Corporate Law Update
- Takeover Panel consults on intention statements
- Court finds payments were salary, not unlawful dividends
The Takeover Panel (the “Panel”) has published a consultation paper (PCP 2017/2), in which it is proposing to make various changes to the City Code on Takeovers and Mergers (the “Code”) relating to statements of intention. We have set out the key proposed changes below.
The Panel has requested responses by 31 October 2017.
Specific statements of intention
Under the Code, if an offeror notifies a target that it has formed a firm intention to make an offer, it must make a public announcement (called a “Rule 2.7 announcement”). It then has 28 days to post an offer document to the target’s shareholders setting out the offer terms.
The offer document must state various things, including the offeror’s intentions and strategic plans for the target’s future business, employees and pension schemes. The Panel expects these intention statements to be specific, not generic, in nature.
However, often an offeror will simply state that it intends to undertake a review of the target’s business once it obtains control, without giving specifics. This may happen if the offeror is unable to conduct due diligence and cannot state any specific intentions, something the Panel has previously acknowledged.
Nonetheless, the Panel remains concerned about the continuing “generic” nature of intention statements. To combat this, it is proposing to extend the requirement on offerors to state their intentions so as to cover further, specified matters. An offeror would be required to state:
- its intentions for the target’s research and development (R&D) functions;
- its intentions to make any material change in the balance of the skills or functions of the target’s employees and management; and
- any likely repercussions of its strategic plans on the location of the target’s HQ and HQ functions.
Timing of intention statements
Once an offer document is posted, the target’s board has 14 days to send its shareholders a circular setting out its views on the offeror’s plans. It must also make a copy of the Rule 2.7 announcement available to its employee representatives and pension scheme trustees. This is to allow them to communicate their opinion on the offer to the target’s shareholders as part of the circular.
If a target receives its employee reps’ or pension trustees’ opinion after it sends out its circular, it must instead publish their opinion on its website and via a regulatory information service (RIS).
An offeror’s statement of intentions is important to employee reps and pension trustees when forming their opinion. However, an offeror need only state its intentions in its offer document, not in its Rule 2.7 announcement. Where an offer is recommended by a target’s board, the offer document and circular are often combined and sent to shareholders at the same time.
The effect of all this is that an offeror’s intentions may not become known until target shareholders have already received the target board’s view. The Panel is concerned this may be depriving employee reps and pension trustees of the opportunity to assess an offeror’s intention and circulate their opinion effectively to target shareholders. Although it would be published on the target’s website, the Panel recognises this is likely to be less effective than communicating directly to shareholders.
To address this, the Panel is proposing to amend the notes to Rule 2.7 of the Code to require an offeror to state its intentions when it publishes its Rule 2.7 announcement. This would be in addition to stating its intentions (again) in its offer document and would cover the same items.
Publishing the offer document
Currently, an offeror must publish its offer document within 28 days of its Rule 2.7 announcement, but there is no minimum “wait” period. It can (and will often want to) publish it immediately afterwards.
The Panel believes it may be desirable for a target’s board to have more time to formulate its views on an offer. It is therefore proposing to amend the Code to require an offeror not to publish its offer document for 14 days from its Rule 2.7 announcement unless the target board consents.
Together with the change to the notes to Rule 2.7, this would have the knock-on effect of giving employee reps and pension scheme trustees significantly more time to digest an offeror’s intentions and form their own opinion on the offer (at least on a non-recommended offer).
Other proposed changes
- Where an offeror or target makes a binding commitment to a course of action following the end of an offer period (a “post-offer undertaking” or “POU”), it must provide periodic written reports to the Panel on how it is complying with the POU. The Panel can require it to make that report public. The Panel is proposing to amend the Code to require automatic publication of these reports, and to require annual reports in the case of longer-term POUs.
- Where an offeror or target makes a mere statement of intention as to a course of action following the end of an offer period (a “post-offer intention statement” or “POIS”), it must consult the Panel before it deviates from that statement. The Panel is proposing to amend the Code to require a party to confirm in writing to the Panel, within 12 months of the end of an offer period, whether it has complied with its POIS and to publish that confirmation via an RIS.
In Global Corporate Limited v Hale , the High Court found that a company that had attempted to pay dividends despite having no distributable profits had effectively instead been making payments of the directors’ salary. The monies could not, therefore, be recovered as unlawful dividends.
Mr Hale and his colleague, Mr Benton, incorporated a company – Powerstation UK Limited (“PUK”) – in November 2004 to carry on their vehicle performance tuning business.
PUK’s accountants had advised that, to minimise the amount of tax payable, PUK should pay each of them £456 per month as salary (the minimum required to ensure their National Insurance contributions were paid) and any excess as dividends. Each individual received monthly payments on this basis.
A company may only pay dividends out of its distributable profits, which must be justified by its latest annual accounts. If a company has distributable profits but its annual accounts do not reflect this, it can draw up “interim accounts” instead. However, if a company has no distributable profits, it cannot pay a dividend. If it tries to do so without having distributable profits, the dividend is “unlawful”, and the recipient must pay it back if he had reasonable grounds for believing it was unlawful.
At the end of each financial year, PUK’s accountants reviewed its accounts to check its distributable profits and see to what extent payments could be characterised as dividends. However, they had not seen its latest accounts for the year ended 30 April 2014, which showed a cumulative loss of £7,794.
Despite this negative balance, from June 2014 to October 2015 PUK proceeded to approve and pay “dividends” totalling £23,511. It did not justify these “dividends” by reference to any set of accounts.
Following financial difficulties, PUK was put into liquidation in November 2015. A claim was later brought alleging that the amounts paid were unlawful dividends and that they should be repaid.
What did the court say?
The court decided that Mr Hale, as a director of the company, when approving the payments, could not have been formally deciding to pay dividends. At most, he could possibly have been approving “provisional dividends”, which were capable of being “undeclared” and re-characterised as salary payments later once PUK’s accountants had assessed the position regarding its distributable profits.
However, the course of advice and decisions over PUK’s history showed that Mr Hale knew that dividends could only be paid out of reserves, that this was why PUK’s accountants reviewed its accounts at the end of each year, and that, when the payments in question were made, Mr Hale could not have known whether PUK had distributable profits.
For these reasons, the judge felt that Mr Hale had not been making any decision at all when the payments were made as to whether they would be dividends or salary payments. He therefore said the payments were not unlawful dividends, but rather payments of Mr Hale’s and Mr Benton’s salary.
The case revolves around specific facts, but taking a low salary and extracting value through dividends is a mechanism frequently employed by small businesses. However, the case asks broader questions about declaring and paying dividends.
For example, from the facts of the case, it looks like Mr Hale believed he was paying dividends: dividend certificates were issued for the payments, and Mr Hale had signed tax dividend forms in relation to them. The judgment does not mention whether board or shareholder meetings were held to declare or approve the payment of dividends, but, if they were, one might expect that the payments would clearly constitute dividends (and, given PUK’s accumulated losses, unlawful dividends).
In addition, the judge’s comments about the dividends being made “provisionally” and subsequently “undeclared” are problematic. In the end, he found this suggestion problematic, because there was no power in PUK’s constitution to allow its shareholders to “undeclare” dividends. However, it is not clear from the facts whether the dividends were paid as “final dividends” approved by the shareholders, or (as is more likely, given they were paid monthly) as “interim dividends” paid by the directors.
The essence of an interim dividend is that it is not enforceable by the shareholders until it is actually paid, which is a legal way of ensuring that, until paid, the directors have the power to revoke (or “undeclare”) the dividend. This should not require a specific power to do so in the company’s articles.
In reality, the court’s decision probably reflects in no small part the fact that Mr Hale had been following advice from his accountants, represented himself in court, and did not fully appreciate the tax and legal fineries surrounding the payments. Nonetheless, the case perhaps provides some reassurance for managers and founders of growing small businesses that the courts may be prepared to show some flexibility when examining the distinction between salary and dividend payments.