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Steering your company through uncertain times (Official List companies)

Steering your company through uncertain times (Official List companies)

Overview

Listed companies: Fundraising options, duties and disclosure

COVID-19 has been a shock to the system of even the best capitalised companies, with cashflow squeezes causing most companies to consider their funding positions. This briefing focuses on the various equity fundraising options for UK companies needing to tap the market and explores the changing nature of directors' duties in this context, as well as the company's disclosure obligations.

How do we decide what type of fundraising is best for the company?

Before considering fundraising options, businesses must carefully consider the impact of COVID-19 on their financial position, cashflow needs and covenants. In addition to seeking additional funding they will also need to determine what steps can be taken to reduce costs. For information on the package of measures developed by the government to assist businesses affected by the pandemic, see our note on COVID-19 UK Government Business Support Measures.

CFOs will have analysed their debt capacity under existing finance arrangements and will be assessing whether undrawn facilities will continue to be available in light of the relevant drawdown CPs and financial and other covenants. Provided it is permitted under the finance documents, additional debt finance may be tapped from existing providers or new interim sources.

However listed companies will also assess, in conjunction with their brokers, what appetite is likely to be available for funding from the equity capital markets and also what gearing will be palatable to equity investors.

Any decisions will obviously need to be taken in proper exercise of directors' duties, a reminder of which is set out below.

Which type of fundraising to choose?

The diagram entitled "Fundraising Options" below represents a "decision tree" for a Main Market company, setting out the different options for equity, based on key considerations such as the desired timing, the authorities that are already in place in relation to allotment of shares and the disapplication of pre-emption rights, and the level of fundraising that is needed.

Shareholder approval and preparing a prospectus

Different fundraising structures will have different requirements; some considerations are set out below.

  • Certain actions require shareholder approval, which takes time and adds uncertainty, as noted further below:

    • Shareholder approval may be needed for authority to allot shares (in most cases companies authorise the directors to allot two thirds of the company's existing share capital each year, of which one third is reserved for rights issues);

    • Shareholder approval may be needed to disapply pre-emption rights (the right of existing shareholders to participate) if a company intends to tap a focused set of investors due to timing or other considerations – generally companies have only been given authority for non pre-emptive issues for cash up to a maximum of 5% of the existing share capital per year, plus an extra 5% for specified capital investments or acquisitions2;

  • Preparation of a prospectus is required for an offer by an official list company of more than 20% of its existing share capital (over a rolling 12 month period) or to more than 150 non-institutional investors per EU member state.

2 On 1 April the Pre-Emption Group relaxed its guidelines to say they would support approvals being sought for up to 19.9% in the current crisis, but companies would still need to seek such authority (or else consider cashbox structures: see below).

Size of the issue

  • The size of the issue will determine the structure and timing of the fundraising. A small fundraising that does not require the issuance of a large percentage of the company's share capital may be able to be done more quickly, without shareholder approval or a prospectus.

  • As set out above, a non pre-emptive fundraising involving the issue of over 5% of the company's existing share capital for cash will generally require shareholder approval3, and an issue by a listed company of over 20% of its existing share capital will require a prospectus. Both these requirements will have time and cost implications.

But see footnote 2 (above). 

Discount constraints

  • The Listing Rules prevent a UK listed company from issuing its shares on a non pre-emptive basis at a discount of more than 10% to market value unless either (i) the terms of the issue (including the amount of the discount) have been specifically approved by the company's shareholders; or (ii) it is an issue for cash within an existing disapplication of pre-emption rights. On 26 March, the FCA was petitioned to relax the 10% restriction during the current crisis, but it remains to be seen whether this will be granted. The "Pre-emption Guidelines" published by the investor protection committees are even more stringent than the Listing Rules and require a company not to issue its shares on a non pre-emptive basis at a discount of more than 5% to the market value although it is likely that if the choice for shareholders were one of survival for the listed company, shareholders would be less concerned with ensuring compliance with these guidelines.

Timing implications for shareholder approval and preparing a prospectus

  • Generally, 21 days' notice must be given of a general meeting but most companies authorise a notice period of 14 days which can be used for a general meeting other than an AGM where time is of the essence. In addition, convening a general meeting has been complicated by the restrictions on public gatherings as a result of COVID-19. The government is working on proposals to facilitate general meetings in the current circumstances, but current best practice is to convene the minimum quorum requirements and tell other shareholders that they should not attend physically.

  • The timetable will be lengthened in the event that a shareholder circular or a prospectus is required to be approved by the FCA (e.g. in the event that a related party (e.g. a >10% shareholder) intends to make an investment in the issuer and the transaction exceeds 5% under the FCA's "class tests" for assessing the size of a transaction).

  • In some cases, the requirement for a shareholder meeting to disapply pre-emption rights may be circumvented by the use of a "cash-box" structure (see below).

  • A deal structure which requires a prospectus may rule itself out in terms of time and cost, but in some cases it will be the only option. An offer requiring a prospectus will generally take a minimum of 10 weeks.

  • Open offers generally involve shorter timescales and lower costs than a rights issue, although both will require a prospectus (except for open offers of less than 20% of the company's issued share capital and raising less than €8m). However, a discount of over 10% on an open offer will require shareholder approval, whereas this will not be required for a deeper discount on a rights issue.

Equity Fundraising Options

GLOSSARY OF FUNDRAISING TERMS

Institutional placing

Shares are "placed" by a broker as agent of the company usually to a small number of large financial institutions. As there is no retail element, a prospectus will not be necessary for an issue of less than 20% of the company's issued share capital (over a rolling 12 month period). This structure is most easily used when the company has sufficient allotment authority and does not need shareholder approval to disapply pre-emption rights.

Cash box placing

This structure is most likely used where a company has sufficient allotment authority but insufficient authority to disapply pre-emption rights and may not have enough time to seek shareholder approval in the event of a distressed situation. A company may issue shares for non-cash consideration without needing shareholder approval to disapply pre-emption rights.  In a cash box placing, the issuer incorporates a company (the "cash box") and the broker subscribes for preference shares in it.  The broker then procures placees for ordinary shares in the issuer, the proceeds of which are used to pay up the preference shares to the value of the fundraise. Instead of the issuer issuing shares for cash, they are issued to the procured placees in consideration of the transfer by the broker of the preference shares to the issuer.  The issuer can redeem the preference shares or borrow from the cashbox company to access the cash.  As the use of the cash box structure has the potential to allow issues up to 20% of existing share capital, potentially without shareholder approval (subject to the requirement for approval of a discount over 10%), it is likely that we will see increased use of cash box structures in  the current circumstances

Rights issue

A rights issue is a pre-emptive offer that generally requires shareholder approval and a prospectus. It is an offer of new shares made to existing shareholders in proportion to their holdings, generally at a discount to the market price. Rights issues require a longer timetable as the offering includes the issuance by the issuer of "nil paid rights", essentially a security which can be traded by existing shareholders prior to the acquisition of the shares which will eventually be issued.  This "nil paid trading period" adds days to the timetable.

Open offer

An open offer is also a pre-emptive offer that generally requires shareholder approval and a prospectus. Unlike a rights issue, there is no trading in nil-paid rights and shareholders who do not accept the offer will not have any right to the proceeds of the shares which they could have taken up in the offer. An open offer is often carried out in conjunction with a placing in order to allow the existing shareholders to participate.

Remember: disclosure obligations

The duty under the Market Abuse Regulation to disclose inside information to the market must be borne in mind at all times. There is guidance from the European Securities and Markets Authority ("ESMA") in relation to delaying disclosure of inside information when an issuer is in "grave and imminent danger. However, this needs to be read against the backdrop of the relevant Disclosure Guidance and Transparency Rules, which provides that an issuer should not delay the disclosure of financial difficulty or a worsening financial situation but may only delay disclosure of details of negotiations to fix it. The inference therefore is that if the issuer is in grave and imminent danger (which itself is inside information) as opposed to financial difficulty, there is arguably some scope to rely on the ESMA guidance in order to delay disclosure of that fact provided there is a realistic prospect of finalising in short order negotiations with a view to ensuring the financial recovery of the issuer.

Directors' duties to shareholders and creditors

Where a company is under financial stress and is pursuing a fundraising and/or negotiation with lenders, its directors will need to be aware of the additional duties which apply to them downside scenario. Consideration should be given to the shift in legal duties to consider the interests of creditors and some of the legal risks to avoid, which could otherwise result in criminal and civil liability for key individuals and may also result in the subsequent invalidity of core elements of a restructuring transaction.

How do directors' duties change in distress?

Ordinarily, the directors' primary duty is to promote the success of the company for the benefit of its shareholders as a whole. However, where a company approaches insolvency, the directors' primary duty shifts, such that they must act in the best interests of the company's creditors, not its shareholders. They must also continue to act in accordance with their general statutory duties, such as the duty to avoid conflicts of interest; the duty to exercise independent judgement; and the duty to exercise reasonable care, skill and diligence.

When does the shift of duties towards creditors occur?

It can be difficult to identify when the shift in duties occurs, but the courts have held that this duty engages when the directors know, or should know, that the company is or is likely to become insolvent (i.e. insolvency is probable). Therefore, directors should be alert and take professional advice when a company begins to show signs of financial decline.

What action should the directors take?

Directors will need to review the company's financials in order to assess the financial position (particularly the cash flow) and develop a plan which, if implemented, will see the company through the effects of COVID-19 on the business. The plan should consider matters such as the financial documentary consents needed for the proposed actions, seeking creditor support and/or forbearance and limiting the number of new creditors. In conjunction with these measures, an equity fundraising of the types described illustrated above may provide a route for avoiding insolvency. It will be important to revisit the plan regularly to make any necessary adjustments as matters develop.

Good corporate governance is also key. The directors should ensure regular trading company board meetings are held and accurate minutes taken, including records of the reasons for decisions. Separate board meetings should be held for each group company, with the correct directors making the decisions at each level.

Professional advice should be sought when implementing the preventive or protective measures: taking action in accordance with the advice can help protect the directors.

Pitfalls to avoid

Wrongful trading (and fraudulent trading) - The government has announced that it will be introducing measures to relax these rules during the Covd-19 crisis with effect from 1 March 2020. At this time little detail has been provided about these measures, and until legislation is passed it would be prudent to continue to be mindful of the rules about wrongful trading. If directors do not believe the company has a reasonable prospect of avoiding insolvent administration/liquidation, they must take every step to minimise potential loss to creditors that they ought to take in order to avoid personal liability: minimise new credit, maintain creditor balances, consider advance deposits, gift cards etc. Fraudulent trading (which involves carrying on a business so as to defraud creditors) will continue to be an offence.

Preferences - Directors should not pay one creditor over another without good reason.

Transactions at an undervalue - Directors should avoid stripping or hiving out assets or selling them cheaply.

Conflicts of interest - Investor directors may be conflicted in negotiations with the relevant investor for funding or in negotiations with bankers. To remedy this, changes to information flows and decision-making processes at the investor level should be considered.

Joint and several liability for unpaid tax - HMRC is to have the power to make (amongst others) directors and shadow directors of a company which is, or is at serious risk of being, subject to insolvency, jointly and severally liable for certain tax liabilities owed to HMRC. The measures will apply to unpaid tax liabilities of a company arising during the accounting period current at the time the 2020 Finance Bill is given royal assent (and thereafter) if those liabilities result from tax avoidance or evasion (or their promotion or enabling) or are outstanding through repeated insolvencies of the same business.  Timing of royal assent is unclear, but may be before the summer recess. 

Beware: serious loss of capital and solvency

Directors of all public companies should note that if the company's net assets fall to half or less of its called-up share capital, the directors are required, within 28 days of becoming aware of the fact, to call a general meeting to consider what steps should be taken.

Conclusion

Whether or not a company is considering a fundraising to ease cashflow pressure or to alleviate other financial difficulties related to the COVID-19 outbreak, directors should seriously consider their duties in the current environment and the protective measures they can employ. As a general principle, directors should ask themselves if their decisions protect creditors or whether they protect shareholders at the expense of their creditors.

In addition, pressure is being brought to bear on BEIS, the FCA and other government bodies to further relax some of the restrictions referenced above. Please do consult your advisers regularly to check whether changes in regulation or guidance have been announced.

Key Contacts

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