S G Warburg Group plc (Warburgs) plans an innovative group reorganisation following the sale of its investment banking business to Swiss Bank Corporation (SBC) which is expected to complete at the end of June.
It proposes a scheme of arrangement pursuant to which its subsidiary, Mercury Asset Management (MAM), will buy Warburgs. Warburgs shareholders will receive shares in MAM and cash (or loan notes) representing their share of the proceeds of sale of the investment banking business.
Following the sale, the ownership structure of MAM will be cumbersome. Warburgs owns 75 per cent. of MAM and a variety of minority shareholders own the remaining 25 per cent. Warburgs' only other significant asset will be the proceeds from the sale of the investment banking business - some £860 million.
It is therefore commercially desirable to collapse the group structure and give shareholders a direct stake in MAM (and their share of the sale proceeds). There are a number of possible ways to achieve this goal, the paramount consideration being to minimise the risk of the MAM shares and/or cash proceeds being treated as a distribution to Warburgs shareholders. The consequences of this would be that Warburgs would be liable to pay ACT on the distribution and its shareholders would be treated as receiving income.
The main other options that could have been considered were a demerger of the investment banking business and MAM either using the dividend method or a scheme under section 110 of the Insolvency Act 1986.
Dividend method. Using this structure, Warburgs could have paid a dividend in specie to its shareholders comprising shares in MAM (or in a newly formed company to which MAM would have been transferred - a so-called three cornered demerger). SBC could then have bid for the remainder of Warburgs' business.
Distributions to effect a demerger are treated as exempt distributions (section 213(3), Income and Corporation Taxes Act 1988) and thus avoid the tax consequences outlined above. But a number of criteria need to be satisfied, one of which is that the demerger must not be part of a scheme the main purpose, or one of the main purposes, of which is the sale of a business carried on by the distributing company to a third party. As this is a key element of the transaction it is unlikely that Warburgs could have obtained the necessary tax treatment to make the dividend method attractive.
Section 110 scheme. Broadly, a section 110 scheme
involves the liquidation of a parent company (Warburgs) and the
transfer of its assets (including MAM and its investment banking
business) to two or more newly formed companies. The consideration
each new company gives in exchange for the transfer of the assets
is the issue of shares in the new companies which the liquidator
distributes, under section 110 of the Insolvency Act 1986, to
shareholders of the liquidated company in satisfaction of their
rights on the winding up of the parent company. The parent company
then dissolved leaving two separate companies each holding
part of the assets of the old company.
The main advantages of a section 110 scheme are that there are reliefs from corporation tax on any gain on the disposal of the parent company's assets to the new companies and the distribution by the liquidator of shares in the two new companies to the parent company shareholders is not treated as income in the hands of shareholders because a distribution in a liquidation is not a distribution for tax purposes.
But there are also a number of factors which make a section 110 demerger unattractive, some or all of which are likely to have been relevant in Warburgs' case. It is a complex and lengthy process; the voluntary liquidation of the parent company may trigger default clauses in financing and other documents; and significantly in the case of a listed company, the liquidator is required to buy out any dissenting shareholders.
The main features of the Warburgs scheme are:
* The issue of new MAM shares to Warburgs shareholders.
* A cash payment (or loan notes) representing part of the sale proceeds of the investment banking business to Warburgs shareholders. The obligation to make this payment will be satisfied by MAM exercising a put option on SBC to purchase Warburgs on completion of the scheme. The proceeds of sale of the investment banking business will then effectively be held directly by MAM.
* Cancellation of the existing Warburgs ordinary and convertible deferred shares and the issue of new Warburgs ordinary shares to MAM. Cancellation of the shares is preferable to transfer mainly to avoid a stamp duty charge.
* Conversion of the MAM shares held by Warburgs into deferred shares which will then be bought back by MAM and cancelled.
The scheme must be approved by Warburgs' ordinary and convertible deferred shareholders at meetings convened at the direction of the court (section 425, Companies Act 1985). At these meetings, the scheme must be approved by a majority in number representing three quarters in value of the members voting.
A section 425 scheme does not do away with other regulatory requirements. Shareholder approval at extraordinary general meetings of Warburgs and MAM will therefore be required for a number of matters including, for example, authority to allot new shares, disapplication of pre-emption rights, reduction of capital and approval of a Super Class 1 transaction.
As part of the agreement between MAM and Warburgs relating to the scheme, minority shareholders in MAM will receive a special dividend of approximately £18 million. The reason given for the payment is to reflect the change in the nature of their relationship with the controlling shareholder, but presumably it will also encourage them to vote in favour of the transaction!
After the scheme has been approved by members it must be sanctioned by the court, following which a copy of the court order must be filed with the Registrar of Companies. The scheme will then become effective and binding on all members.
A company cannot be a member of a company which is its holding company (section 23, Companies Act 1985). No Warburgs shares can therefore be issued to MAM whilst Warburgs holds a 75 per cent. interest in MAM. The scheme therefore provides for MAM to issue new shares to Warburgs shareholders, diluting Warburgs holding in MAM from 75 per cent. to around 40 per cent. before shares in Warburgs are issued to MAM.
At first glance it may appear that the payment of the proceeds of the sale of the investment banking business to Warburgs shareholders could constitute financial assistance for the acquisition of its own shares contrary to section 151 of the Companies Act 1985. But section 151 does not prohibit anything done in pursuance of an order of the court under a section 425 scheme of arrangement (section 153(3)(e)). It could also be argued that the payment does not constitute a gift but compensation to the shareholders for giving up legal rights.
Because the scheme is structured as a takeover, Warburgs shareholders will be treated as receiving capital rather than income.
Subject to an appropriate Inland Revenue clearance being granted, shareholders will not be treated as having made a disposal for capital gains tax purposes to the extent that they receive either new MAM shares and/or loan notes (roll-over relief).CJM.
* The principal legal advisers on the transaction were Slaughter and May (S.G. Warburg Group PLC), Clifford Chance (Swiss Bank Corporation), Herbert Smith (Lazard Brothers, financial advisers to MAM) and Allen & Overy (Mercury Asset Management).