Corporate Law Update
- A scheme of arrangement involving a reduction of capital did not breach anti-tax avoidance laws
- The final report from the independent Brydon review into audit has been published
- The Government is to press ahead with national security, audit and transparency reforms
- The FRC has published an updated practice aid for audit committees
- New FAQs have been published to assist private equity firms with valuing their investments
- ESMA has published recommendations on ways to tackle short-termism in companies
- The European Commission is seeking views on regulating and markets for cryptoassets
The High Court has held that a scheme of arrangement involving the cancellation and re-issue of a company’s shares was not prohibited by tax avoidance legislation.
In the matter of Galliford Try plc  EWHC 3252 (Ch) concerned Bovis Homes’ recent takeover of Galliford Try’s Linden Homes and Partnerships/Regeneration divisions. Following the takeover, Galliford Try would be left only with its Construction division.
The High Court was asked to (i) convene a shareholder meeting to consider and vote on the proposed scheme of arrangement, and (ii) give a non-binding comfort that the scheme fell within the permitted uses of a cancellation scheme under section 641 Companies Act 2006.
The takeover was structured as a series of steps as follows:
- Under a scheme of arrangement, Galliford Try plc (Galliford) would cancel all of its shares in a reduction of capital, then re-issue them to a new Jersey company (Jerseyco). In exchange, Jerseyco would issue shares to Galliford’s shareholders in the proportions in which they held shares in Galliford. This kind of arrangement is known as a “cancellation scheme”.
- Galliford would then distribute the shares in its Linden Homes business to Jerseyco.
- Under a second scheme, Jerseyco would cancel some of its shares and transfer the shares in Galliford to a new UK company (Holdings), effectively isolating the Linden Homes business as a subsidiary of Jerseyco. In exchange, Holdings would issue shares to Jerseyco’s shareholders, so that it ceased to be a subsidiary of Jerseyco. This kind of arrangement is known as a “three-cornered demerger”.
- Bovis would then acquire Jerseyco, giving it control of the Linden Homes business.
- Finally, Bovis would acquire the Partnerships/Regeneration business from Galliford for cash, leaving the construction business in Galliford.
At the end, Bovis would have acquired Linden Homes and the Partnerships/Regeneration business from Galliford, and Galliford’s existing shareholders would, through their shareholding in Holdings, retain the Construction division.
What was the issue?
Cancellation schemes were once a popular structure for public takeovers. As they involved cancelling and issuing the target’s shares, rather than transferring them, the bidder did not pay stamp duty.
From 2015, cancellation schemes were outlawed for takeovers. Section 641(2A) of the Companies Act 2006 prohibits a company from reducing its share capital as part of a scheme through which a person (or group of people) acquires all the shares in the company (i.e. a takeover).
But there is an exception. Section 641(2B) allows a company to use a cancellation scheme to insert a new holding company, so long as its shareholders receive shares in the holding company in the same proportions in which they held shares in the existing company.
Step 1 involved precisely this kind of arrangement. All of Galliford’s shares would be cancelled, and Jerseyco would issue new shares to Galliford’s shareholders in the same respective proportions.
However, courts do not always interpret legislation literally. Under a doctrine known as the “Ramsay principle”, a court will ask whether a particular statutory provision is intended to apply to a particular transaction “viewed realistically”, rather than literally.
In this case, as a result of step 4, Bovis would gain effective control over Galliford. This was arguably what section 641(2A) was trying to prevent. The question was whether the court would apply the Ramsay principle, looking past step 1 to the overall effect of the transaction, and find that the entire arrangement would be prohibited by section 641(2A).
What did the court say?
The court said the exception applied.
The judge said that the court will not look at a scheme in isolation, but also at any arrangements entered into pursuant to the scheme (Stemcor Trade Finance Limited  BCC 194). But, in this case, step 1 clearly was limited to inserting a new holding company. It fell within the exception.
The court then considered whether the scheme formed part of a wider transaction that fell within the prohibition in section 641(2A). The judge said it did not. The overall effect of the transaction was to sell two subsidiaries, not to transfer control over Galliford. Step 1 was merely an “internal reorganisation undertaken for proper commercial purposes” to permit the sale of those subsidiaries. A sale of those subsidiaries was not the kind of transaction section 641(2A) was trying to prohibit.
What does this mean for me?
This is yet another example of the courts taking a pragmatic approach to prohibitive legislation and, in particular, the ban on cancellation schemes. Judges have now had to consider sections 641(2A) and (2B) on several occasions, and each time they have reached a commercial conclusion. For example:
- In Re Home Retail Group plc  EWHC 2072 (Ch), the court permitted a scheme to insert a new holding company, even though soon afterwards a bidder would acquire the holding company. The scheme was part of a “real world transaction” (and it appears no stamp duty was avoided).
- In Re Man Group plc  EWHC 1392 (Ch), a cancellation scheme was permitted even though a deferred shareholder did not participate or become a shareholder in the new holding company. Similarly, in Re Steris plc  EWHC 751 (Ch) the court approved a scheme where preference shareholders did not participate (see our previous Corporate Law Update for more information).
- And in Re Unilever plc  EWHC 2546 (Ch), the court approved a scheme which would fall within the exception purely because new nominee holding arrangements were to be put in place, but where in substance the shareholder base was changing. The proposal did not involve any artificial steps designed to avoid paying stamp duty.
The Government has published the final report from the independent review into the quality and effectiveness of audit, led by Sir Donald Brydon.
The review, which was announced in December 2018, is designed to examine the quality and effectiveness of the UK audit market. In particular, its aims include to understand the expectations of investors and other stakeholders and to make audits more informative for the public.
The report contains numerous recommendations, including the following:
- Purpose of audit. This should be enshrined in law. Auditors would need to take the purpose of audit into account when making their report and provide information to help present and future investors, creditors and other stakeholders make rational decisions.
- Public Interest Statement. Directors should be required to state in the annual report how they view the company’s legal, financial, social and environmental responsibilities to the public interest. The auditor would state whether this statement is consistent with the annual report.
- APMs and KPIs. Alternative performance measures, and key performance indicators used to calculate executive remuneration, should be subject to audit. In addition, a company’s payment policies and performance should be subject to some level of reporting and audit.
- Internal controls. A company’s CEO and CFO should confirm to the board that the company’s internal financial reporting controls have been evaluated. This is an attempt to replicate requirements from the US Sarbanes-Oxley Act in UK law.
- Risk and viability. The existing going concern and viability statements should be replaced by a new “resilience statement”. This statement would be divided into three sections dealing with the short (up to two years), medium (up to five years) and long (beyond five years) terms.
- Beyond the financials. Auditors should look beyond just the accounts and annual report and state whether other public information (such as materials used in investor presentations) has been materially misstated. They should also be able to base their report on information published by the company but not provided by the directors during the audit.
- Expanding the concept of “auditor”. The profession should be redrawn to include persons from disciplines other than accounting, who would review other aspects of a company’s business. The report gives environmental, social and governance (ESG) matters, cyber-security and culture as examples of potential areas for separate audit.
- Engaging with shareholders. The audit committee should be required to invite shareholders to make requests for areas of emphasis by the auditor. In addition, companies should publish an “audit and assurance policy” every three years and put it to an advisory shareholder vote. That report would explain the auditor appointment process, the scope of its work and its fees.
- Reforming the standard of accounts. The “true and fair view” requirement should be removed. Instead, accounts should present the company’s state of affairs fairly in all material respects. In addition, the report recommends reforming the Companies Act 2006 to provide more clarity on what ongoing accounting records a company must keep.
- Outgoing auditors. The law should be amended to require more information for shareholders on why an auditor has resigned, been dismissed or decided not to participate in a retender. There should also be a general meeting within 42 days so that shareholders can quiz the auditor.
- Audit committees. Minutes of audit committee meetings should be published 12 to 18 months after the meeting (with appropriate redactions). Where a company has separate audit and risk committees, the auditor should have access to both.
The recommendations are aimed primarily at public interest entities (i.e. Main Market companies and credit and insurance firms), with a suggestion that they apply initially to those in the FTSE 350.
The report contemplates significant changes in the way the current audit process operates. Although only recommendations at this stage, some of these initiatives are already being considered formally. We will continue to monitor developments in this area.
Following the recent General Election on 12 December 2019, the Government has published the Queen’s Speech and the accompanying background briefing notes. The notes set out the Government’s proposed legislative agenda in some detail and reveal the following:
- National security. The Government is proposing a “National Security and Investment Bill”. The Bill’s stated aim is to strengthen the Government’s powers to scrutinise and intervene in business transactions in order to protect national security. The proposal follows the consultation on long-term national security measures which the Government published in August 2018. For more information, see our previous Corporate Law Update.
- Audit reform. The Government intends to develop proposals on company audit and corporate reporting, including by introducing the new Audit, Reporting and Governance Authority (ARGA) and giving it powers to “reform the sector”. This naturally follows on from the outcome of the independent Brydon review (see above).
- Beneficial ownership. The Government is also proposing to progress legislation to combat money laundering and achieve greater transparency. This includes progressing the existing Registration of Overseas Entities Bill, which was published in draft in July 2018 and is based substantially on the UK’s existing PSC regime. For more information on this, see our previous Corporate Law Updates from July 2018 and July 2019.
- FRC updates its advice for audit committees. The Financial Reporting Council (FRC) has updated its practice aid for audit committees. The document, which was first published in 2015, aims to assist audit committees with evaluating the quality of their company’s audit and communicating this to shareholders. The guide is aimed principally at premium-listed companies but will be useful to any company that has adopted the UK Corporate Governance Code.
- IPEV issues FAQs on new valuation guidelines. The International Private Equity and Venture Capital Valuation (IPEV) Guidelines Board has published frequently asked questions on the new Valuation Guidelines it published in December 2018. The FAQs cover topics such as how the last funding round affects fair value, how to value an early-stage business where commercial viability is yet to be established, and how frequently valuation adjustments should be made to investments in portfolio companies.
- ESMA issues recommendations on short-termism. Following its consultation in June this year, the European Securities and Markets Authority (ESMA) has published a report providing recommendations on ways to tackle undue short-term pressure on corporations. The report focusses on key areas, including disclosure of environmental, social and governance (ESG) issues and engagement with institutional investors. The European Commission will now consider the report and decide whether to take any of the recommendations forward.
- EU consulting on cryptoassets. The European Commission has published a consultation on establishing a European framework for markets in cryptoassets. The Commission is seeking views on how cryptoassets should be classified, which would in turn determine which regulatory regime would govern them. It has also asked for views on security tokens (which are regulated), as well as unregulated cryptoassets and how best to mitigate the risks to which they give rise. The consultation deadline is 18 March 2020.