The Court has recently confirmed that the Chairman of a class meeting on a scheme of arrangement to effect a takeover was right to discount the votes of a number of shareholders who had one share each gifted to them by one other shareholder shortly before the meeting. If the votes had been allowed, the scheme would have failed.
In the UK, a takeover may be effected either by a contractual offer or by a scheme of arrangement. A scheme of arrangement is a court process under the Companies Act 2006. When used as part of a takeover, it is usually initiated by the target and involves an arrangement being put to target shareholders whereby their shares will be transferred to the bidder in return for the consideration on offer. A key attraction of a scheme over a contractual offer is that it requires a lower threshold to be met in order for the bidder to acquire 100% ownership of target.
On a scheme, the necessary threshold is a two limb test requiring:
- the approval of a majority in number of the class of shareholders present and voting, which must also represent
- at least 75% in value of that class of members present and voting.
On a scheme, the class meeting in question is convened at the direction of the Court. If the approvals required at that meeting are obtained, the scheme must then be sanctioned by the Court in order to be effective. This takes place at a later Court hearing at which the Court has discretion to sanction the scheme or not.
The two limb test referred to above has resulted in there being a concern that shareholdings could potentially be manipulated to affect the outcome of the majority in number test. For example, by splitting one shareholding into a larger number of holdings amongst different persons who would all vote in a particular way, numbers could be swelled to achieve a desired effect – either to ensure the majority in number test is met or to defeat it.
Where such a "share splitting" is orchestrated to bring about the success of the scheme there is some protection due to the need for the Court to then decide whether or not it will sanction the scheme. This was the position in the Hong Kong case of Re PCCW Limited. In that case, the Court determined, at the sanction stage, that the votes which were the subject of the share split should be disregarded and this resulted in the scheme failing. However, if the majority in number test is not met, the scheme will necessarily fail and will not proceed to the subsequent Court hearing to consider its sanction. This means that in those circumstances there is no opportunity for the Court to consider the effect of the share splitting.
Despite the concerns over share splitting in the UK, there has not, until the recent takeover of Dee Valley Group Plc ("Dee Valley") by Severn Trent Water Limited ("Severn"), been an instance of share splitting. This alone makes the Dee Valley case interesting, but the fact that the purported share split would have had the effect of defeating the scheme also makes the case stand out from the Hong Kong case referred to above, where the objective was for the scheme to succeed.
The case in question
The bid for Dee Valley by Severn was structured as a scheme. Shortly before the class meeting, the Dee Valley board became aware that 443 new shareholders (the "New Shareholders") had come onto the register of members as a result of being gifted one share each by another shareholder, an employee of Dee Valley. Proxy forms in respect of most of these shares voting against the scheme were subsequently lodged with Dee Valley's registrars. There was therefore a concern that the original shareholding in question had been split amongst a high number of individuals in order that they could vote against the scheme with a view to defeating it on the majority in number test referred to above.
For this reason, Dee Valley applied to Court for directions prior to the holding of the class meeting for which the proxy forms had been lodged. At the directions hearing, the Registrar directed that the Chairman of the meeting should have discretion to disregard the votes of any New Shareholders. However, this was on the basis that, assuming the necessary consents were obtained, the Court would then determine whether it was appropriate to disregard such votes at the sanction hearing.
Accordingly, at the class meeting, the Chairman exercised his discretion to reject the votes cast by New Shareholders so that the statutory majorities referred to above were achieved. If the votes had not been disregarded, the scheme would have failed because the simple majority test would not have been passed, even though it would have passed the 75% in value test. As a result of the Chairman disregarding the votes, and therefore allowing the scheme to succeed at the class meeting, the scheme was able to proceed to the court sanction stage so that the Court could then determine whether the votes in question had been correctly disregarded.
At the Court sanction hearing, the Court held that the Chairman had been right to disregard the votes of New Shareholders cast at the class meeting and had the discretion to do so. As both limbs of the test had therefore been satisfied, the Court went on to determine whether the scheme should be sanctioned which it was.
Points to note
Important points to note from the Judgment are that:
- the reason for disregarding the votes was that members voting at a class meeting directed by the Court (and therefore distinct from a class meeting called by the company) must exercise their power to vote for the purpose of benefiting the class as a whole, and not only individual members,
- the Chairman had sufficient evidence to conclude that the votes of New Shareholders were not being cast for the purpose of benefiting the class as a whole – this was not due to the imputed or expressed motives of the New Shareholders but because the only possible explanation for their conduct in accepting a gift of a single share immediately after the class meeting had been convened was to further a share manipulation strategy intended to defeat the scheme by use of the majority in number test,
- the Chairman had the power to reject the votes of New Shareholders at the class meeting on proper grounds notwithstanding that on this occasion he also had the express permission of the Court, and
- the Court would not be able to consider whether or not to sanction a scheme where both of the approvals needed are not obtained at a class meeting – this underlines the importance, where the effect of a share splitting would be to defeat the scheme, of the Chairman considering an exercise of his discretion to disregard votes, or, as in the Dee Valley case, seeking directions from the Court prior to the class meeting – in this way, the ability for the Court to determine the position may be preserved.
Whilst the case is important for being the first in the UK to consider the effects of share splitting in the context of a scheme being used to effect a takeover, it raises interesting questions as to the extent to which the principles discussed in the case are to be confined to the facts in question such as the shares being gifted to new shareholders and the timing of those gifts. For example, can it still be regarded as manipulation if a major shareholder splits his shareholding in advance of any scheme takeover so as to be able to defeat a bid which is not supported by him as and when it might be made? Also, in the past, shareholders have sought to leverage their position in takeover situations by threatening the use of such devices and it will be interesting to see whether this case will now allow bidders to stand up to such threats.
To read the Dee Valley judgment in full, click here.