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1. What is a scheme of arrangement and when might you use it?
While the word ‘scheme’ may give you pause, a scheme of arrangement is a well-trodden path to purchase UK companies via a court-approved process.
A scheme of arrangement is the most common structure for acquiring a UK public company when the target’s board is supportive of the deal – accounting for 81% of announced public deals in 2021 (up from 69% in 2020 and 71% in 2019) – and also can be used for private company acquisitions. A scheme entails the target company applying to the English court for permission to put a proposal to its shareholders in a ‘scheme meeting’. If a sufficient majority of each class of ‘scheme shareholder’ approves the proposal (more on that below), and all conditions to the transaction are satisfied, the scheme will be sanctioned by the court and the deal will complete.
In the acquisition of a private company, a scheme can offer a solution that avoids requiring 100% of shareholders to sign deal documentation when the target’s governing documents don’t include drag-along provisions (and it’s not possible or deemed too risky to introduce such provisions prior to the deal taking place). A scheme also may enable cross-border transactions involving the issuance of securities to the target company to qualify for an exemption from US securities law.
2. What threshold do you need for the scheme to be approved?
For the scheme to be effective, the target must obtain consent from each class of scheme shareholders, voting by a majority. A majority vote means both a majority by headcount of the shareholders voting at the scheme meeting (either in person or by proxy), and that the shareholders voting in favour of the scheme hold at least 75% in the value of the shares represented at the meeting. Alternatively, in a public takeover structure (similar to a tender offer), the buyer would need to acquire at least 90% of the outstanding shares in order to effect a ‘squeeze out’ to acquire 100% of the target.
Similarly, in a private company share purchase, all shareholders would need to enter into the acquisition agreement, or the buyer would have to rely on a drag right to acquire the nonconsenting shares (because unlike the US and some other European jurisdictions, there is no merger regime in the UK). In a scheme, it is common for major shareholders, directors and executives to give the buyer irrevocable undertakings – also known as voting and support agreements – at the signing of the transaction agreement to vote in favour of the scheme.
3. Can you offer share consideration in a scheme?
For US buyers, perhaps the most significant benefit of undertaking a scheme of arrangement is the well-established exemption from US federal securities laws’ registration requirements under Section 3(a)(10) of the Securities Act of 1933. A scheme structure can be very handy in cases where part or all of the consideration offered in a transaction consists of securities, and the parties can’t avail themselves of other exemptions, such as the private placement exemption under Regulation D or Regulation S of the Securities Act, or the target board does not want to allocate the available cash consideration to the unaccredited investors and disproportionately allocatee securities to the other shareholders. For example, a buyer could use a scheme to purchase a private UK target company with a large number of US shareholders by using buyer stock or mixed cash and stock without having to register the stock under an S-4 registration statement (or seek approval under a fairness hearing process, if available in certain US states). In a jurisdiction where a scheme structure is not available, in the above scenario, the buyer likely would have to offer cash to unaccredited investors to avoid an S-4 registration process or proceed with an S-4 registration process (which for a private buyer would have the effect of making it ‘go public’ for reporting purposes).
4. Why is class composition important in the context of a scheme?
A key item you need to address at the planning stage and monitor as the negotiations play out is how many classes you have for the purposes of the scheme, as a scheme must be approved by a sufficient majority of each class of scheme shareholders. Generally speaking, the fewer classes you have, the easier it will be to obtain approval.
In the context of a scheme, a class is essentially a grouping of shareholders. This is not the same as the classes of shares in a company’s share capital (i.e., common stock vs. preferred stock) – a company may have several issued share classes, but the shareholders can all form a single class for the purposes of the scheme. The key here is to assess what rights are being given up and what rights are being granted in return, and whether the treatment differs amongst shareholders to such an extent that it would be impossible for them to have a common interest and consider the scheme together in a single class.
For example, if all common stock shareholders receive the same consideration, then they are all likely to be deemed members of the same class. If, however, some shareholders receive a different mix of consideration or another benefit as a result of the transaction (such as a transaction bonus, repayment of shareholder debt, etc.), they may be deemed to form a separate class and be excluded from the class vote of the other common stock shareholders. Similarly, if the proceeds are flowing through a liquidation waterfall without any element of discretion being applied by the target, you may be able to take the position that the shareholders’ interests are sufficiently aligned, and they can form a single class. As noted above, each class then must approve the scheme by a majority by headcount and at least 75% in the value of the shares represented by such class at the meeting.
5. What about process and timing?
As with all M&A transactions, the process to agree a scheme will usually start with a term sheet. Once the principal terms are agreed, the parties typically will draft a document that sets out the steps that the target and the buyer need to take to make the deal happen – referred to as an implementation deed/implementation agreement or a cooperation agreement – and a proposed timetable for the deal. The parties also will appoint a barrister or Queen’s Counsel (QC) to represent the company throughout the scheme process.
Once that transaction document is agreed, the parties will turn to the long-form document that the target will send to its shareholders. Referred to as the ‘scheme circular’, this document typically sets out the acquisition terms, an explanatory statement from the directors, and certain other financial and background information about the companies and the transaction. The circular is not reviewed or commented on by the court.
The QC will then apply to the English court on behalf of the target for permission to convene a meeting of the target shareholders to consider the acquisition proposal. Once that date is set, the target must circulate the scheme circular to its shareholders and give them at least 21 calendar days to consider the proposals. After the scheme meeting has taken place, the target will apply to the court for the scheme to be sanctioned. You should expect even the simplest schemes to take between three to four months to complete, in the absence of competition or other regulatory approvals extending the timeline.
6. So are schemes here to stay?
While schemes have the court process as an added layer of complexity, they can be very effective in delivering deal certainty, given the lower shareholder approval thresholds compared to takeover offers or share purchases. Schemes involving securities as consideration also can save overall on time and cost, when compared to a share exchange that would require securities to be registered and disclosure documents to be reviewed by regulators. In an age where we’re seeing more and more private companies acquired by buyers with stock as consideration, schemes also may become a go for private company acquisitions.