UK Schemes of Arrangement and US Securities Considerations
European Leveraged Finance Client Alert Series: October 2020
12 min read
In structuring a UK scheme of arrangement that involves the restructuring of existing securities and/or the offer of new securities, due consideration must be given to the relevant US securities laws and registration exemptions thereunder, since security holders who are US persons or resident in the United States may be involved or new securities offered as part of the scheme of arrangement may be distributed into the US.
The following US securities laws may be applicable in the scheme of arrangement context, and it is important to ensure that the relevant offering components are built into a transaction timeline.
Securities Act of 1933
Section 5 of the Securities Act requires offers and sales of securities in the US to be registered with the US Securities and Exchange Commission (SEC), unless an exemption is available. Preparing a US registered offering is a significant undertaking and, following a registered offering, a SEC registrant is subject to, among other obligations, SEC disclosure requirements and increased levels of potential securities law liability. Therefore a company is likely to prefer a route that does not require such a registration. In the context of a scheme of arrangement, the following exemptions from registration may apply:
Section 4(a)(2) of the Securities Act
Section 4(a)(2) exempts from registration offers and sales by an issuer that do not involve a public offering or distribution. In order to comply with Section 4(a)(2), an issuer may only offer and sell securities into the US to persons the issuer reasonably believes are accredited investors as defined in Rule 501 under the Securities Act ("accredited investors"). In addition, Regulation D under the Securities Act provides a non-exclusive "safe harbor" for the Section 4(a)(2) exemption, which permits the offer of securities to an unlimited number of accredited investors, using the Section 4(a)(2) exemption. Issuers often voluntarily enhance this requirement to require investors to be institutional accredited investors or qualified institutional buyers (as defined under Rule 144A), to limit the number of security holders without professional investment experience.
To ensure that the offer of securities as part of the scheme does not constitute a public offering, it is therefore customary that the offer in the US of scheme securities is made only to institutional accredited investors. Offers outside the US are typically made in an "offshore transaction" without "directed selling efforts" in order to comply with the safe harbour of Regulation S under the Securities Act.
If the registration exemptions above cannot be used for particular investors who are not eligible under one of the above exemptions, mechanisms to avoid unfairness to holders have been created, such as placing the scheme securities with a trustee for a holding period during which the ineligible holder may designate an eligible recipient to receive the restructured securities, and to whom the holder will have in effect sold their entitlement. If no eligible recipient is designated within the set timeframe, the trustee will sell the securities and give cash proceeds to ineligible holders.
The principal advantage of relying on Section 4(a)(2) and the relevant safe harbours is that debt securities issued under this exemption are exempt from the Trust Indenture Act (See "Other Considerations—Trust Indenture Act" below). In addition, while neither of the exemptions mentioned herein pre-empt "blue sky laws", and the company will need to conduct a "blue sky laws" survey to determine the residency of offerees to identify applicable US state exemptions, so long as the US sales are made only to accredited investors in compliance with Section 4(a)(2) this is expected not to raise any "blue sky laws" concerns.
The principal disadvantage of relying on Section 4(a)(2) and the relevant safe harbours is that the utility of this exemption depends on the composition of the creditors subject to the scheme of arrangement, i.e. accredited investors or offers made in offshore transactions. In addition, the securities offered will be "restricted securities" and may not be freely resold in the US without registration thereof or an exemption from registration.
Section 3(a)(10) of the Securities Act
Section 3(a)(10) provides an exemption from registration based on a court or a government agency's approval of the fairness of the offering. The SEC, in no-action letters and in guidance on this topic, has clearly stated its view that the term "any court" in Section 3(a)(10) may include a foreign court (such as the English High Court considering a scheme of arrangement), provided all relevant requirements that apply to exchanges as approved by US courts, as set out below, are met:
- the securities must be issued in exchange for securities, claims or property interests and cannot be offered for cash;
- a court or authorised governmental entity must approve the fairness of the terms and conditions of the exchange;
- the reviewing court must find, before approving the transaction, that the terms and conditions of the exchange are fair and be advised before the hearing that the issuer will rely on the 3(a)(10) exemption; and
- the court or authorised governmental entity must hold a hearing before approving the fairness of the terms and condition of the transaction, which must be open to everyone to whom securities would be issued in the proposed exchange; adequate notice of the hearing must be given to all those persons, and there cannot be any improper impediments to the appearance by those persons at the hearing.
Schemes can typically be structured to meet these requirements.
Securities issued in reliance on Section 3(a)(10) are generally not considered "restricted securities" and are not subject to US. resale limitations, unless the recipient is an "affiliate" of the issuer (or was one within the prior 90 days).
The principal disadvantage of this exemption is that the securities may not be offered for cash and debt securities issued under this exemption are not exempt from the Trust Indenture Act. In addition, the securities will be subject to blue sky laws.
Rule 802 of the Securities Act
Rule 802 under the Securities Act provides an exemption from the registration requirements of the Securities Act for certain cross-border exchange offers and business combinations by foreign private issuers involving the issuance of securities. The exemption is available if (i) the issuer is a foreign private issuer and is not an investment company; (ii) US holders hold no more than 10% of the securities to be exchanged; and (iii) the issuer permits US holders to participate in the offering on terms at least as favourable as those offered to other security holders. An issuer is presumed to be a foreign private issuer and US holders are presumed to hold less than 10% of the outstanding securities unless:
- the average daily trading volume of the securities in the US for a recent twelve-month period ending on a date no more than 60 days before the public announcement of the tender offer exceeds 10 percent of the average daily trading volume of that class of securities on a worldwide basis for the same period; or
- the most recent annual report or annual information filed or submitted by the issuer with securities regulators (in any jurisdiction) indicates that US holders hold more than 10 percent of the outstanding subject class of securities; or
- the issuer knows or has reason to know, before the public announcement of the offer, that the level of US ownership exceeds 10 percent of such securities.
Rule 802 is an attractive option since the debt securities issued under this exemption will be exempt from the Trust Indenture Act. The principal disadvantage of this exemption is that the information sent to investors must be submitted to (but not registered with) the SEC and the securities issued in reliance on Rule 802 will be "restricted securities" and may not be freely resold in the US without registration or exemption from registration. In addition, the securities will be subject to blue sky laws.
Non-exclusive nature of exemptions
Neither Sections 4(a)(2), 3(a)(10) nor Rule 802 act as an exclusive exemption; an issuer making an offer or sale of securities in reliance on one of these exemptions or safe harbours may also rely on any other applicable exemption from the registration requirements of the Securities Act. As detailed above, each exemption has different requirements, advantages and disadvantages, depending on the specific circumstances of the proposed securities offering and the companies have the ability to choose the most suitable combination.
In a number of recent schemes of arrangement that involved securities, a combination of Sections 4(a)(2) and 3(a)(10) were used, indicating that issuers continue to value the pre-emption of state securities laws, the exemption from the Trust Indenture Act (in case of debt securities) and the exemption from the SEC filing requirements.
Other US Securities Law Considerations
An offer to all, or a substantial majority of, security holders which results in an offer for, or exchange of, existing securities, may potentially constitute a tender offer under US securities laws. The term "tender offer" is not defined under US securities laws, but a scheme of arrangement which results in the transfer or purchase of securities may potentially contain several of the features of transactions that the SEC has considered to qualify as a tender offer. Rule 14e-1 under the Exchange Act makes it unlawful for any person who makes a tender offer to: (i) hold the offer open for less than 20 business days; (ii) make certain material changes to the offer without extending the offer period for an additional 10 business days; (iii) fail to pay the consideration offered or return the securities deposited; or (iv) extend the length of a tender offer without sending a notice. As such, adequate time should be allotted for the offer to be held open.
12(g) under the Securities Exchange Act of 1934
Section 12(g) of the Exchange Act requires that a foreign private issuer register any "class" of "equity securities" with the SEC if: (i) it has total assets exceeding $10 million and (ii) such class of equity securities is "held of record" by 2,000 or more persons (US or non-US) globally or 500 or more non-Accredited Investors (US or non-US) globally. As such, in schemes where equity is being offered or transferred, attention should be given to the number of holders.
Trust Indenture Act
It should be kept in mind that an indenture for debt securities must be qualified under Section 305 of the Trust Indenture Act or must meet the requirements for an exemption from qualification under Section 304 of the Trust Indenture Act. Section 304 of the Trust Indenture Act provides an exemption for debt securities issued pursuant to the registration exemption of Section 4(a)(2) under the Securities Act. However, Section 304 of the Trust Indenture Act does not provide an exemption for debt securities issued pursuant to the exemption available under Section 3(a)(10) of the Securities Act (and therefore an application for qualification under the Trust Indenture Act must be filed and approved by the Securities Exchange Commission if relying on the exemption available under Section 3(a)(10) of the Securities Act).
The Trust Indenture Act applies only to debt securities, so the Trust Indenture Act will not be relevant if a scheme entitles the scheme creditors to equity securities only.
The content of an explanatory statement in respect of a scheme whereby the scheme creditors will be entitled to securities in the scheme proposals will be deemed to have been made by the issuer, so the issuer, and potentially any officer of the issuer, will be subject to potential liability under Rule 10b-5. Among other provisions, Rule 10b-5 provides that it is unlawful in connection with the sale of any security "to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading". As such, care should be taken that the explanatory statement contains sufficient detail, in an accurate manner, to allow scheme creditors to make an informed decision on the securities offered in the scheme proposals.
Blue Sky laws
While the SEC regulates and enforces the federal securities laws, each state has its own securities regulator who enforces what are known as "blue sky" laws. If a company is offering securities, it must comply with both federal regulations and state securities laws and regulations in the states where securities are offered and sold (typically, the states where offerees and investors are based). None of the exemptions discussed here pre-empt blue sky laws so the issuer will need to conduct a blue sky survey to determine the residency of the investors and to identify applicable state exemptions. Although securities offered and sold in private offering pursuant to Section 4(a)(2) do not pre-empt blue sky laws, as long as the US sales are made only to accredited investors in accordance with Section 4(a)(2) this is not expected to raise "blue sky laws" concerns.
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