more bona fide outstanding securities, claims or property interests, or partly in such exchange and partly for cash, where the terms and conditions of such issuance and exchange are approved, after a hearing upon the fairness of such terms and conditions at which all persons to whom it is proposed to issue securities in such exchange shall have the right to appear, by any court, or by any official or agency of the United States, or by any State or Territorial banking or insurance commission or other governmental authority expressly authorized by law to grant such approval . . . .
The exemption was initially promulgated for state fairness hearings which were prevalent prior to the adoption of the Securities Act. And still today, particularly in California, the procedure is used in takeover transactions to issue securities exempt from registration under the Securities Act (for more on California fairness hearings see here; every M&A lawyer in California should be familiar with and advise their clients of this structure where appropriate). Smart U.S. lawyers practicing abroad picked up that this exemption also fit the parameters of the proceedings for a scheme of arrangement and began to petition the SEC for no-action letters to this effect for schemes under the laws of different countries. A practice developed in the early 1990s that the SEC would issue no-action relief on a case-by-case basis for each scheme. Then in October 1999, the SEC issued a legal bulletin specifying the circumstances in which a foreign scheme of arrangement could qualify for the 3(a)(10) exemption. Today, almost all schemes now qualify and the practice is no longer to seek no-action from the SEC, but rather to rely upon the requirements set forth in the October 1999 bulletin.
The scheme of arrangement is a particularly advantageous way to extend an offer into the United States because there are no filing requirements with the SEC and no real substantive requirements other than that the judge be informed of the exemption and rule specifically on the fairness of the terms and conditions of the transaction. These are lesser information and filing requirements than required even by the SEC's Cross-Border exemptions. Because of this, U.S. lawyers often advise their non-U.S. clients to pursue a scheme of arrangement in order to significantly avoid U.S. securities law requirements even when U.S. holders number less than 10% and the cross-border exemptions can be met. This makes no sense, of course -- why U.S. holders do not get the benefits of U.S. registration requirements or the protections of the cross-border rules for this type of structure but not in the case of an offer has never been justified fully by the SEC other than statements that the strictures of 3(a)(10) are met. But if the SEC ever attended one of these scheme hearings they would see that the "fairness" ruling upon which the exemption is based is a pro forma event without significant substance. As I have argued before, the cross-border exemptions are due for some significant fine-tuning. If and when the SEC finally gets around to this acting to make the exemptions more usable, hopefully they will also reconsider the 3(a)(10) exemption for schemes.