Corporate Law Update

A round-up of developments in corporate law for the week ending 9 November 2018.

This week:

Government publishes draft “no-deal” company law and merger control regulations

The Government has published draft regulations addressing certain areas of company and corporate law if the UK leaves the European Union (EU) without the two sides entering into transitional or implementation arrangements (a so-called “no-deal Brexit”). This could be on 29 March 2019, when the UK is scheduled to leave the EU, or alternatively at the end of any “transition” period if no final implementation arrangements are concluded.

The changes are set out in seven separate sets of regulations which relate to merger control, accounts and reports, auditors, takeovers, European companies (SEs), European Economic Interest Groupings (EEIGs) and general corporate matters. Together, they would create a position following a no-deal Brexit as set out below.

It is worth noting that whether the regulations come into force, and (if so) in what respects, will depend heavily on whether the UK and the EU can agree the final form of a withdrawal agreement and (if they do) the content of that agreement.

  • Merger control. The UK and EU merger control regimes would be completely separated. After exit day, the UK Competition and Markets Authority (CMA) would be the sole competition authority responsible for examining the UK aspects of mergers.

    The principal consequence is that the current “one stop shop” regime, under which a merger falling within both the EU Merger Regulation (EUMR) and the UK merger control regime is investigated by the European Commission (EC) alone, would end. Instead, where a merger falls within both regimes, the parties would need to obtain clearance from both the EC and (if they decide to notify the merger voluntarily in the UK) the CMA.

    This is very important for planned mergers that may fall within both regimes. If the EC clears a merger before exit day, the CMA will not subsequently investigate it. However, if the EC has not given clearance before exit day, a merger that meets the UK thresholds would fall within the UK’s regime, even if the clearance process under the EU regime has reached its most advanced stages. In these cases, the CMA has advised merger parties to engage with it at an early stage.
  • Cross-border mergers. The cross-border mergers regime would be abolished entirely in the UK, making cross-border mergers involving a UK company impossible. Any organisation planning a cross-border merger with a UK company would need to ensure the entire procedure (including all court approvals) is completed before exit day, or else the merger may not be effective.
  • Takeovers. As we noted last week, draft takeover regulations would make minor changes to incorporate certain parts of the EU takeovers regime properly into UK law. We explain more about these changes, as well as proposed changes to the UK Takeover Code, below.
  • Accounts and reports. Broadly speaking, a company whose group is headed by a parent established in the European Economic Area (EEA) would no longer be treated any differently from one whose group is headed by a non-EEA parent. This would entail two key changes.

    First, dormant subsidiaries within an EEA group would no longer be able to exempt themselves from producing individual accounts.

    Second (and perhaps more significantly), an intermediate holding company with an immediate EEA parent would need to start producing group accounts unless its parent produces group accounts equivalent to those required by the Companies Act 2006. (Currently, intermediate companies do not have to produce group accounts if their immediate EEA parent produces group accounts under EU accounting requirements.)

    This effect of this would be to tie the exemption to UK, rather than EU, accounting requirements or standards deemed equivalent. However, as UK requirements are already modelled on EU standards, it seems likely that the UK would deem existing EEA accounting regimes equivalent, at least as they stand on exit day.

    This proposed change should not affect an intermediate holding company whose immediate parent prepares group accounts under international accounting standards (IAS) (or standards deemed equivalent to IAS).
  • Auditors. The Government and the Financial Reporting Council would have the power to decide whether audit frameworks outside the UK are “equivalent” for the purposes of UK law, rather than the EC. Importantly, all EEA audit frameworks would be deemed equivalent for a transitional period ending on 31 December 2020. In addition, all frameworks currently recognised by the EC as “equivalent” would automatically be granted equivalence. This includes Abu Dhabi and Dubai IFC, Australia, Canada, the Channel Islands, China, the Isle of Man, Japan, South Africa, Switzerland, Turkey and (until 31 July 2022) the United States.
  • Other company filings. Non-UK entities registered in the EEA would be treated in the same way as entities registered outside the EEA or the UK, and would need to provide the same information to Companies House. This would increase the filing burden on EEA entities with an establishment in the UK, particularly in relation to accounts and reports.
  • Disclosure of protected information. At the moment, the residential address and date of birth of directors and persons with significant control are not publicly available, but Companies House can disclose the information to public authorities and credit reference agencies in the EEA, provided certain conditions are met. After exit day, Companies House would continue to be able to disclose to EEA public authorities, but not to credit reference agencies outside the UK.
  • European companies. It would no longer be possible to form or register a European company (or SE) in the UK. Every SE registered in the UK on exit day would convert automatically into a “United Kingdom Societas”, a new corporate entity similar to an SE. This would be a “temporary stage”. A UK Societas could convert into a public limited company at any time after exit day.
  • European Economic Interest Groupings (EEIGs). Similarly, it would no longer be possible to form or register a European Economic Interest Group (EEIG) in the UK. Every EEIG registered in the UK on exit day would convert automatically into a “UK Economic Interest Grouping” (or “UKEIG”), a new corporate entity similar to an EEIG. Again, this would be a “temporary stage” until the UKEIG identifies and moves to a more suitable domestic structure.

Amendments to takeovers regime proposed to address Brexit

We noted last week that the Government had published draft regulations designed to address the regulation of company takeovers in the UK following Brexit. In the past week, the Government has published revised draft regulations containing a minor correction.

In addition, the Takeover Panel has published consultation paper PCP 2018/2, in which it is proposing certain amendments to the Takeover Code (the Code) to address the UK’s withdrawal from the EU.

As we noted last week, the draft regulations would make minor and technical changes (principally to the Companies Act 2006, to incorporate the EU regime into UK law). By and large, the same principle applies to the Panel’s proposed amendments to the Code.

The only significant proposed change is that the current “shared jurisdiction” regime will cease to apply following Brexit. This is because that regime relies on reciprocal arrangements between member states of the EU and the European Economic Area (EEA) and, in a no-deal scenario, the UK will cease to be a member of the EU or the EEA. We have set out more detail on this below.

In addition, as the UK will no longer be able to participate in the cross-border mergers regime, the Panel is proposing to withdraw its Practice Statement 18 on cross-border mergers.

What is the “shared jurisdiction” regime?

Broadly speaking, the shared jurisdiction regime applies where the target of a takeover offer falls within one of the following two categories:

  • It is registered in the UK, but its securities are admitted to trading only on EEA regulated markets outside the UK. The Panel estimates that this currently affects 11 UK companies.
  • It is registered in another EEA state, but its securities are admitted to trading only on an EEA regulated market in the UK (or, in some cases, to multiple EEA regulated markets), and not to a regulated market in the country in which it is registered. The Panel estimates that this currently affects 25 EEA companies.

Where the regime applies (depending on which of the two conditions above the company meets), some parts of the takeover are governed by the Code, and the other elements are governed by the takeover rules of another EEA state.

How would this change?

Under the proposed no-deal arrangements, this regime would end. Following exit day, the Code would apply only to offers for companies that are registered in the UK and which either have securities admitted to trading on a UK regulated market or multilateral trading facility, or have their central management and control in the UK (the so-called “residency test”).

This means that the 25 EEA companies referred to above would no longer be subject to the Code in any respect. They may, however, become subject to the full extent of the takeover rules in their country of registration. (The Panel notes that this would be the case for companies registered in Ireland.)

The 11 UK companies referred to above would remain subject to the Code, but only if they satisfy the residency test. However, if they do satisfy that test, they will be subject to the entire Code, and not merely parts of it as at present.

The Panel has also noted that the changes could result in some companies coming under “dual jurisdiction”. This would happen where the company is registered in the UK and satisfies the residency test, but its securities are admitted only to a regulated market in one or more other EEA states. This can give rise to conflicts between different takeover systems, and the Panel should be consulted if this is likely so that it can give guidance.

The Panel has asked for comments on its proposals by 17 December 2018.

Chancellor announces changes to entrepreneurs’ relief

As part of his Budget, the Chancellor has confirmed two significant changes to the availability of entrepreneurs’ relief (ER).
ER allows individuals to reduce their tax liability on a disposal of their “personal company”. So long as the shares being sold meet the qualifying criteria, an individual will pay capital gains tax at a reduced rate of 10% (rather than the normal rate of 20%), up to a maximum lifetime limit of £10 million of gains.

Although initially designed to encourage entrepreneurial investment, ER has become a staple feature of private equity- and venture capital-backed deals involving management.

The two changes are as follows:

  • Longer holding requirement. Currently, an individual must meet the conditions for ER for a minimum period of 12 months before being able to take advantage of the relief. From 6 April 2019, this will double to two years. The longer period applies to disposals on or after that date, so shares held today may well become subject to the new two-year period.
  • Economic requirement. Currently, to qualify for relief, the individual must hold at least 5% of the share capital and voting rights in the company in question. However, from 29 October 2018, an individual will also need to be entitled to at least 5% of the company’s profits distributable to “equity holders”. Broadly, this is designed to exclude preference shares from the calculation.

    However, in running this calculation, it is important to note that the concept of “preference share” for ER purposes is narrow and does not include some instruments that might traditionally be considered preference shares. Moreover, certain equity-like instruments, such as convertible notes, may also qualify as equity for ER purposes. Failing to take these kinds of instrument into account when calculating the economic requirement could result in an individual appearing to satisfy the threshold when in fact they hold an economic entitlement of less than 5%.

    Although the economic requirement only kicked in on 29 October 2018, it applies to all shares held as at that date. The result is that some shares that would otherwise have qualified for ER on that date may no longer qualify if they do not satisfy the economic requirement.
    The changes mean that much fewer individuals will benefit from ER than before. Anyone expecting to benefit from the relief should review their arrangements to confirm whether they are still eligible.

Other items

  • The Financial Reporting Council (FRC) has launched a new project to “challenge existing thinking” around corporate reporting. The purpose of the project is to consider how companies can better meet the information needs of shareholders and other stakeholders. The FRC will review current reporting practices and consider the purpose of corporate reporting generally. It has called for 15 participants to join the study group. Nominations should be submitted by 15 November 2018.
  • The FRC has also published a new report on corporate reporting by smaller listed and AIM companies. The report examines 22 non-FTSE 350 listed companies and 18 AIM companies, focussing on alternative performance measures (APMs) and strategic reports, pensions disclosures, accounting policies (including critical judgments and estimates), cash flow statements and tax disclosures. The FRC has noted improvements in all areas since 2017, particularly among the larger companies it examined and especially among APMs, judgments and estimates, but says there is “clearly still scope for further improvement”.
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