The High Court yesterday held that a Chairperson of a shareholder scheme meeting may reject votes cast against a scheme of arrangement in circumstances where the shares were acquired through an artificial share-splitting exercise designed to frustrate the scheme. It is the first English case to consider this issue and while it arose in the context of a shareholder scheme, the impact is also significant for debt restructurings implemented by way of a creditor scheme of arrangement.
Background
Severn Trent’s takeover offer for Dee Valley was to be effected by means of a Court approved scheme of arrangement. A scheme is a statutory mechanism under the Companies Act 2006 which, under the supervision of the English Court, is often used in the UK to achieve a takeover as an alternative to a traditional tender offer (a 'member scheme') or to restructure a company’s debt (a 'creditor scheme'). A scheme is an arrangement between the company and its creditors or shareholders that, if approved by the requisite majority and sanctioned by the Court, is binding on all creditors or shareholders.
The statutory test is two-fold and requires that a majority:
(i) in number; and
(ii) representing 75% in value
of creditors or shareholders present and voting in person or by proxy must approve the scheme at a meeting of creditors or shareholders, which the Court permits the company to convene. If these majorities are achieved, a further Court hearing (the 'sanction hearing') is necessary at which the Court decides whether to sanction the scheme. If the scheme is not approved by the requisite majority, the Court does not have jurisdiction to sanction the scheme and it cannot become effective.
Facts
After Dee Valley had convened the shareholder scheme meeting, it realised that a series of approximately 434 transfers of small holdings in its shares had taken place. This was capable of distorting the outcome of the shareholder vote to approve or reject the scheme (a practice commonly known in shareholder schemes as share splitting and for the purposes of creditor schemes referred to as vote splitting). Based on the total number of Dee Valley shareholders, if all the 434 'new' shareholders voted against the scheme, the majority in numbers test would not be met, although more than 75% by value of the shareholders were still expected to vote in favour.
Dee Valley applied to Court for directions allowing the Chairperson of the meeting not to accept the votes of the holders of the transferred shares. This was intended to allow the scheme to proceed to the Court sanction hearing so that the issues raised by the share splitting could be considered fully then.
At the scheme meeting, the resolution approving the scheme was passed only because the Chairperson disregarded the votes of the holders of the transferred shares. Had he accepted those votes, the resolution would have failed the majority in number test.
Outcome
The Court held that shareholders voting at a class meeting directed by the Court must exercise their power to vote for the purpose of benefitting the class as a whole, and not merely individual members of that class. Once the Court has allowed the meeting to be summoned, the Court is effectively directing the Chairperson to take all appropriate steps to hold a fair meeting. This will include disregarding votes where appropriate - for example, the Chairperson has the ability to reject proxies if they obviously do not emanate from the relevant shareholder.
On the facts the Court held that the Chairperson of the Dee Valley scheme meeting had sufficient evidence to conclude that the only explanation for the conduct of the 'new' shareholders was that they were furthering a share manipulation strategy to defeat the scheme through the majority in number jurisdiction requirement. It was therefore proper for the Chairperson to reject those votes as he was entitled to protect the integrity of the meeting against such manipulative practices.
The Court stressed that its decision was not because the 'new' shareholders’ imputed or expressed motives fell outside the band of what was permissible. Indeed, the Court held that 'the interests of the class may be very complex and are not always going to be purely financial'. It was solely because in accepting the gift of a single share in the circumstances demonstrated that they could not have given any consideration to the interest of the class of members which they had joined.
While the Chairperson here had the express authority of the Court’s directions to disregard the votes, the Court held that given the circumstances he did not in fact need a Court order to exercise his inherent power to reject the votes.
Impact on debt restructurings
In recent years, schemes of arrangement have increasingly been used to implement debt restructurings and to give effect to a 'compromise or arrangement' between a company and its creditors. Regardless of whether a proposed scheme is a creditor scheme or a shareholder scheme, it must be approved by the same two-fold majority - ie, both a majority in number and 75% in value. As such, the Dee Valley judgment will be highly relevant for debt restructurings.
Rationale for, and pitfalls of, the 'numerosity' test
The rationale behind the majority in numbers requirement (the so called numerosity test) is that it provides a 'check and balance' and protects the interests of creditors with minority debt holdings. It prevents, for example, a scenario in which a company and a small number of its supportive, large creditors could otherwise impose a debt restructuring on a large number of opposing, small creditors.
Nevertheless, the numerosity test has been criticised in restructuring circles as it may potentially be used as a tactical tool to defeat a scheme. If a scheme is not approved by the majority of creditors by number it fails, even where it otherwise has the support of an overwhelming majority of creditors by value as the Court cannot approve a scheme that does not meet the statutory majority requirements.
Given this binary result, restructuring professionals argued and a government report in 2001 recommended that the test be dispensed with (see the DTI’s report: 'Modern Company Law for a Competitive Economy: Final Report (2001)'). The protection it seeks to provide could be achieved through other means, for example, the treatment of small creditors could simply be another factor for the Court to consider when assessing the overall fairness of the scheme. Legislative changes were not made to implement those recommendations.
Bank debt
In instances where the company is negotiating a large-scale bank debt restructuring with its key lenders it may be able to take steps to try and mitigate the risks. In all likelihood, the company would be put on alert if there is increased trading in its debt. In such cases, the company could work with its key supportive lenders to ensure the credit agreement includes reasonably high monetary thresholds for lenders to transfer a part of their debt, thereby dissuading existing debt holdings to be split into numerous small holdings (and, in due course, scheme votes).
Voting record date
Where there is a real risk that a company’s debt could continue to fracture ahead of the scheme meeting resulting in significant execution risk for the scheme, the company could seek the Court’s assistance by asking it to set an early voting record date. While the voting record date is usually a day or so before the scheme meeting, on a creditor scheme it is open to the Court to set an earlier voting record date: this could be as at the date of the convening hearing or possibly even earlier. This would mean that any debt transfers which took place between the voting record date and the scheme meeting could be ignored. This is not possible in the context of a shareholder scheme of a listed UK company since, in that case, legislation dictates that the voting record date cannot be more than two days before the scheme meeting.
Comment
Although this case arose in the context of a shareholder scheme, the outcome is just as relevant for creditor schemes. While the two-fold statutory test has been criticised, it remains on the statute book. While the issue did not need to be decided here, the judge made the point that that if the two-fold test is not met, the Court does not have jurisdiction to sanction a scheme.
However, the judgment makes clear that the Chairperson is entitled to protect the integrity of the scheme meeting against manipulative practices such as share-splitting by disregarding such votes. In practice, this can put significant pressure on the Chairperson – it may not be easy to identify votes that should be disregarded and there may be a lack of evidence. Where the point has been raised by (supportive) creditors, how much diligence will be required for the Chairperson to be comfortable enough to disregard the votes?
It is clear that in the context of a large-scale bank debt restructuring the scheme company will need to keep a close eye on how its debt is traded (in particular following an announcement of a scheme and/or the convening hearing). This will make it likely that there will be some forewarning where vote splitting might cause difficulties in respect of the numerosity test. If spotted early, there are ways to mitigate the risk (for example, by increasing the lender transfer threshold or asking the Court to set an early voting record date).
This post comes to us from Catherine Balmond, Craig Montgomery, Priyanka Usmani and Katharina Crinson of Freshfields and is based on a piece available here.
