Restricting Share Capital Reductions in Takeovers

The Companies Act 2006 (Amendment of Part 17) Regulations 2015 (the “Regulations”) came into force on 4 March 2015.¹ The Regulations amend section 641 of the Companies Act 2006 to prevent a company from reducing its share capital as part of a scheme of arrangement (known as a ‘cancellation’ scheme) by virtue of which a person would acquire all the shares, or all the shares of a particular class, in that company. The Regulations recognise that such schemes may be appropriate in other situations and include a specific carve-out for restructurings that insert a new holding company and do not involve substantial changes to the company’s ultimate shareholders and their respective shareholdings. 

The Regulations are in the same form as the draft regulations previously published on 16 January 2015 and contain a transitional provision that restricts their application to takeovers announced on or after 4 March 2015 or, for companies not subject to the Takeover Code, to takeovers where the terms are agreed between the parties on or after 4 March 2015. 

Rationale 

Takeovers are typically structured either as contractual offers to purchase shares from the shareholders of the target company or through court sanctioned ‘schemes of arrangement’. Traditionally, two main types of scheme have been used: 

• ‘transfer’ schemes, where shares in the target company are transferred to new shareholders under a court order; and 
• ‘cancellation’ schemes, where the court authorises the target company to issue new shares to new shareholders following a reduction of share capital. 

The latter has been more commonly employed due to a simple stamp duty saving; implementation of a transfer scheme requires payment of tax (0.5% of the consideration paid for the shares), but no such liability arises when implementing a cancellation scheme. The UK Government identified this inconsistency in tax treatment as “a tax loophole” which had to be closed “through a targeted amendment” to the law.² As such, the new rules seek to ensure that parties implementing takeovers are subject to stamp taxes, no matter how they are carried out. Levying a tax charge directly to cancellation schemes was considered as an alternative policy option but this approach was obstructed by the legal constraints imposed by EU rules prohibiting the taxation of new issues of shares.³ 

The end for schemes of arrangement? 

The new rules do not signify the end of schemes in the takeover context; clearly transfer schemes will still be available, albeit without benefiting from the traditional stamp duty savings associated with cancellation schemes. What is more, given the high value of most takeover deals, the relatively low stamp tax burden of transfer schemes is unlikely to have any significant impact on the desire to (or not to) pursue such transactions.

It is also important to bear in mind that it is questionable whether stamp duty savings have been the principle driver behind effecting takeovers through schemes as opposed to via contractual offers. The main advantage of schemes, which applies equally to transfer schemes, is the reduction of the voting threshold required to enable the buyer to compulsorily acquire the entire issued share capital of the target. Whereas the statutory acceptance threshold for contractual offers is 90%, for a scheme to be approved only a simple majority in number representing 75% in value of shareholders must vote in favour at the court meeting. Other benefits such as increased certainty as to outcome and timing and avoidance of certain overseas securities law implications add to the appeal. Schemes are therefore expected to remain in favour, the demise of cancellation schemes most likely simply being met with a corresponding resurgence in the use of transfer schemes. 

Footnotes 

_{1) The Companies Act 2006 (Amendment of Part 17) Regulations 2015 (PDF)
2) Explanatory Memorandum to the Companies Act 2006 (Amendment of Part 17) Regulations 2015 No 472
3) EU Capital Duties Directive (2008/7/EC)}