Initial Public Offerings Flashcards
What are Shareholders’ Primary Apprehensions when new Shares are issued?
- Dilution.
-
Directors’ ulterior motives, e.g:
- Unjust enrichment;
- Maintenance or increase of power;
- Transfer of wealth to other investors;
- Unfair prejudice against minority shareholders;
- Distortion of market accountability mechanisms (à la ‘friendly shareholders’ and takeover bids);
Textbook – P. 128.
What are the Two Forms of Dilution?
- Value Dilution: Diminishment of current holdings’ real value and claims to company capital.
- Voting Dilution: Diminishment of voting strength.
Textbook – P. 128.
Is it Acceptable for Directors to propose Issuing Shares at a price below Market (Trading) Value?
Yes, insofar as the discount is pursuant to ensuring the Issuance’s success and is otherwise in line with DDs.
Shearer v Bercain [1980] 3 All ER 295; Howard Smith v Ampol Petroleum [1974] AC 821.
Ferran and Ho state that up to 40% discounts to par value have been observed and permitted in the UK.
What are the Benefits of placing Share Issuance largely under Directoral Discretion?
- Larger pools of investors decrease the cost of equity finance.
- Less bureaucracy increases equity financing’s efficiency and speed, which is especially important in a pinch.
Textook – P. 133.
What are the means by which Shareholders are shielded against either Dilution or Directors’ Ulterior Motives?
- DDs.
- Pre-emption rights.
- Minority shareholder rights.
- Requisite shareholder authorization.
How do Directors’ Duties protect Shareholders’ Interests?
They align shareholders’ interests with Directors’ interests, theoretically therefore decreasing the likelihood of diultion.
Companies Act 2006 – Chapter 2.
To what extent do Directors’ Duties assuage Shareholders’ Apprehensions?
Moderatly. Although they work to guard against the threat of ulterior motives,* given that it is acceptable to issue at below market value, they are largely ineffective against diultion.
Textbook – P. 130; *Howard Smith v Ampol Petroleum [1974] UKPC 3
Regarding Issuance and Ulterior Motives, how is it Determined whether the Board has Transgressed its Duties?
The Proper Purpose Test, namely whether the dominant and primary purpose of the Issuance was compliant or transgressive.
Textbook – P. 130; Hirsche v Sims [1894] AC 654; Eclairs Group v JKX Oil & Gas [2015] UKSC 71.
Therefore, if an incidental, albeit desired, effect of an Issuance is to, for example, block a takeover bid, it will not result in a transgression of DDs.
What is the Consequence of Issuing Shares pursuant to an Ulterior Motive?
The Issuance will be voidable,* and the Directors will be in breach of their duties.**
Textbook – P. 130; *Hunter v Senate Support Services [2004] EWHC 1085 (Ch) and Hogg v Cramphorn [1967] Ch 254; **Howard Smith v Ampol Petroleum [1974] AC 821.
What is the Effect of Minority Shareholders’ Rights?
Shareholders may have a claim against the firm if they can demonstrate that their rights have been adversely affected by an Issuance.
Textbook – P. 131.
Regarding Minority Shareholders’ Rights, what are the Lessons to be learned from the Precedent in Mutual Life Insurance?
- No shareholder has an absolute right to expect their interest to remain constant forever.
- Either the shares themselves or the rights attaching thereto must be affected; mere enjoyment is insufficient.
- Good faith and commercial sensibility will prevent a claim from biting.
Textbook – P. 131; Mutual Life Insurance v The Rank Organisation [1985] BCLC 11.
The First Lesson contrasts with CJEU precedent, which states that shareholders’ right to retention of a proportionate share in the company’s capital is an inherent right, and that in cases of non-cash consideration, it is open for Member-States to provide for Preemption.* Following the case, it has become very common to exclude overseas shareholders from rights issues.
*Case C-42/95 Siemens AG v Henry Nold [1996] ECR I-6017.
Do the Procedures on the Variation of Rights apply to an Issuance which seeks to Allot Shares Ranking Alongside, or indeed Ahead of, an existing Class of Shares?
No. Even though the commercial effect is a reduction of value, neither the shares themselves or the rights attaching thereto are affected by such an Allotment.
Textbook – P. 131; White v Bristol Aeroplane [1953] 2 WLR 144.
In practice, this issue may be resolved by having the Articles of Association state that such an Allotment would be treated as a Variation, namely of the existing shareholders’ rights, and thus requiring approval under the procedures laid out in §630-§631.
Is an Unfair Prejudice (§994) claim a meaningful alternative to a Minority Shareholders’ Rights claim?
No. It is at best an exit strategy, and difficult to execute at that, given its high threshold.
Textbook – P. 132; Companies Act 2006 – 994; Re BSB Holdings (No 2) [1996] 1 BCLC 155; Re Sunrise Radio [2009] EWHC 2893; Re Unisoft Group (No. 3) [1994] 1 BCLC 609; Re Coroin [2013] EWCA Civ 781.
In Sunrise, the Court found in favor of the claimants because the Board knew, or could foresee, that the shareholders either could not or were not inclined to subscribe and did not give the share price proper consideration in light of this knowledge.
Regarding §994, what are the Lessons to be Learned from Sunrise Radio?
- The notion of unfair prejudice is to be applied flexibly to meet the circumstances of the particular case.
- Where the Board knows or can foresee that a minority does not or may not have the funds or inclination to subscribe, it should factor that information into its pricing.
- Shares should not unthinkingly be priced at par, especially if that would create a large discrepancy between value and price.
- Failure to give proper consideration to price is a breach of fiduciary duty.
Re Sunrise Radio [2009] EWHC 2893.
To what extent does Requisite Shareholder Authorization assuage Shareholders’ Apprehensions?
Context-dependent. The Articles can circumvent the need for ordinary resolution, and in private companies with only one class of shares, the Board can outright issue unless the Articles so prohibit.
Textbook – P. 134; Companies Act 2006 – §549-§551.
What is the Consequence of Issuing Shares without due Authorization from Shareholders?
The Issuance is not voided or voidable, but the Directors face criminal liability if they were knowingly involved.
Textbook – P. 134; Companies Act 2006 – §549.
What are Preemption Rights?
Incumbent Shareholders’ right to first be offered a sum of the Allotment in nominal proportion to their existing holdings before Issuance, and on the same or more favorable terms thereof.
Companies Act – §561.
Under §561(4)(a), Treasury Shares are disregarded for these purposes. Proportionality is tempered by considerations of practicality, but in most cases, that should present no issues.
Do Pre-emption Rights apply in all Issuances or Allotments of Equity Securities?
Yes, save for four exceptions, namely:
- Bonus shares (§564);
- Non-cash issues (§565);
- Employee share schemes (§566).
- Compromises or Arrangements sanctioned in accordance with Part 26A, i.e. companies in financial difficulty (§566A).
CA 2006.
Under §560(1), an ‘Equity Security’ is an ordinary share or the rights to subscribe for, or to convert a security into, an ordinary share.
For how long does an Offer made pursuant to Preemption stand?
At least 14 days, commencing from send date. Such an offer may be made either on paper or electronically.
CA 2006 – §562.
In Practice, how can Pre-emption Rights be circumvented?
Pursuant to §565, if the proposed Issuance is supported by any non-cash consideration, pre-emption rights may be disapplied.
Textbook – P. 137; Companies Act 2006 – §565.
Vendor Placings and Cashbox Structures are two means of achieving this effect.
What constitutes Cash and Non-Cash Consideration?
The following constitute Cash Consideration:
- Cash;
- Cheque received in good faith, i.e. no suspicion it will bounce;
- Release of a company’s liability for a liquidated sum;
- Undertaking to pay cash at a future date, i.e. deferred consideration; or
- Payment by any other means giving rise to a present or future entitlement to a payment, or credit equivalent, in cash.
Therefore, anything else is non-cash consideration.
CA 2006 – §583(3)
Can Preemption Rights be Disapplied?
Yes, either through the Articles of Association or by special resolution. Disapplication may also entail a modified application of Preemption Rights.
Textbook – P. 139; CA 2006 – §569-§571 pursuant to §551.
If disapplication is effected by means of resolution, it ceases to be effective once the §551 authorization to which it relates is revoked or expires (absent renewal). Special resolution majority is 75% under §283.
Can Preemption Rights be Excluded?
In a private company, yes, through a provision in the Articles.* In a public company, not really, because an alternative to the statutory scheme must be incorporated into the Articles.**
Textbook – P. 139; CA 2006 – *§567-**§568.
In either case, therefore, positive steps must be taken to opt out of the regime. This is appropriate given Pre-emption Rights’ importance as a shareholder safeguard.
Why do Companies elect to Disapply Preemption Rights?
- Efficiency. Although they protect shareholders, they increase the cost of funds for firms.
- To escape the statutory regime and opt for the Listing Rules regime.
Ferran and Ho – P. 120.
Listing Rules, particularly LR 9, only apply to premium-listed companies.
What are the Advantages of the Listing Rules Regime over the Statutory Regime?
- Shorter minimum offering period, i.e. ten business days for the date on which the offer is first open for acceptance.
- Enables the sale of fractional shares for the firm’s benefit.
- Enables the notification of overseas shareholders as the firm sees fit.
- Allows use of Open Offers in lieu of Rights Issues.
Ferran and Ho – P. 121-125. FCA Listing Rules – 9.3.11-9.3.12, 9.5.1-9.511.
To whom do Preemption Rights not apply to begin with?
The Holders of:
- Warrants;
- Convertible debt securities; or
- Non-voting (participating) preference shares.
Ferran and Ho – P. 117.
According to the authors, this is because otherwise would not be compatible with the Second Company Law Directive: European Commission v Spain [2008] ECR I-10139.
Are Preemption Rights are Reliable Safeguard against Dilution?
Context-dependent. Shareholders may not possess the necessary finances to maintain their proportion, and if the company is private, the necessary liquidity to facilitate the trade of shares may be absent.
What is a Letter of Allotment?
A letter which permits the transference of preemption rights from a willing shareholder to a third-party, typically because the former cannot afford to exercise said rights while the latter can.
CA 2006 – §561(2).
“The Companies Act does not require offers to be made in the form of renounceable letters of allotment. In this respect, therefore, statutory protection is less than comprehensive.”
Ferran and Ho – P. 116.
Must Offers pursuant to Preemption be made in the Form of Renouceable Letters of Alltoment?
Not under the Companies Act, but under the FCA Listing Rules, in the case of a Rights Issue, shareholders must be made a Preemption Offer in such a form.
Ferran and Ho – P. 116.
A Rights Issue is, “an offer of new shares or other securities made to existing shareholders in proportion to their shareholdings.”
Thomson Reuters, Rights Issue.
How does a Renouceable Letter of Allotment aid Shareholders relative to a Preemption Offer?
Shareholders, using their Renounceable Letters of Allotment (or other (or other negotiable document, e.g. Provisional Allotment Letter) can sell their right purchase the shares in the market nil paid.
Thomson Reuters, Nil Paid Rights.
What is the Consequence for Failure to Comply with the laws on Preemption Rights?
The firm, and any officer who knowingly authorized or permitted the contravention, will be held jointly and severally liable to compensate entitled parties for any resultant loss, damage, costs, or expenses.
CA 2006 – §563.
An entitled party is whomever was owed a Preemption Offer but was never made one. A two-year cut-off applies to claims under §563.
Does a Failure to Comply with Preemption Laws Invalidate the relevant shares?
No. However, the Court can exercise its §125 power, “to rectify the Register of Members by removing the names of persons to whom shares have been wrongly allotted.”*
Ferran and Ho – P. 116; *Re Thundercrest [1995] BCLC 117.
Critically, Thundercrest concerned a small private company and a wrongful allotment of shares by the Board to itself. Wrongfulness was a result of an illegaly short minimum offering period and actual knowledge of the Board that the entitled party did not receive the offer letter. The Court believed that not using §125 would have enabled the Directors to profit from their own wrongdoing.
Under the Companies Act, if Proper Procedure is observed, do Peemption Rights guard Shareholders against Dilution?
No. Passive and non-responsive shareholders increase the risk of wealth erosion and dilution for active shareholders.
Ferran and Ho – P. 117.
Henceforth, this shall be termed the Lazy Shareholder Problem.
How does the FCA Listing Rules address the Lazy Shareholder Problem?
Shares that would have otherwise gone to Lazy Shareholders must be offered publicly, and any premium obtained thereupon (expenses netted) must be returned to their would-be Holders.
FCA Listing Rules – 9.5.4.
That is, unless the proceeds do not exceed £5, in which case they may be ratined by the firm.
According the Preemption Group, what are some of the Factors that Investors consider when presented with a Preemption Disapplication Resolution?
- Dilution of value and voting power.
- Soundness of the firm’s reasoning for doing so.
- Firm’s size, sector, and stage of development.
- Firm’s stewardship, governance, and performance.
- Availability of alternative means of finance, and the necessity of disapplication in their light.
- Contingency plans.
- Ex ante management of shareholder relations.
Preemption Group – Disapplying Preemption Rights, a Statement of Principles (2015) [7].
What are the Advantages of Going Public?
- Broader investors pool from which to raise equity, thereby decreasing the cost of equity capital.
- Circumvention of financial limitations or disinclinations of existing shareholders.
- Exit route for existing shareholders.
- Decreased dependence on debt and retained earnings.
- Increase share liquidity and value, given the transferability requisites that come with listing.*
- Use the firm’s shares as consideration, e.g. share-for-share transactions.
- Benchmark metric for share value and company performance, thereby facilitating pay-for-performance or other metric-based tools.
- Corporate governance improvements, whether due to market pressures or the onboarding of new key managers.
- Higher prestige, whether through the ‘Plc.’ mantle or greater publicity.
- Decreased cost of debt capital (for the all reasons above).
Textbook – P. 487-492; *FCA Listing Rules – 2.2.4.
