House of Commons - Explanatory Note

Company Law Reform Bill [HL] - continued	House of Commons

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Clauses 665 and 673: Power to extend to Isle of Man and Channel Islands

1164. These clauses allow any provisions of Chapters 1 and 2 to be extended to the Isle of Man or any of the Channel Islands by Order in Council, with any specified modifications.

CHAPTER 2: IMPEDIMENTS TO TAKEOVERS

Summary and background

1165. Article 11 of the Takeovers Directive seeks to override, in certain circumstances relating to a takeover, a number of defensive devices that may be adopted by companies prior to the bid, such as: differential share structures under which minority shareholders may exercise disproportionate voting rights; restrictions on transfer of shares in the company articles or in contractual agreements; and limitations on share ownership.

1166. There are currently no restrictions on the way that UK companies which are admitted to trading on a regulated market can structure their share capital and control. However, market pressure brought to bear, in particular, by institutional investors has ensured that there are now few UK listed companies with differential voting structures.

1167. As permitted by Article 12 of the Directive, it has been decided not to apply the provisions of Article 11 in all cases but instead to include in the Bill (clauses 666 to 672) provision for companies with voting shares traded on a regulated market to opt in to its provisions should they choose to do so.

Clauses 666, 667 and 670: Opting in and opting out; Further provision about opting-in and opting-out resolutions; and Communication of decisions

1168. A company may pass a special resolution opting in to Article 11 (an "opting-in resolution") provided that three conditions are met:

a) it has voting shares admitted to trading on a regulated market (it is not considered necessary to extend this provision to other types of companies which are not covered by the Directive);

b) the company's articles of association do not contain restrictions as are mentioned in Article 11 (or other provisions which would be incompatible with Article 11) or, if they do contain those restrictions, the restrictions will not apply in circumstances related to a takeover bid as described by Article 11. Article 11 relates to both the takeover bid period and the time following the bid when the bidder has acquired 75% or more of the company's capital carrying voting rights. It provides that restrictions both on the rights to transfer shares and on voting rights that are contained in the articles of the company should not apply. It also provides that, in certain circumstances, shares carrying multiple voting rights shall only have one vote and extraordinary rights of shareholders concerning the appointment or removal of board members should be disapplied; and

clause 666(8)

1169. Clause 666(5) enables a company to revoke an opting-in resolution by means of a further special resolution (an "opting-out resolution").

1170. Clause 667 sets down provisions relating to the date that the opting-in and opting-out resolutions will take effect. Generally, this will be the date stated in the resolution.

1171. Clause 670 requires companies, within 15 days of an opting-in or opting-out resolution being passed, to notify the Panel and any other takeover supervisory authority in a Member State in which the company has shares admitted to trading on a regulated market or has requested such admission. Where a company fails to comply with this requirement, the company and every officer in default will be guilty of an offence and be liable on summary conviction to a fine not exceeding level 3 on the standard scale (and to a daily default fine for continued contravention).

Clause 668: Effect on contractual restrictions

1172. This clause provides that agreements entered into between shareholders in the company on or after 21 April 2004 (the date on which the Takeovers Directive was adopted), and agreements entered into between a shareholder and the company before as well as on or after that date, are invalid in so far as they impose any of the restrictions set out in subsection (2).

1173. Those restrictions relate both to the bid period and to the time following a takeover bid when the bidder holds 75% or more in value of all the voting shares in the company. Types of restrictions overridden are those imposing restrictions on the transfer of shares and on rights to vote at general meetings of the company to decide on action to frustrate the bid and at the first meeting to be held after the end of the offer period. For the purposes of determining when the bidder holds 75% or more in value of all the voting shares in the company, both debentures and shares which do not normally carry rights to vote at a general meeting (such as preference shares) held by the bidder are to be disregarded (see subsection (8)).

1174. The provisions related to the types of contractual agreements to which override will apply (including the date at which such contracts were entered into) and the restrictions which are made invalid are designed to replicate the provisions of Article 11 of the Directive.

1175. Clause 668(6) provides that a person who suffers loss as a result of a contractual agreement being overridden can apply to the court for compensation. It is expected that, in the first instance, such compensation will be offered by the bidder in making the takeover offer. Where, however, the compensation offered by the bidder is not acceptable to the person whose rights are being overridden, there is a right to apply to the court. The court will award compensation to the person who suffers loss on a just and equitable basis to be paid by any person (which could include the bidder or the other party to the contract which has been overridden) who would have been liable to him for committing or inducing the breach of contract which would have been committed had the restriction in question not been made invalid by this clause.

Clauses 669 and 672: Power of offeror to require general meeting to be called; Transitory provision

1176. Clause 669 provides the bidder with the special right to require the directors of an opted-in company to call a general meeting of the company when he holds 75% in value of all the voting shares in the company (excluding debentures and shares that do not normally carry rights to vote at a general meeting (such as preference shares)). Clause 669(3) applies clauses 286 to 288 of the Bill, which deal with the calling of meetings, to such a request (with the necessary modifications). But as those clauses may not be in force at the time when clause 669 comes into force, clause 672 makes the same sort of adaptations in relation to the equivalent provisions of the 1985 Act. In particular, clause 672(3) alters the application of section 378(2) so that a special resolution may still be passed at a general meeting called at only 14 days' notice (normally at least 21 days' notice would have to be given of the meeting for it to be able to pass a special resolution).

CHAPTER 3: AMENDMENTS TO COMPANIES ACT 1985

Clause 674: Matters to be dealt with in directors' report

1177. This clause implements Article 10 of the Takeovers Directive. Article 10.1 and 10.2 require companies admitted to trading on a regulated market to provide in their annual reports detailed information relating to matters such as the control and share structures of the company. It is, therefore, provided by amendment to Part 7 of the 1985 Act that the information required by the Directive must be set out in the directors' report.

1178. Additionally, Article 10.3 of the Directive requires boards of companies to present an explanatory report to shareholders on the issues referred to in Article 10.1 and 10.2 at the company's annual general meeting. This clause requires this additional explanatory material to be contained in the directors' report submitted to the annual meeting of shareholders.

1179. Clause 674(5) amends section 251 of the 1985 Act on summary financial statements. It provides for the explanatory material required by Article 10.3 of the Takeovers Directive either to be included in the summary financial statement or to accompany it.

1180. Failure to include either the information concerning control and share structures or explanatory material in the annual report will attract existing criminal sanctions under section 234(5) of the 1985 Act (directors responsible for the failure to comply with provisions related to the directors' report are to be liable to a fine).

1181. Clause 674(6) provides that these new provisions will apply in relation to directors' reports for financial years beginning on or after 20 May 2006 (the date by which the Directive had to be implemented).

1182. These are general requirements designed to bring greater transparency to the market and apply to all relevant companies whether or not they are involved in a takeover. Accordingly, the requirements will apply to all companies registered in the

UK which have voting shares traded on a regulated market, whether or not that includes an official listing on the London Stock Exchange.

1183. Under Part 15 of the Bill (clause 398), the Secretary of State will in future make regulations as to the contents of the directors' report and those regulations will incorporate the provisions introduced by clause 674(2) to (4). Regulations under clauses 409 and 410 will make provision for the additional explanatory material when a summary financial statement is sent out rather than the full accounts and report.

Clause 675: Takeover offers; and Schedule 3 (amendments to Part 13A of the Companies Act 1985)

1184. The concepts of "squeeze-out" and "sell-out" are designed to address the problems of, and for, residual minority shareholders following a successful takeover bid. Squeeze-out rights enable a successful bidder to compulsorily purchase the shares of remaining minority shareholders who have not accepted the bid. Sell-out rights enable minority shareholders, in the wake of such a bid, to require the majority shareholder to purchase their shares. Because they involve the compulsory purchase or acquisition of shares against the will of the holder of the shares or the acquirer, high thresholds apply to the exercising of such rights and there are protective rules on the price that must be paid for the shares concerned.

1185. Squeeze-out and sell-out provisions have been a feature of national company law for many years. Articles 15 and 16 of the Takeovers Directive, however, introduce EU-wide rules requiring all Member States to put appropriate provisions in place for the first time.

1186. The rules laid down in the Directive in relation to squeeze-out and sell-out are broadly consistent with existing provisions under Part 13A (sections 428 to 430F) of the 1985 Act. The amended provisions will apply equally to all companies and all bids within the current ambit of Part 13A of the 1985 Act, regardless of whether or not the Directive is required to be applied to such companies and bids.

1187. The following changes are made to Part 13A in implementation of the Directive:

Calculation of Squeeze-out Threshold (new section 429(1), (1A), (2A) and (2B)) - there is a dual test imposed: in order to acquire the minority shareholder's shares, the bidder must have acquired both 90% of the shares to which the offer relates, and 90% of the voting rights carried by those shares. Where the offer relates to shares of different classes, then, in order to acquire the remaining shares in a class, the bidder must have acquired 90% of the shares of that class to which the offer relates, and 90% of the voting rights carried by those shares. Currently, in each case only the first limb of that test applies;

Calculation of Sell-out Threshold (new section 430A(1A), (1B), (1C), (2), (2A), (2B)) - mirroring the change to be made in relation to the squeeze-out threshold, a dual test is similarly imposed in relation to the sell-out threshold, so that a minority shareholder may force a bidder to acquire his shares (i) when the bidder holds 90% of the shares in the company, and 90% of the voting rights attached to those shares, or (ii) when the bidder holds 90% of the shares in the class to which the minority shareholder's shares belong, and 90% of the voting rights attached to those shares. Currently, the test is that the bidder should have acquired 90% of all shares in the company (or in the class concerned);

Revised Period During Which Squeeze-Out and Sell-Out Rights may be Exercised - the Directive provides (Articles 15.4 and 16.3) that squeeze-out and sell-out rights must be exercisable within a 3 month period following the time allowed for acceptance of the bid. Currently, Part 13A provides that squeeze-out may be exercised within a period of four months beginning with the date of the offer and must be exercised within two months of reaching the 90% threshold (section 429(4)). Accordingly, the rule provided by the Directive is substituted for the existing rule in the Companies Act. (An exception to this rule is provided where takeover bids are not subject to regulation by the Panel, for instance takeovers of most private companies. In these cases, the squeeze-out notices must be given within six months of the date of the offer if this is earlier than the period ending 3 months after the end of the offer. This is intended to prevent offerors continually extending the offer period where the transaction is not regulated by the Panel. A change is also made as regards the period during which sell-out may be exercisable so that this period is to be either three months from the end of the offer or, if later, three months from the notice given to the shareholder of his right to exercise sell-out rights (new section 430A(2C)). An extended period during which the sell-out right can be exercised where notice of such a right is only given after the end of the offer period is consistent with provisions of the Directive allowing more stringent provisions to be put in place (in this case to ensure the proper protection of minority shareholders); and

The court will no longer be able to reduce the consideration in relation to squeeze-out or sell-out following a takeover bid to below the consideration offered in the bid (which the Takeovers Directive presumes to be fair in all cases). Again utilising provisions of the Directive which allow more stringent provisions to be included to protect minority shareholders, minority shareholders will continue to be able to apply to the court to request that consideration higher than that offered in the bid be paid in exceptional circumstances (new section 430C(3A)).

1188. In most instances, it is considered that the first and second changes above will make no practical difference as the percentage of total capital carrying voting rights in a company (or class of shares) and the percentage of voting rights will normally be the same. The provisions about voting rights will not apply where the shares being squeezed out or sold out are non-voting shares.

1189. The CLR also considered the issue of squeeze-out and sell-out and the scope for improving the existing provisions in the 1985 Act. Its Final Report (chapter 13, pages 282 - 300), made a number of recommendations in relation to the reform of Part 13A. Some of these recommendations are closely related to implementation of the Takeovers Directive. For instance, the CLR questioned whether, in calculating the relevant squeeze-out and sell-out thresholds, only shares that had been unconditionally acquired should be taken into account or whether shares acquired subject to contract should also be included.

1190. In implementing the Takeovers Directive, the opportunity is being taken to adopt recommendations of the CLR, whether or not related to implementation of the Directive, except to the extent that they are not consistent with Articles 15 and 16 of the Directive or are no longer appropriate as a consequence of the Directive. The recommendations made by the CLR to be implemented by Schedule 3 are set out below:

Definition of takeover offer (section 428(3A))

1191. In order to be a takeover offer for the purposes of Part 13A, an offer to acquire shares has to be on terms which are the same in relation to all the shares to which the offer relates. One problem with the existing legislation is how to treat any variations in value between shares of the same class that are attributable to the fact that some of the shares, because they were allotted later, do not yet carry a dividend. New section 428(3A) rectifies this problem by providing that, even if the offeror offers to pay more for shares that carry a dividend than for those in the same class which do not, the offer will be treated as being made on the same terms in relation to those shares.

Definition of a takeover offer and communication of that offer (section 428(4A), (4B), (4C))

1192. To deal with issues arising from an increasingly globalised market in shares and different legislative regimes outside the EEA, it is made clear that an offer is not prevented from being a takeover offer for the purposes of Part 13A merely because there are some offerees who will be unable to accept it (for instance, where the offeree cannot accept the offer because of restrictions on the cross-border transfer of cash or securities in the country in which the offeree resides). It is also provided that an offer will be a takeover offer for the purposes of the squeeze-out and sell-out provisions if a shareholder has no registered address in the UK and the offer is not communicated to him to avoid contravening the law of another country as long as either the offer itself is published in the Gazette or a notice is published in the Gazette stating that a copy of the offer document can be obtained from a place in the EEA or on a website.

Shares that the offeror has "contracted to acquire" (sections 428(5) and 429)

1193. A number of clarificatory amendments are to be made to these provisions. In the phrase "contracted to acquire" in section 428(5), which deals with the offeror's position at the start of the bid, for the purposes of determining which shares cannot be counted towards the achievement of the 90% threshold (at which point shares may be compulsorily purchased), it is presently unclear as to whether section 428(5) covers conditional as well as unconditional contracts. It is, therefore, clarified that, in ascertaining the offeror's position at the start of the bid, the shares he has conditionally contracted to acquire (other than those subject to irrevocable undertakings (see below), as at present) should be treated as being shares already held by the offeror. This means that only shares that the offeror has either acquired or unconditionally contracted to acquire will count towards the 90% total needed to exercise squeeze-out. Consequential changes are also made to the provisions on joint offers and associates of the offeror to bring these into line with the above (sections 430D and 430E).

1194. As the 1985 Act stands, the registered holder of shares may give an irrevocable undertaking to accept a takeover bid, and if he does this for no consideration or only in exchange for a promise to make the bid, his shares are still treated for the purposes of squeeze-out as included within the offer. This is extended to include undertakings given for only negligible consideration and undertakings the effect of which is to require the registered holder to accept the offer (where the undertaking is given by a person who is not the registered holder of the shares but can contract to bind the registered holder, such as the manager of shares held by a bare nominee). ("Irrevocable undertakings" are contractual agreements entered into by a bidder usually with major shareholder(s) of a proposed target company. Such agreements aim to give the bidder certainty - he will know that support for the offer can be guaranteed from shareholders party to the contract - so that his bid has a greater prospect of success. Such undertakings would normally prevent the giver of the undertaking from selling their shares or exercising voting rights to prevent the takeover from becoming successful.)

Date of the offer (section 429(6A))

1195. The "date of the offer" is defined to mean either the date of publication, or if the offer is not published or notice of the offer is sent out earlier, the date on which the offeror first sends notice of the offer to the offerees.

Right of offeror to buy out minority shareholders: treatment of options etc (section 429(2B))

1196. Where an offeror makes an offer for all the target company's allotted shares and all or any shares subsequently allotted, it is provided that (a) in deciding whether the offeror has reached the 90% threshold for the purposes of section 429(1), the offeror need only bring into the calculation shares which are actually in issue (i.e. allotted) at the relevant time; (b) if the offeror serves notices under section 429(1) and more shares are subsequently allotted which take the percentage of acceptances then received below 90%, that will not invalidate squeeze-out notices already served; and (c) if the offeror wishes to serve further squeeze-out notices under section 429(1), he

must have at least 90% acceptances of shares (or shares in a class) then in issue and subject to the offer at the time he sends the notices out.

Consideration not exclusively in cash (section 430(3A) and (4))

1197. It is clarified that where an offer of shares, or a mixture of shares and cash, is made, and it is no longer possible when the offeror exercises his right of squeeze-out to give the consideration in shares, the offeror should pay the cash equivalent irrespective of whether the shareholders had previously been offered a choice (i.e. whether the offer was "mix and match" or not). Parallel changes are made as regards sell-out (section 430B(3A) and (4)).

Shares that the offeror has "contracted to acquire" (section 430A(1B)(b) and (2))

1198. These provisions are clarified so that, in addition to shares acquired by the offeror, shares subject to both conditional and unconditional contracts of acquisition are included in calculating whether the sell-out threshold has been reached. As a result of this change, there might be circumstances where the 90% threshold required for sell-out to be exercised was reached only because of shares which the offeror had conditionally contracted to acquire. However, if the conditions of such contracts were not fulfilled, the offeror could in fact find that he was being required to buy a minority shareholder's shares even though the offeror had not actually acquired 90% of the shares. So section 430A(3A) and (3B) provide that, if that is the case at the time when the minority shareholder exercises his right of sell-out, the offeror does not have to purchase the shares unless he has acquired or unconditionally contracted to acquire 90% or more of the shares by the time the period referred to in section 430A(2C) (the period within which shareholders can exercise sell-out rights) ends. (A corresponding change is made in section 429 by new subsections (3B) and (3C) to prevent minority shareholders in this situation who have to wait to see if they can exercise sell-out from being squeezed out in the meantime.)

Applications to the Court (section 430C)

1199. This section provides that a shareholder receiving a squeeze-out notice may make an application to the court (within six weeks of receiving the notice) seeking to overturn an offeror's intention to purchase his shares compulsorily (or the terms of that purchase). A requirement that the offeror be promptly notified of such an application is now included. As a consequence of this requirement, it is also required that the offeror is obliged, at the earliest opportunity, to notify shareholders who are being squeezed out or who are exercising their rights of sell-out, and are not party to a section 430C application, that proceedings have been initiated.

PART 25: COMPANY INVESTIGATIONS

BACKGROUND

Powers to appoint inspectors

1200. The 1985 Act gives the Secretary of State the power to appoint competent inspectors to carry out inspections, and report the result to him, in a number of circumstances. There are three categories of inspections at present:

investigations into the affairs of companies;

investigations into the membership or control of companies; and

investigations of dealings in share options by company directors and their families and failure to disclose interests in shares.

1201. Investigations by inspectors into the affairs of companies and certain other bodies corporate can be initiated under sections 431 and 432. Such inspections can be launched on the application of a company or a proportion of its members, or on the Secretary of State's own initiative, and must be carried out where the court orders it.

1202. Investigations by inspectors into the membership or control of companies are initiated under section 442. The Secretary of State can launch such an inspection on his own initiative under section 442(1), and is obliged to do so where the requisite number of members of a company apply.

1203. Inspections in the third category, under section 446, relate to suspected contraventions of certain provisions of Part 10 of the 1985 Act. The Bill repeals the relevant provisions of Part 10 (see clause 816) and section 446 is repealed in consequence.

1204. Two inspectors are generally appointed to carry out an inspection - usually a QC and a partner in one of the leading accountancy firms.

1205. Inspectors are appointed to investigate and to report the results of their investigations to the Secretary of State. At the end of an inspection, the inspectors generally have a duty to make a final report to the Secretary of State. The inspectors may also make interim reports during the course of the inspection, and the Secretary of State can direct them to do so.

1206. Unless the appointment was made on terms that any report is not for publication (section 432(2A)) interim and final reports are publishable; the Secretary

of State has discretion to publish an interim or final report under section 437(3). The availability of a published report is a crucial aspect of the inspection system.

Prepared: 26 May 2006