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Change to Pre-emption Guidelines urgently required

British investors take their pre-emption rights very seriously – and rightly so. However, the trickle of UK companies trampling over these precious rights is threatening to become a flood as “cash-box” placings become ubiquitous.

Cash-box placings channel capital raised through an offshore companies (generally located in Jersey or Guernsey). The underwriters subscribe for redeemable preference shares in the offshore company rather than paying the funds raised directly to the issuer. These redeemable preference shares are then transferred to the issuer, which claims the capital raised by redeeming the shares.

As this involves the exchange of ordinary shares for preference shares, rather than for cash, such placings also qualify for merger relief under the UK Companies Act 2006 and therefore most of the capital raised is transferred to “other reserves”, a distributable reserve which can be used to pay dividends if the funds are suddenly no longer required. The capital raised from a traditional placing is entered into the share premium account, and is not distributable.

Cash box placings originally evolved out of the “vendor placing” structure – a structure involving a placing to fund an acquisition, in which the shares are also treated as being offered for non-cash consideration and therefore exempt from pre-emption rights. Vendor placings have historically been accepted by institutions, provided they did not exceed 10% of share capital. As the size of the issue is less than 10% and is limited to institutional investors, no prospectus is required – thereby reducing the timetable for the fundraising.

Under the UK Companies Act, shareholder approval is required for any dis-application of pre-emption rights by way of a special resolution (requiring 75% approval). This provision only applies to issues of shares for cash, and thus any non-cash issues are exempted from the provision – although these fall within the remit of the more general authority to issue shares.

Institutional investor guidelines recommend a 5% limit on the dis-application of pre-emption rights (with a stance requiring detailed explanations of higher requests), while for the more general issue of shares the recommended limit is 33% of the issued share capital (rising to 66% in the event of a rights issue).

In recent times however, issuers have driven a horse and carriage through the guidelines as the popularity of “cash-box” placings continues to grow. Today sees yet another company announce a placing in excess of the limit on the dis-application of pre-emption rights approved by its shareholders at its prior AGM. This announcement, by Liberty International, noted that the placing was for 9.9% of the current issued share capital. There will be no shareholder approval sought for the placing due to the “cash-box” structure of the placing. Incidentally, the dis-application resolution request scraped by at Liberty Internationals AGM with the requisite majority of 75% only barely achieved.

The counter-argument notes that most European companies allow for higher levels of dis-application of pre-emption rights – and yes indeed this is true. However it should be borne in mind that many of the legal provisions in other markets regarding dis-application pre-emption rights are drafted differently, such as issues for non-cash as well as cash covered under the provisions in some other markets.

The Association of British Insurers (ABI) sent a letter to company chairmen on the issue in February 2009, expressing concern that “this device is being used in a way that circumvents both the statutory requirements to observe pre-emption rights and the ability of shareholders in general meeting to decide on the extent to which pre-emption rights may be dis-applied”. The ABI letter noted that its Investment Committee would “hold boards to account for such breaches” and emphasised that it was “anxious that the pre-emption principle not be eroded through abuse of cash-box issues”.

However the letter has not proved sufficient – if anything it appears to the use of such devices have increased since February. Urgent action on the matter should be taken by The Pre-emption Group in order to protect shareholders’ interests to bring such “cash-box” placings within the remit of the Pre-emption Guidelines.

Companies Utilising Cash-box Placings
Costain Group Logica Drax Group Henderson Group
Misys Autonomy HBOS G4S
Liberty International Peter Hambro Mining Reed Elsevier Bovis Homes
Tullow Oil BAE Systems Dimension Data

Note 1: This is not an exhaustive list. If you are aware of companies that should be added please contact us.

Note 2: Cash-box structures may also be used for pre-emptive issues, to take advantage of the more flexible treatment of the capital raised. Examples of such cases include: Royal Bank of Scotland, Lloyds TSB, Centrica, Standard Chartered, Xstrata and British Land.


ABI Letter to Chairmen >>

The Pre-emption Group >>

Companies Act 1985, provisions regarding pre-emption rights >>

What do you think?