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Schemes of arrangement: the current structure of choice for acquisitions of UK-listed companies02/07/2008. Source: Latham & Watkins. Peter Myners
 The scheme of arrangement is the current structure of choice for purchasers acquiring large, UK-listed companies, and there have been recent, significant developments in market practice as well as welcome changes to the legal and regulatory regimes applicable to scheme, writes Peter Myners of law firm Latham & Watkins.
What is a Scheme?
A scheme of arrangement is a courtbased arrangement between a target company and its shareholders, and an alternative to the standard contractual offer made by an offeror direct to target shareholders. Schemes are governed by the City Code on Takeovers and Mergers (the Takeover Code) but structured, procedurally, in line with court rules and the court timetable. A scheme will require the approval of 75 percent of votes cast at the general meeting convened at the direction of the court for the purposes of approving it, and a majority in number of those attending. Once approved by shareholders and sanctioned by the court, however, a scheme will bind 100 percent of target shareholders.
The majority of recent “megamergers” in the UK have been structured by way of scheme, and a consensus is building among principals and their advisers that the advantages associated with schemes generally outweigh the disadvantages.
Why Structure a Deal by Way of Scheme?
There are two principal advantages associated with schemes when compared with contractual takeover offers: (i) probable stamp duty tax savings of 0.5 percent of the total consideration payable; and (ii) speed and certainty of acquiring 100 percent of the target’s shares. The latter will be of real importance in the context of hostile minorities, highly leveraged deals and public-to-privates.
It is also possible that an acquisition structured by way of scheme will reduce some of the complexities associated with offers to overseas shareholders.
So Why Isn’t Every Public Takeover Structured as a Scheme?
Traditionally, schemes have been viewed as inflexible, time-consuming and costly structures, relative to contractual offers, and on smaller deals the stamp duty saving may be outweighed by the extra cost associated with preparing the necessary documentation (which will be more extensive as compared to a contractual offer) and engaging counsel to assist with court procedures.
There are detailed rules regarding the composition of separate classes of shareholders (with uncertainty in relation to the impact of so-called “hard” irrevocable undertakings), each of which will need to approve the scheme, as well as the ability to vote at the relevant meetings. The latter will impact the balance of power at the court convened meeting, as well as the tactical decision as to whether or not to build a stake in the target.
Historically, due to the fact that schemes are largely target-controlled and the target board is able to withdraw a scheme at any time prior to the final court order being granted if it considers this to be in the best interests of shareholders (for example, in the event of a higher bid), schemes have offered appreciably less deal protection than is available on a contractual offer.
Perceived Inflexibility in Competitive Situations
In the context of competing bids, the ability to increase the price offered to target shareholders and otherwise improve the terms on which an offer is made is essential.
The issue on a scheme is the extent to which a court will permit a bidder to alter the terms of its scheme once the court process has commenced, and whether a further meeting of the target’s shareholders will be required if the initial meeting of target shareholders has already taken place by the time the revised terms are announced. Historically, a bidder in such a scenario would seek to exercise its reserved right to switch to an offer, and abandon the scheme of arrangement, to allow it to be more responsive and to operate independently of the target board. Recent changes to the Takeover Code have, however, clarified the offeror’s ability to amend the terms of a scheme under the rules of the Code.
Competing Schemes
The traditional view had been that it would not be appropriate for a competing bidder to structure its offer by way of a scheme in circumstances where an original offer has already been structured as a scheme and the court process in relation to that scheme has already commenced.
However, recent deals have prompted a debate about the ways in which competing schemes could be structured. There are, theoretically, two principal structures that could be used for competing offers made by way of scheme: the “parallel” scheme (involving separate scheme documents being posted to target shareholders) and the “dual-option” scheme (where the target sends to shareholders a scheme document containing both schemes and convening both schemes’ respective court meetings and EGMs for the same day). Complex timetabling and procedural issues are likely to arise, and advice from counsel will be needed as to the possibility of either scheme being struck out for abuse of process.
Implementation Agreement
It is now market practice for the general imbalance between the offeror and the target as regards control of the scheme process to be addressed in an implementation agreement. Market practice has developed in relation to the level of comfort obtained, with the agreement typically including a break fee and non-solicit and increasingly a “matching right” in the event of a competing bid.
What Has Prompted Recent Market Practice?
The main drivers behind the recent trend toward more innovative use of schemes appear to have been a shift in the attitude of the courts, and the flexibility of the Panel. There is evidence (for example, in their sanctioning of so-called “hybrid” schemes which contain both transfer, in respect of loan note elected shares, and reduction elements) that courts are prepared to be more flexible provided the terms of the scheme are clear and the manner in which those terms are put to shareholders is fair and reasonable.
And Will the Trend Continue?
Market practice had developed over time and been reflected, albeit on an informal basis, in the approach adopted toward schemes by the Panel, but it had never formally been reflected in the Takeover Code. Welcome changes to the Takeover Code took effect on 14 January 2008, and these have clarified the application of the Takeover Code to takeovers implemented by way of scheme.
The changes to the Takeover Code provide a more certain framework within which acquisitions of UK public companies can be implemented by way of scheme, and are likely to further increase confidence in schemes of arrangement as a means of structuring takeovers.
In addition to the changes to the Takeover Code, new practice directions came into force on 1 October 2007 with the aim of streamlining the court-based procedures applicable to schemes.
So Schemes Are Here to Stay?
It remains to be seen whether the increased and more innovative use of schemes and the associated procedural complexity will overload and give rise to a backlash from the courts, or whether a general decrease in the number and relative value of highly leveraged bids will give rise to a reduced need to structure takeovers by way of scheme. In the meantime, however, the current trend is set to continue.
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