Distressed situations and the UK Takeover Code

In these uncertain times, borrowers, lenders and their advisers always need to bear in mind the potential impact of the UK City Code on Takeovers and Mergers (“Code”) when undertaking a rescue situation and when security is being taken or enforced.

As the economy contracts as a result of the reaction to the COVID-19 pandemic, large numbers of companies face significant pressure and need to shore up their balance sheets.

So far, companies have been able to drawdown on existing RCFs, secure new lines of credit (whether through Government backed schemes or otherwise) and raise emergency capital through secondary issues of equity. Whilst it is hoped that the economy recovers quickly, significantly higher numbers of companies will have to address their financing needs. This may include debt finance where shares in a listed company form part of the assets secured by the lender.

We look at the Code implications of rescue funding and taking and enforcing security over shares in companies which are subject to the Code.

Which companies does the Code apply to?

The Code applies to various types of companies. Broadly it applies to:

• companies which have their registered offices in the United Kingdom, the Channel Islands or the Isle of Man if any of their securities are admitted to trading on a regulated market or multilateral trading facility (e.g. AIM) in the United Kingdom or on any stock exchange in the Channel Islands or the Isle of Man

• other public companies and certain private companies which are resident in the United Kingdom, the Channel Islands or the Isle of Man,

  (each referred to as a Code company in this insight).

When does Rule 9 apply?

Under Rule 9 of the Code the acquisition or consolidation of control of a Code company (i.e. taking an interest in shares carrying 30% or more of the voting rights or acquiring any interest in shares carrying voting rights when already interested in shares carrying not less than 30% and not more than 50% of the company’s voting rights) will result in the acquiror having to make a mandatory offer for all the other shares in the company. Control being:

• taking an interest in shares carrying 30% or more of the voting rights; or
• acquiring any interest in shares carrying voting rights when already interested in shares carrying between 30% and 50% (inclusive) of the company's voting rights.

Certain financing related transactions involving a Code company could fall within the scope of Rule 9. For example,

• an issue of new shares constituting 30% or more of the voting rights to a single party or a concert party, which would otherwise require a waiver of Rule 9 under Appendix 1 of the Code (a “whitewash”), or
• an acquisition of shares or interests in shares which would otherwise breach the limits in Rule 9, when the security is enforced by a lender.

How does the Code apply to rescue operations/security over shares?

We consider below how the Code might apply if:

• a Code company wants to raise significant amounts of capital through the issue of new shares, particularly in a rescue funding situation, or
• when lending in response to the crisis, lenders want to take security over shares in Code companies, and/or
• lenders need to enforce security over shares in default situations under existing loans.

Rescue operations

There are situations where a Code company is in such a serious financial position that the only way it can be saved is by an urgent rescue operation involving either the issue of new shares without approval by a vote of independent shareholders or the acquisition of existing shares by the rescuer which, in either case, would be caught by Rule 9 and so normally would require a general offer.

The Rule 9 requirements can be waived by the Panel in such circumstances provided that either:

• approval by a vote of independent shareholders is obtained as soon as possible after the rescue operation is carried out; or
• some other protection for independent shareholders is provided.

Where neither of these can be provided, a general offer under Rule 9 will be required. But the Panel may consider an adjustment of the offer price which would otherwise be required under Rule 9.

The rationale for this dispensation is that the normal rights of shareholders (not to see control passing without receiving an offer or consenting by a vote of independent shareholders) may be overridden where to insist on this would, or might be likely to, lead to the insolvency of the company and the likely loss by shareholders of their entire investment. The Code makes it clear that the dispensation can be given only if that is the only way the company can be saved.

The Rule 9 requirements will not normally be waived where a major shareholder in a Code company rather than the Code company itself is in need of rescue. The major shareholder's situation may have little relevance to the position of other shareholders and, so, the purchaser of a stake of 30% or more from a major shareholder must expect to be obliged to make a mandatory offer to all other shareholders.

Alternative solution

If the dispensations referred to above are not practicable, it may be possible to use an alternative dispensation - that provided by Note 5 on the dispensations from Rule 9. This allows the Panel to grant a dispensation where:

• holders of shares carrying 50% or more of the voting rights state in writing that they would not accept a Rule 9 offer;
• shares carrying 50% or more of the voting rights are already held by one other person; or
• in the case of an issue of new securities, independent shareholders holding shares carrying more than 50% of the voting rights of the company which would be capable of being cast on a “whitewash” resolution confirm in writing that they approve the proposed waiver and would vote in favour of any resolution to that effect at a general meeting

The availability of this dispensation will clearly depend on the make-up of the relevant Code company’s shareholder register but can provide a useful and quicker alternative structure to a formal whitewash.

Taking security

The Code makes it clear that:

“A bank taking security over shares or other securities in the normal course of its business will not normally be considered to be interested in those shares or securities.”

As a result, taking security should not have any immediate Code consequences. Other types of lenders, other than banks, should also fall within this if the taking of security is in their normal course of business but those lenders should always get specific advice on how the Code applies.

Enforcement of security

Again, the Code is helpful when enforcing security. In loan enforcement situations which would otherwise trigger a mandatory offer obligation under Rule 9, the Panel will not normally require an offer if:

• sufficient interests in shares are disposed of within a limited period to persons unconnected with the lender, so that
• the percentage of shares carrying voting rights in which the lender (together with persons acting in concert with it) is interested is reduced to below 30% in a manner satisfactory to the Panel.

(In this situation, the Panel may impose restrictions on the exercise of the voting rights of the shares before they are disposed of.)

When a lender sells all or part of a shareholding following enforcement, Rule 9 will still apply to the purchaser of those shares. So that if the purchaser breaches the limits in Rule 9 the purchaser will have to make a Rule 9 offer. Similarly, although a receiver, liquidator or administrator of a company is not required to make an offer when it acquires an interest in shares carrying 30% or more of the voting rights in a Code company (which forms part of the first company’s assets) Rule 9 does apply to a purchaser from such a person.